Race to the Next Income Frontier

Chapter 11. Key Financial Stability Reforms as a Path to Emerging Market Economy Status

Ali Mansoor, Salifou Issoufou, and Daouda Sembene
Published Date:
April 2018
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Patrick A. Imam


Emerging markets comprise a large and diverse group of countries whose financial systems have grown in importance in recent decades and have been relatively unscathed by the global financial crisis. They differ greatly in economic size, legal and institutional frameworks, and the sophistication of their financial systems. Despite this diversity, their financial systems tend to be relatively larger (as a share of GDP), less concentrated, and typically more complex than systems in low-income countries. Banks continue to play a large role, but other financial institutions such as insurance and capital markets are developing rapidly (see Claessens 2016). There is also, though not uniformly, a relatively smaller involvement of the state in the financial system than in lower-income countries. Following the crisis of the 1980s in low-income countries and that in the 1990s in emerging markets, both groups of countries appear to have learned crucial lessons, and they managed to navigate the financial crisis relatively well.

The financial stability paradigm that was dominant prior to the global financial crisis provides a blueprint, though an incomplete one, for what emerging markets should strive to achieve to have a stable financial system (see United Kingdom, Financial Services Authority 2009). While the financial stability paradigm is being challenged, many of the key building blocks are still needed to achieve stability in emerging market economies. According to the paradigm that prevailed at the time, an optimum financial stability model should at a minimum have the following elements:

  • Central banks should focus on keeping inflation contained through active monetary policy, creating macro-stability.

  • Financial stability should be pursued by means of microprudential regulatory and supervisory tools.

  • Microprudential regulation should prevent banks from taking excessive risks, by ensuring that financial institutions are safe, sound, and able to honor their obligations.

Within this paradigm, low-income countries aimed to enhance financial stability by focusing on strengthening supervisory independence and capacity, completing their legal frameworks, and adopting international standards at a pace consistent with the level of their financial development and supervisory capacity.

The global financial crisis has, however, shaken the prevailing financial stability and prudential regulatory paradigms of the last 20 years. There is an emerging consensus concerning the inadequacy of the pre-2008 macroeconomic paradigm and traditional prudential regulation to anticipate and contain the recent crisis. Major research efforts are underway that involve rethinking macroeconomic policy in general and redesigning financial regulations in particular. While revisiting macroeconomic policy has not produced major tangible results so far (see Blanchard, Dell’Ariccia, and Mauro 2010 and Blanchard, Dell’Ariccia, and Mauro 2013), some advances have been made in reformulating a new financial stability paradigm, which, while still incomplete, is being adopted by an increasing number of countries. Prudential regulations are being expanded and new institutions are being established to address system-wide financial vulnerabilities. This is because the crisis has shown that prudential policies that focus on individual bank stability are necessary, but insufficient, to mitigate systemic risk, requiring a reorientation.

Macroprudential policy has emerged as the cornerstone in the new financial stability paradigm to prevent systemic crises. The formulation of macroprudential regulations has made important strides, although it is still far from being settled in all of its details (Akerlof, Blanchard, and Romer 2014; Blanchard, Dell’Ariccia, and Mauro 2013; Blanchard, Rajan, and Rogoff 2016; Committee on the Global Financial System 2012; Nier and others 2011). Microprudential policy conceives of the stability of the financial system as the sum of individual sound institutions. However, it does not take into account that what constitutes prudent behavior from the point of view of one institution may create broad problems when all institutions engage in similar behavior, such as tightening credit standards or holding on to cash. Microprudential regulation also does not typically recognize that institutions can be a threat both to other financial institutions and to markets, where many large financial firms raise and place funds.

The discussion about the design and implementation of financial stability policies has largely been confined to advanced and (to a lesser extent) emerging market economies. The institutional architecture for macroprudential policy, the nature of the vulnerabilities to be identified and monitored by the macroprudential authority, and the instruments suggested to tackle such vulnerabilities have been envisaged in the context of high-income and (to a lesser extent) middle-income countries. This is not surprising. The recent financial crisis fundamentally struck the North Atlantic advanced economies, with few direct reverberations on the financial systems of low-income countries, which had endured a number of their own systemic crises during the preceding two decades.

Some analysts, however, question the appropriateness of the new emerging financial stability paradigm in the context of low-income countries. Gottschalk (2014) warns that not all international regulations are appropriate in the low-income country context, as they are designed for advanced and emerging market economies, with complex rules that low-income countries may have problems following, owing to limited data, limited skill set of supervisory staff, and so on. Griffith-Jones, Gottschalk, and Spratt (2015) also point out that financial systems and regulations in low-income countries are still in their early stages, with authorities having to achieve two simultaneous goals—financial stability and financial sector development—that may in certain circumstances be contradictory.

What do these new reform proposals imply for shaping the financial stability framework for countries like Senegal that are on the verge of graduating to emerging market status? Should Senegal mimic what the United Kingdom or even emerging market economies have done to create an effective macroprudential policy function? More specifically, should macrofinancial authorities in low-income countries monitor the same type of vulnerabilities as those in advanced and emerging market economies? What type of macroprudential policy instruments are more suitable for correcting systemic vulnerabilities in low-income countries? What are the channels that Senegal should be aware of?

This chapter provides a general overview of the financial stability arrangements facing soon-to-emerge low-income countries and highlights some issues for further consideration. It is organized as follows. The next section provides an overview, examining the characteristics of the financial stability framework in the West African Economic and Monetary Union (WAEMU), contrasting the role of the national authorities with that of the regional supervisor. The section following that provides an overview of the financial-stability risks in Senegal. The chapter then looks at ways to analyze systemic risk and finally reviews policies to mitigate systemic risk and improve the crisis management system, with the last section concluding.

