Financial Innovation and Money Demand in Sub-Saharan Africa

Abstract Financial innovations are considered important factors in the development of the financial sector and economic growth. Following the 2007/2008 financial crisis, their effects, both positive and negative, have become an issue of considerable debate, especially in industrialised countries. While a number of empirical studies on the effects of financial innovation have been undertaken for industrialised countries, few developing country studies exist. This is surprising, given the remarkable growth of financial innovation in some developing economies. In particular, mobile money (M-PESA), a technology first developed in Kenya that enables individuals to transfer, deposit and save money using cell phone technology without necessarily having a bank account, has quickly spread to several developing countries and is expected to continue to expand. This thesis contributes to the limited literature by undertaking a panel study of the effect of financial innovation on money demand in Sub-Saharan Africa as well as a case study of the home of mobile money, Kenya. A third study considers how mobile money has influenced household consumption behaviour using data from Uganda. In chapter two, the effect of financial innovation on money demand in Sub-Saharan Africa is investigated in 34 countries for the period 1980 to 2013 using dynamic panel data estimation techniques. Money demand is found to be relatively stable in the region with financial innovation significant with a negative sign. While the coefficients on the other relevant variables are significant with expected signs, the size of the coefficients change with the inclusion of financial innovation. This suggests that exclusion of financial innovation may have led to biased or misleading estimates of the money demand equation in previous studies, and that financial innovation plays a significant role in explaining money demand in Sub-Saharan Africa. Given the potential importance of this form of financial innovation, a case study of the impact of mobile money on money demand in Kenya is undertaken in chapter three. Using time series analysis on a quarterly basis for the period 2000–2014, the results suggest a positive relationship between mobile money and money demand. The Kenyan demand for money is found to be stable when mobile money is taken into consideration. These results are robust even with the use of alternative measures of mobile money and imply that this particular financial innovation has ii important implications for the effectiveness of monetary policy in Kenya and possibly in other similar countries. While mobile money has been found to have important macroeconomic effects, there is little research on how it affects the real economy. Chapter four investigates the way this type of financial innovation can alter household behaviour, particularly household consumption patterns. Since data was not available for Kenya, Uganda was used as a case study. It is one of the countries that has been successful in mobile money usage since its introduction in 2009. The Financial Inclusion Tracker Surveys (FITS) household level survey conducted in 2012 also provides valuable data. Using ordinary least squares and seemingly unrelated regression estimation techniques, the results suggest that mobile money users spend less on food, a necessity, and more on luxury goods, than non-users. In addition, mobile money users are more likely to receive more remittances, and as a result, they are able to spend more efficiently on particular commodities than non-users. This suggests that mobile money could potentially improve individuals’ livelihoods. Finally, chapter five concludes with a discussion of the summary of the findings from the thesis, the policy implications, and the suggestions for future research.