The Financial Stability Framework in the Waemu Banking Union

Financial stability is fundamentally concerned with maintaining a stable provision of financial services to the wider economy—credit supply, payment services, and insurance against risk. The design of a financial stability framework hinges critically on the characteristics of the financial system and the types of vulnerabilities that are likely to emerge. There are no “off-the-shelf” financial stability models, but rather each country has to find its own model based on its unique circumstances and adapt it as the financial system evolves.

There is a division of labor that prevails: in most countries, this responsibility falls on (1) the central bank, which among other tasks has responsibility for monetary policy and contributes to financial stability by promoting the smooth functioning of the payments system and by acting as a lender of last resort; (2) the supervisory authority, which is responsible for regulating deposit-taking institutions, securities firms, and insurance companies and often, though not always, takes the lead role in restructuring and resolution efforts (in countries where deposit insurance systems exist, it can have wide-ranging powers for the protection of depositors including by participating in a wide-range of resolution outcomes for distressed banks); and (3) the Ministry of Finance, which acts as the fiscal agent for the government and has an important role in protecting the use of public monies.

There is no single preferred model for institutional arrangements in support of macroprudential policy. Institutional arrangements are shaped by country-specific circumstances, such as the culture for cooperation, the perceived need for checks and balances, and legal traditions. This reflects the fact that the regulatory architecture varies from country to country: in some countries, the responsibilities for both monetary policy and prudential regulation, particularly for banks, are assigned to the central bank; in others, these responsibilities are split, with regulatory oversight assigned to one or more specialized agencies. Central banks are likely to be the agencies best placed in terms of expertise in economic analysis for monitoring and assessing systemic risks. This does not suggest that there is not significant value for other agencies to make their own sectoral assessments of risk—and many do—but it is the central bank that has a comparative advantage in providing a system-wide perspective. Hence the view of some observers, including the Group of Thirty (G30), is that macroprudential responsibilities are best assigned to the central bank. This is particularly the case in those countries where the central bank is also the prudential regulator of banks—a role that makes it especially well placed for marrying monetary and microprudential policies in the best interests of financial stability. Nonetheless, monetary and macroprudential policies are ultimately distinct, and it is vital that this marriage not be permitted to undermine the inflation objectives of the central bank (see also Caruana 2009).1

From an operational perspective—being part of a monetary and banking union—responsibility for financial stability in Senegal is largely discharged between the national (Senegalese) and regional (WAEMU) authorities (see Figure 11.1). The ultimate responsibility for financial stability resides with the conference of heads of state and governments. Banks and other large deposit-taking institutions (including large microfinance institutions) with more than CFAF 2 billion in deposits or loans are supervised at the regional level by the Central Bank of West African States (BCEAO) and the WAEMU Banking Commission.2 Smaller microfinance operators are supervised at the national level by the Ministry of Finance. Capital market activity is supervised regionally under the supervision of the Regional Council for Public Savings and Financial Markets (CREPMF, after its French name). The Ministry of Finance, in conjunction with the supraregional insurance sector regulator CIMA (Conférence Interafricaine des Marchés d’Assurances), supervises insurance companies. The 2010 central bank reform created the Financial Stability Council, charged with macroprudential supervision and guaranteeing the stability of the overall financial system at the regional level. The roles that national authorities play within the WAEMU system matter, because they are key to fostering the development of the financial system, although their roles are more limited when it comes to financial stability. National authorities have a crucial role in deepening the banking system by increasing the availability of information on borrowers through the development of the national credit registry. Improving the functioning of the legal system to facilitate borrowing also falls within their portfolio. Products that have not yet been developed at the regional level, such as Islamic banking and finance, can also grow if the national authorities take the lead on that, as was the case in Senegal. They play another important role in shaping the stability of the financial system through their minority and majority ownerships in banks. Additionally, since banking licenses are provided by the BCEAO—after a qualified opinion is issued by the WAEMU Banking Commission—following requests from the national governments, it is understood that banks and subsidiaries that are in trouble will have to be supported by the governments of the countries in which they are located, and not by the country of the parent company.

Figure 11.1.The Financial Stability Framework in Senegal

Source: Ministry of Finance, Senegal.

Note: BCEAO = Banque Centrale des États de l’Afrique de l’Ouest (Central Bank of West African States); BRVM = Bourse Régionale des Valeurs Mobilières (Regional Securities Exchange); CIMA = Conférence Interafricaine des Marchés d’Assurance (Regional Body of Insurance Industry); CREPMF = Conseil Régional de l’Epargne Publique et des Marchés Financiers (Stock Market Regulator); DMC = Direction de la Monnaie et du Crédit (Money and Credit Department); DRS-SFD = Direction de la Reglementation et de la Supervision des Systèmes Financiers Decentralisés (Supervisory and Regulatory Department for Microcredit Companies); SGI = Sociétés de Gestion et d’Intermédiation (Asset Managers); SGP = Sociétés de Gestion de Patrimoine (Wealth Management); and SICAV = Sociétés d’Investissement à Capital Variable (Open-Ended Mutual Funds).

The work that these regional agencies (the BCEAO, the WAEMU Banking Commission, and the Financial Stability Council), with the support of the national authorities, need to undertake jointly to promote financial stability can be broken down into three broad streams (Hall and Imam 2013):

  • The first stream is surveillance—the early identification of potential threats to financial stability. In general, the main challenge for surveillance is to collect the macroeconomic and financial variables that provide the most insight into the potential risks and vulnerabilities facing the financial system. The challenge is to identify the data set that is most likely to provide the authorities with some early warning of systemic risks and so provide an opportunity to respond preemptively.

  • The second stream is mitigation—the measures that need to be taken to make the financial system more resilient to shocks. In principle, the mitigation of risk within the financial system is a shared responsibility with the central bank and regulatory agencies. Much of the central bank’s contribution to these efforts will come from fulfilment of its other core policy objectives: guiding a sound monetary policy to promote a low-inflation environment and developing a robust payments infrastructure, including a reliable real-time gross settlement system. The central bank’s support for system liquidity through financial market operations is also vital to financial stability. For the regulatory agencies, risk mitigation requires that each of them pursue the types of best prudential practice identified in the various international standards and codes, tailored where appropriate to national circumstances. International experience also tells us that progress around issues such as corporate governance, insolvency, creditor protection, and implementation of suitable accounting and auditing standards also plays a vital role in promoting financial stability.

  • Finally, the third stream is crisis management—the principles and procedures for responding to distress or failures in the financial system. The need for crisis management arrangements is an acknowledgment that the risk of failure within the financial system is never eliminated, notwithstanding the best efforts around surveillance and mitigation. The authorities need to have contingency plans for responding promptly to a crisis that may involve one or more financial institutions. Ultimately, the key to an effective financial stability framework is cooperation and coordination among the various agencies, both during the good times when the financial system is in robust health and during times of crisis.

Weakness of the Shock-Absorbing Capacity in Low-Income Countries

Monetary and fiscal policy may not act as stabilizing forces in low-income countries as they do in advanced economies, putting an even more important burden on regulation and supervision to contain systemic risk and achieve financial stability (see also Imam and Kolerus 2013). The economic policy framework—fiscal and monetary policy—as illustrated below, is typically shallow, making it harder for low-income countries to handle the economic and financial cycles compared to more advanced economies.

First, monetary policy is weak, creating a weak monetary transmission mechanism. Several factors hinder the effectiveness of monetary policy, making it hard for it to contain systemic risk, as Mishra, Montiel, and Spilimbergo (2010) and Kireyev (2016) show for countries within WAEMU. The following four factors are significant:

  • Persistent excess liquidity. The banking system in many low-income countries is highly heterogeneous and segmented, including regarding the distribution of liquidity. The reluctance of banks to trade liquidity means that liquidity needs from illiquid banks need to be met by means of direct injections from the central bank. In addition, banks also tend to hold large precautionary excess reserves due to weaknesses with the payments system (for example, remote branches may need to hold excess reserves because of transportation problems). Such a context makes it very hard for central banks to focus on overall liquidity management; the central bank also gets limited signals from the shallow interbank market.

  • Underdeveloped financial markets. The limited range and quantity of financial assets in low-income countries means that monetary policy has a limited impact. Banks and other institutional investors generally have buy-and-hold strategies, and with no developed secondary markets, they cannot adjust their portfolio easily (except through central bank refinancing).

  • Credit rationing. Imperfect information is an important issue in low-income countries, where enforcement of loan contracts may be difficult owing to weaknesses in the legal and judicial system. When a financial institution raises its lending rates following a change in policy rates, it may increase the riskiness of new lending because of adverse selection and moral-hazard issues (Stiglitz and Weiss 1981). If unwilling to accept higher risk, the bank may ultimately decide to keep its lending rates unchanged, muting the impact of monetary policy decisions. The presence of state-owned banks may also blunt the transmission channel; preferred lending practices are frequent with these institutions and can mean that certain customers will not get credit, irrespective of the level of policy rates.

  • Limited bank competition. Several factors, such as high average interest and profit margins and segmentation, suggest that competition in the banking market may not be very strong. In such circumstances, monetary policy changes might be partly and temporarily absorbed by changes in profitability.

As a result of these characteristics, the transmission of monetary policy is hampered. Three important channels, through which monetary policy has an impact on the economy, are weak or nonexistent in many low-income countries, removing an important stabilizing tool.3

  • Exchange rate channel. Many low-income countries on the cusp of becoming emerging markets, such as Senegal, have a fixed exchange rate, rendering the exchange rate channel mute. In countries that have a more floating exchange rate regime, this is often the most potent channel of monetary policy effectiveness. However, a flexible exchange rate may often become procyclical if, following a shock, interest rates have to be raised to limit capital outflows.

  • Interest rate channel. There is little evidence, including in WAEMU, that this channel works effectively in most low-income countries. Changes in policy rates and liquidity injections do not affect the interbank market rate, which is underdeveloped and therefore does not feed into bank lending rates (see Kireyev 2016). Most low-income country banking systems are highly heterogeneous and segmented, including with regard to the distribution of liquidity.

  • Asset price channel. With a shallow stock exchange (and illiquid housing market), the functioning of the asset price channel is impeded.

Second, fiscal policy is weak or procyclical. Limited fiscal policy hampers another potential lever against systemic risk. With no intercountry fiscal transfers except for foreign aid, which is likely to decrease, given tight constrains in advanced economies, many low-income countries lack fiscal space to run countercyclical fiscal policies and may find it impossible to bail out financial institutions should the need arise (see Talvi and Vegh 2005). With fiscal space lacking to bail out too-big-to-fail/too-integrated-to-fail banks, another important source of stability is short-circuited, and the bank resolution process acquires an even more important role (implied government guarantee is weak). Fiscal policy is further constrained by financially underdeveloped systems. Governments lack the ability to borrow large amounts during downturns—ultimately resulting in procyclical outcomes. Four factors contribute to this:

  • Liquidity (interest rate) risk. As debt is issued at short maturities, liquidity and rollover risks become substantial if liquidity dries up, exposing sovereigns to interest rate risks.

  • Fiscal costs. Shallow financial markets tend to raise the marginal cost of borrowing.

  • Diversified investor base. A homogenous investor base in the form of banks creates a one-sided market that may easily be disrupted in cases of shocks.

  • Financing public investment. Longer-term investments—providing higher social rates of return—are constrained in economies with shallow markets because of the inability to obtain long-term financing, thereby holding back growth.

Third, resolution mechanisms are weak, making it even more important to prevent systemic crisis. With fiscal space lacking to bail out too-big-to-fail/too-integrated-to-fail banks, the bank resolution process acquires an even more important role. The track record of closing down banks in the region—with banks taking years to close down and depositors losing their access to their deposits—demonstrates the potential problems that a failure of a large institution could pose for the system as a whole, as it may linger on and impose large externalities on the rest of the system.

To resume, low-income countries have a weak shock-absorbing capacity in the face of systemic risk. Unlike advanced economies, these countries cannot rely much on monetary or fiscal policy to control systemic risk or contain the fallout from a banking crisis. In addition, these countries often lack the tools and experience to close down banks in an orderly manner. Thus, containing systemic risk by systematically monitoring it is capital. An effective surveillance framework is predicated on a good understanding of systemic linkages: those interactions that transmit and—sometimes—amplify risks between the real economy and the financial system and also within the financial system itself. These linkages shift and vary over time.

Surveillance of Systemic Risk

Surveillance is a difficult task, not just in low-income countries, not least because the term systemic risk, while widely used, is difficult to define and quantify. This kind of risk most obviously exists when there is a broad-based breakdown in the functioning of the financial system, normally realized after the fact, as a large number of financial failures. However, policymakers cannot afford to wait until systemic risk crystallizes in this way, so surveillance needs to function in an ex ante mode. That is, it should help authorities identify the sources of systemic risk and the various channels through which these risks are propagated. This is particularly the case in low-income countries that aspire to become emerging market economies, such as Senegal, where the banking system is still growing but shock-absorbing capacities are relatively weak and the rule that “prevention is better than cure” clearly applies.

Systemic Risk

Systemic risk comes in two forms (see Caruana 2010). The first type—time-series systemic risk—relates to the way in which aggregate risk evolves over time. In particular, there is a procyclical bias to risk, with financial institutions tending to take on excessive amounts in the upswing of an economic cycle only to become overly risk averse in a downswing. This characteristic amplifies the boom-and-bust cycle in the supply of credit and liquidity—and by extension in asset prices—that is so damaging to the real economy. In emerging markets, this aspect of systemic risk has been prominent, reflecting the strong growth environment.

The second type of risk is cross-sectional systemic risk. It is attributable to common exposures and interconnectedness within the financial system—relationships that amplify and rapidly transmit shocks between financial institutions. As a result, the failure of one institution, particularly one of significant size, can threaten the system as a whole.

Time-Series Systemic Risk

As in most emerging markets, in Senegal time-series risks, while still contained, are mutating fast. Like other frontier market economies, Senegal has exhibited a cyclical trend in credit growth from 2001 onward, which is highly correlated at 0.6 (Figure 11.2). Credit is growing at a high rate—a sign of healthy financial deepening—but loan performance is also expected increasingly to be associated with the GDP trajectory, not unlike in other emerging markets. At this stage, much of the credit growth appears to have been in that offered to the private sector, though there are tentative signs that extension of riskier credit to consumers is also taking place (Imam and Kolerus 2013). Low intermediation—of small and medium-sized enterprises and households—points to significant prospects for financial sector growth. As financial markets develop further, the time-series risk is bound to mount, and the financial sector accelerator will creep up in the data. Senegal, as part of WAEMU, has in place capital account restrictions on both inflows and outflows, reducing its exposure to the vagaries of international capital markets, a typical source of time-series volatility.

Figure 11.2.Time-Series Systemic Risk: GDP Growth and Change in Private Sector Credit, Senegal, Tanzania, Uganda, and Zambia

Sources: IMF, International Financial Statistics, and IMF, World Economic Outlook.

Caution is required to use predictors from advanced and emerging market economies and apply them to countries such as Senegal. There is more uncertainty involved when it comes to assessing time-series systemic risk in low-income countries, since the sustainability of credit growth is also dependent on whether financial deepening is taking place. Whereas the best predictor of crisis in advanced and emerging market economies is strong credit growth, which leads to unsustainable leverage and elevated asset prices, in low-income countries this is not the case (see Borio and Drehmann 2009). This is because developing countries are typically less diversified and are subject to shocks beyond their control, such as commodity shocks and natural disasters, which can harm the financial system. As illustrated by Chen and Imam (2014), exogenous factors such as terms-of-trade shocks or political instability are better explanatory variables in explaining banking crises in low-income countries. While it is too early to say whether the rapid credit growth of recent years deviates from a historical trend to try to answer the question of whether credit growth poses any risk, history suggests that a watchful eye is warranted.

Cross-Sectional Systemic Risk

In contrast to the time-series risks, cross-sectional risks in Senegal are a clear and present danger, requiring close monitoring. Three main risks deserve attention:

  • Interconnectedness across countries. Linkages between the financial system and the world economy are intensifying as emerging market banks—witness the arrival of EcoBank from Togo, as well as Nigerian, Moroccan, and South African banks—are seeking opportunities within the WAEMU region, and in particular in Senegal (see Enoch and others 2015). The presence of foreign banks is significant and mounting. In Senegal, French banks have an important presence—a legacy of the colonial period—that largely accompanies French groups and high-net-worth individuals (see Tables 11.1 and 11.2 for a selection of Pan-African banks and the countries in which they operate). This presence has recently been complemented by the emergence of Pan-African banking groups (see Tables 11.1 and 11.2). The share of foreign bank assets is high in most low-income countries, above 50 percent in Senegal, and reaching close to 100 percent in countries such as Madagascar, Mozambique, and Swaziland (Kasekende, Brixova, and Ndikumana 2010). While interconnection among banks is limited within Senegal and across WAEMU, reflecting the underdevelopment of money markets (see Imam and Kolerus 2013), interconnectedness across countries driven by the emergence of cross-country banking groups requires monitoring. The presence of foreign banks brings benefits—expertise, technology, and managerial skills that can help absorb domestic shocks. But it also carries risks, as these banks often focus on the least-risky segments, such as domestic and foreign blue chip companies, and may not contribute much to the development of domestic financial deepening. Foreign banks may also transmit and amplify foreign shocks into the domestic economy, which also requires monitoring. With the planned development of the interbank and government debt markets, bank interconnectedness across WAEMU countries could increase quickly. At present, the small interbank market is predominantly dominated by intra-banking-group transactions within the WAEMU region.

  • Interconnectedness between banks and nonbanks. Linkages between the financial and nonfinancial sectors are often large, given the conglomerate structure of companies. In Senegal, banks do not have the tradition of holdings or taking stakes in corporate equities, unlike in other emerging markets. This reflects a combination of several factors: the formal sector is typically nascent, with few companies outside some large (export) corporations and the government able to issue bonds. Despite limited data, there is mounting evidence of rising (indirect) cross-sector linkages (“cross-institutional linkages”) (Imam and Kolerus 2013). For instance, insurance companies use bank deposits as an investment vehicle, rather than simply for liquidity purposes; buy regional bank bonds; and have equity participation in some of the banks. In addition, microfinance institutions also place their money in banks, with some microfinance institutions even owning a bank (Imam and Kolerus 2013). Lack of detailed data does not allow further analysis of the importance of these linkages, but such a risk mapping warrants further investigation by the authorities. Equity and bond markets are underdeveloped or nonexistent, and therefore the risk from cross-sector holding, if it existed, would be low. 4

TABLE 11.1Selected Foreign Banking Groups Operating in Africa, 2011
Foreign Banks outside Africa
United KingdomFrenchPortuguese
Barclays GroupABSA (South Africa)1Standard CharteredHSBCSociete GeneraleBPCECredit AgricoleBNP ParibasBanco Espirito SantoCaixa Geral de Deposits (nationalized)Banco Comercial PortuguesBanco BPIOther PortugueseBanco Africano de InvestimentoBanco Formento de AngolaBanco Privado AtlanticoCaixa Economica de Cabo VerdeBank of Baroda (India)Deutsche BankUBSCiti GroupInternational Commercial BankProcredit Bank (Germany)Orabank
Rand Area
South Africax18xxxxxxxx
Larqe Oil Exporters
Other Countries without Conventional
Exchange Rate Pegs
Congo, Democratic Republic of the37
Gambia, The20
Sierra Leone18
Central African Republic
Congo, Republic of8
Equatorial Guinea24
Burkina Faso1210
Côte d’Ivoire21893
Other Countries with Conventional
Exchange Rate Pegs
Cabo Verde0501030
São Tomé and Príncipe
Total Number of Subsidiaries or Branches941321043534213111182111112
Percentage of 44 Sub-Saharan African Countries with Bank Presence209305239711795272222185225225
Sources: Annual reports; bank websites; Bankers Almanac; BankScope; country authorities; and IMF staff.Note: Where BankScope data are available, the table shows the percentage of deposits in 2010. Shaded cells denote systemically important subsidiaries, using both the deposit and asset share criteria. Existing operations for which data are not available for the period 2007 to 2011 are denoted with an x. BMCE = Banque Marocaine du Commerce Extérieur; CEMAC = Central African Economic and Monetary Community; SSA = sub-Saharan Africa; WAEMU = West African Economic and Monetary Union.

ABSA is a subsidiary of Barclays.

Sources: Annual reports; bank websites; Bankers Almanac; BankScope; country authorities; and IMF staff.Note: Where BankScope data are available, the table shows the percentage of deposits in 2010. Shaded cells denote systemically important subsidiaries, using both the deposit and asset share criteria. Existing operations for which data are not available for the period 2007 to 2011 are denoted with an x. BMCE = Banque Marocaine du Commerce Extérieur; CEMAC = Central African Economic and Monetary Community; SSA = sub-Saharan Africa; WAEMU = West African Economic and Monetary Union.

ABSA is a subsidiary of Barclays.

TABLE 11.2Selected Pan-African Banking Groups, 2011
Pan-African Banks
South African
EcobankOceanic (absorbed by Ecobank)United Bank for AfricaBank of AfricaAccess BankAfrilandBGFI bankBanque AtlantiqueCommercial BankABCSociete Ivoirienne de BanqueBanco EcuadorIsland BankCompagnie bancaire de l'Afrique occidentaleBanque Sahélo-Saharienne pour l'Investissement et le CommerceStandard Bank Group/StanbicABSA1Nedbank2First Rand
Rand Area
South Africax27182113
Large Oil Exporters
Other Countries without Conventional Exchange Rate Pegs
Conqo, Democratic Republic of the3003115
Gambia, The6x7
Ghana Guinea25x
Sierra Leone1223
Central African Republic5522
Congo, Republic of7x51
Equatorial Guinea4513x
Burkina Faso16x18x
Côte d’Ivoire12151118
Other Countries with Conventional Exchange
Rate Pegs
Cabo Verde0
São Tomé and Príncipe325294
Total Number of Subsidiaries or Branches31417129768761111217458
Sources: Annual reports; bank websites; Bankers Almanac, and BankScope.Note: Shaded cells denote systemically important subsidiaries, using both the deposit and asset share criteria. Existing operations for which data are not available for the period 2007 to 2011 are denoted with an x. BMCE = Banque Marocaine du Commerce Extérieur; CEMAC = Central African Economic and Monetary Community; SSA = sub-Saharan Africa; WAEMU = West African Economic and Monetary Union.

ABSA is a subsidiary of Barclays.

Nedbank has a cooperation agreement with Ecobank. It is a subsidiary of a British financial entity, Old Mutual.

Sources: Annual reports; bank websites; Bankers Almanac, and BankScope.Note: Shaded cells denote systemically important subsidiaries, using both the deposit and asset share criteria. Existing operations for which data are not available for the period 2007 to 2011 are denoted with an x. BMCE = Banque Marocaine du Commerce Extérieur; CEMAC = Central African Economic and Monetary Community; SSA = sub-Saharan Africa; WAEMU = West African Economic and Monetary Union.

ABSA is a subsidiary of Barclays.

Nedbank has a cooperation agreement with Ecobank. It is a subsidiary of a British financial entity, Old Mutual.

  • Common (and concentrated) exposures. Common exposure is also a general feature of financial systems in low-income countries where the lending concentration is high. Lending typically goes to the sovereign and a few large foreign and domestic companies in these countries. There is a strong sovereign-banking symbiotic relationship, which is a vulnerability when the balance sheet of sovereigns is gearing up (Imam and Kolerus 2013). One form of concentration risk that is less pertinent in Senegal than in other countries is the exposure of the country to a given commodity. Banks in many sub-Saharan African countries are highly exposed because of assets’ concentration in a few commodities. As a result, the concentration of loan portfolios in their exposure to single borrowers or single export sectors is a source of vulnerability (see Maino, Imam, and Ojima 2013 for risks commodities pose for financial stability). The last 10 years of high commodity prices have not raised the exposure of banks to the commodity sector, but the recent dramatic deceleration in prices following headwinds from China is a call for caution.

Difficulty of Measuring Systemic Risk

Measuring just how much systemic risk exists in the financial system at any point in time is extremely challenging. Some distribution methodologies attempt to do so by using equity prices and credit spreads for the dual purpose of estimating the likelihood of firm-level failure and correlated defaults. In other words, they assume that market prices embed an estimate of each institution’s leverage and its distribution across the system (Huang, Zhou, and Zhu 2009). Unfortunately, the advantage gained from using readily available price data has to be weighed against this disadvantage: market prices are often least reliable as measures of risk when risks are highest, as was the case shortly before the global financial crisis. As a result, although price-based models can help provide a valuable perspective on risk, they do need to be used very carefully. In the case of Senegal, no subsidiary of a local bank is quoted, and the only data available are (outdated) book value data, rendering such a methodology redundant.

Instead of trying to measure systemic risk, financial stability analysis in emerging markets therefore often aims to identify a set of leading indicators to convey a broad sense of how risk in the financial system is evolving. A parsimonious, but useful, set is commonly derived from the behavior of credit and asset prices (Borio and Drehmann 2009). In particular, there is evidence that sustained rapid credit growth combined with large increases in property prices increases the probability of an episode of financial instability. The challenge in emerging low-income countries like Senegal is to differentiate between an expansion in credit that is the corollary of a successful financial deepening program and an expansion that is suggestive of imprudent borrowing (Chen and Imam 2014). Consequently, a good understanding of credit—who is borrowing, how much, and why—is a basic building block of macroprudential surveillance. Similarly, an understanding of the conditionality of credit—both in aggregate and by industry—can provide some valuable insights into the evolving risk environment. In this regard, many central banks find periodic surveys of credit loan officers a useful adjunct to their quantitative analysis.

Early Warning Indicators

An effective early warning system needs to organize surveillance efforts so that they both identify vulnerabilities and rank them as a threat to financial stability. Early warning indicators are a major element of disaster risk reduction, helping reduce the economic impact of disasters by warning policymakers that systemic risk is building up. This is important because some vulnerabilities may resolve themselves over time without contributing to a crisis, while others may crystallize quickly, requiring an immediate policy response. Realistically, however, no early warning system will be able to avoid Type I and Type II errors. Crises are unpredictable, and attempts to forecast them will be largely unproductive. However, “flag-raising”—identifying trends that leave markets, sectors, and countries vulnerable to unanticipated shocks—is worthwhile. But because many vulnerabilities (such as credit and housing booms) are slow to build, while others (such as cross-border spillovers) are difficult to identify, there is a danger of crying wolf, leading to risk fatigue and policy inaction. Nonetheless, the use of an early warning system that maps problems from different angles and drills down to the underlying issues can make a constructive contribution to the policy debate.

Sectoral Balance Sheets

Even more useful, though also more data-intensive, are leading indicators obtained from the analysis of sectoral balance sheets: those of the household, corporate, and public sectors. By tracking debt and debt-servicing requirements over time, balance sheet analysis aims to anticipate the potential for higher levels of default should economic growth falter. Similarly, the analysis of state and local government balance sheets may also be rewarding if any doubts exist over their debt-servicing capabilities and whether the central government stands behind them. Again, this type of leading indicator may be more difficult to estimate in emerging market economies due to limitations in the national accounts data. But this gap can be partially filled through the use of targeted surveys of firms, households, and local governments. Inevitably, there is always some demand for a snapshot of the outlook for financial stability. This usually takes the form of an index—a single quantitative measure of financial conditions derived from a weighted sum of variables drawn from foreign exchange, debt, equity markets, and the banking sector (Illing and Liu 2003).

Ultimately, surveillance efforts will be useful to policymakers only if they provide some early warning of potential problems. However, a crisis may be triggered by any number of macroeconomic, financial, or geopolitical shocks—some completely unforeseen, others which are the realization of known risks. The subsequent amplification of these shocks is then dependent on systemic linkages and the existence of economic and financial vulnerabilities. This means that an increase in systemic risk may present as either a higher probability of a shock, or as an expansion in the number and/or size of the underlying vulnerabilities.

Application to Senegal

The BCEAO and the Banking Commission—the two leading regional bodies largely in charge of supervision for Senegal—have increased the resources devoted to macroprudential surveillance, but will need to do more to match emerging market economies’ efforts. The annual Financial Stability Report casts the surveillance net widely, with extensive reviews of financial and economic developments, both domestic and overseas. The Banking Commission is attempting to establish early warning systems that draw on both quantitative and qualitative information, but it is seriously hampered in this work due to major data limitations. Even accounting data is not always reliable or timely enough to provide comfort. Only in recent years have stress tests, a basic toolkit, started to be used on an annual basis, despite data limitations.

Imperfect and Incomplete Financial Stability Indicators

Financial stability indicators are available on a timely basis for the commercial banks, though they are missing for nonbank financial institutions (see Box 11.1 for background on the empirical difficulties with identifying appropriate early warning systems). Coverage of nonbank financial institutions is limited. This seems to reflect a number of factors: nonbank activities often do not include accounting and disclosure standards; there are methodological and interagency coordination difficulties; and existing data collection services fail to keep pace with financial sector growth and innovation. Collecting financial stability indicators on the nonbank financial sector, combined with a good understanding of systemic linkages, will enable the authorities to provide an informed assessment of how shocks to nonfinancial sector balance sheets are transmitted to the financial system and vice versa.

Need to Fill Information and Data Gaps

Effective surveillance requires that information and data gaps be filled, and the Banking Commission should be seeking to develop measures that might help determine whether systemic risks are changing over time, in line with those in other emerging markets. There has been no work yet on financial network risk, drawing on data from the payments and settlements system. The focus of the Banking Commission should also be on developing an early warning system for individual financial institutions, rather than just for the system as a whole. In the coming years, the supervisors should aim to extend the commission’s surveillance of asset prices, particularly of residential and commercial property. When undertaken in conjunction with the close scrutiny of credit, this can provide valuable insights into potential vulnerabilities, monitoring leverage and the associated debt-servicing requirements in corporate, household, and public sector balance sheets. Public banks in particular require close scrutiny, given the implications they have for the budget. Given the central role of government in the economic and financial life of WAEMU countries, an understanding of public sector balance sheets and contingent liabilities will be of particular value, and so will interagency data sharing.

BOX 11.1Empirical Limitations of Early Warning Systems

Empirical evidence suggests that surveillance efforts will frequently not be useful enough to policymakers to provide an early warning of potential problems. However, except for early warning indicators based on an endogenous cycle perspective, existing approaches to measuring latent financial instability do not appear promising either. Borio and Drehmann (2009) assess a range of measuring tools along three dimensions: (1) how far in advance, as opposed to contemporaneously, measures are provided, (2) to what extent behavioral interactions that amplify systemic distress are considered, and (3) to what extent the approaches “tell a story” about the transmission mechanism for financial distress. Their results are summarized in Table 11.1.1. They conclude that the tools used generally justify little faith in the estimates obtained, and that too little lead time is provided for adequate remedial action.

TABLE 11.1.1Approaches to Measuring Latent Financial Instability
ApproachIs It a Leading Indicator?Does It Measure Behavioral Interactions?Does It Help “Tell a Story”?
Financial Stability Indicators (FSIs) or Related IndicesNo. Backward looking or contemporaneous.No.No.
No. Forward looking in theory, downgrades “sticky” in practice.No.No.
Market Price-Based IndicatorsNo. Narrow coverage. Market biases embedded. Lead too short for policy action.No.No.
Early Warning Indicators (EWIs)Good EWIs: deviations from long-term trend in credit/GDP and in 1960 deflated real estate and equity prices.Can help identify interactions among risk factors and suggest system-endogenous effects.Can help frame broad stories.
Most promising EWIs: those drawing on an endogenous cycle perspective.
Single-Module Measures: Value at RiskCan provide forecasts of financial distress, but are unable to incorporate boom-bust cycles.Take into account feedback effects and can trace shock propagation, but macro-financial linkages are poorly modeled.Lack of structure: allow some storytelling but too simplistic. Very little to say about the dynamics of distress.
Multiple-Module Measures: Macro Stress TestsExplicitly forward looking; can cover a broad range of scenarios, but failed to anticipate the recent turmoil.Can trace shock propagation, but macro-financial linkages are poorly modeled. Do not capture system-endogenous instability.Much more structure and granularity. Helpful for storytelling and communicating concerns.

Need for a Bottom-Up Holistic Approach

The Senegalese authorities also continue to play a key role in the surveillance of most activities outside the major banks and need to develop a more holistic view of systemic risk at the national level. No single entity within Senegal has a detailed view of the whole financial system within the country, the interconnection of its various components, and where the potential pockets of systemic risk may arise. Such a function should be developed in Senegal, preferably under the purview of the Ministry of Finance, and in close collaboration with the other regulators and supervisors, particularly the BCEAO.5 This bottom-up approach would ensure a peek through the various “cracks” that the top-down approach by the Banking Commission, which is largely focused on the large entities, does not. The cell responsible for this function would also be well placed to reflect on the scope for national macroprudential regulation to address country-specific systemic risk.6 Such a reflection should obviously be conducted in a concerted fashion with the regional authorities and regulators. This cell should ensure that the Banking Commission keeps it in the loop on the problems that may occur with the larger banks, as these may have repercussions for the smaller banks.

The national authorities need to be careful not to let data availability drive the list of indicators to help identify systemic risk. Instead, they should envision where the potential risks lie and try to shape the data collection accordingly. The challenges of macroprudential measures, as already mentioned, include the absence of clear metrics on potential feedback loops, the degree of procyclicality, and amplifications effects. Judgments on where the risks lie are necessarily based in part on the historical experience of Senegal, but the risk is to fall into the trap of “fighting the last war.” The Senegalese financial landscape has changed tremendously in recent years, the behavior of asset prices has changed, and the implications of a given level of leverage have evolved, changing the patterns of tail risks.

Need to Monitor Shadow Banking

The Senegalese authorities should extend the perimeter of surveillance to include so-called shadow banking, which by definition is hard to monitor. Shadow institutions—which are more pertinent for Senegal—include firms whose activities may not be well defined (such as private equity funds) and are typically subject to less regulation than the core of the financial system. Nonetheless, they can be highly leveraged and closely interconnected with the rest of the financial system and therefore have the potential to amplify and propagate stresses, hence the need for a macroprudential overlay to microprudential policies. Other risks emanating from shadow institutions could lead to Ponzi-type schemes. Mobile banking flows should also be closely scrutinized for their information content. The emergence of crowdfunding and other recent trends also requires extra vigilance, more for the political and reputational costs they may impose than for the risks they pose to the stability of the financial system. Filling all these information needs is challenging, as the relevant data may not be available, and the costs of collection and interpretation are nontrivial.

Mitigation of Systemic Risk

The macroprudential approach to promote financial stability by reducing systemic risks—risks within the financial system that have potential to inflict significant damage—has been a major recent development within emerging markets. This is deemed a central lesson of the global financial crisis, which many emerging markets have taken close to heart. In contrast to the microprudential approach to regulation and supervision, which focuses on the safety and soundness of individual financial institutions, markets, and infrastructures, the macroprudential approach calls attention to the financial system as a whole. In particular, a macroprudential perspective respects the fact that financial institutions are typically linked together in a complex web of relationships so that the failure of one institution can generate spillover effects to other firms and, by doing so, place the entire financial system at risk (Hall and Imam 2013). Such externalities are most obvious in the case of the largest financial institutions and financial market utilities, such as central counterparties, but they may also arise within a set of small and medium-sized enterprises that are engaged in activities with highly correlated returns.

The global financial crisis and prior emerging market crises highlighted major weaknesses in the risk mitigation arrangements in many countries. Specifically, they highlighted that too many banks, in too many countries, lack the capital and liquidity needed to absorb economic and financial shocks. In some cases, the risks will be best mitigated by policies that are structural in nature and do not change as economic conditions vary, while others will be best addressed by policies that are sensitive to economic developments (see Box 11.2 for a summary of the evolution of financial crises in frontier markets).

Hence, efforts are being made at the global level to strengthen microprudential regulation significantly by (1) improving the quantity and quality of capital, so that it can more easily absorb losses; (2) adjusting capital requirements so that they are more closely aligned with the risks they are meant to protect against—and, in particular, more fully capture market risk, counterparty credit risk, and the risk in securitized portfolios; (3) applying a gross leverage ratio as a backstop against excessive leverage; and (4) introducing measures to protect against liquidity shortages by requiring larger liquidity buffers and lowering the dependency on less secure forms of funding (see Basel III).

BOX 11.2Crisis in Emerging Low-Income Countries: A Snapshot

For much of the last decade or so, emerging low-income countries like Senegal have found themselves in a unique situation, and in contrast to advanced economies, emerged relatively unscathed from the global financial crisis. They had to worry less about the fallout from the global financial crisis, which was very prevalent in advanced economies, and they were characterized by a lack of risk taking. Emerging low-income countries faced a very different macroprudential challenge—one associated with risk taking given strong investor confidence, as rapid economic growth and rising commodity prices were driven by China. These countries weathered the global financial crisis reasonably well, largely because their financial systems were not part of the run-up in systemic risk arising from the interaction of rapid credit growth, asset price inflation, and subprime lending.

Following the various crises that hit emerging low-income countries in the 1980s and 1990s, most of these countries were able to maintain a stable financial system through a period of rapid economic expansion and oftentimes significant structural change. This commendable achievement reflects the great strides made by these countries in deepening financial reform, mitigating financial risks, and strengthening supervisory capabilities. Neither was the environment supportive of the types of structured financial products that deepened and complicated the resolution process in many countries. Nevertheless, many economies initially contracted sharply in the wake of the crisis, owing to the shock to exports, and the authorities responded with a range of initiatives in support of their financial systems, led by China.

Emerging low-income countries, like emerging markets, have been hit by numerous systemic crises in previous decades, but financial stability has been the norm in recent years (Figure 11.2.1). Various factors underlie banking crises in frontier markets. As a group, emerging low-income countries are heterogeneous, having different levels of economic development, multiple economic structures, and distinct political environments stemming from their historical roots. There is not one but a variety of causes explaining banking crises in these countries.

Figure 11.2.1.Banking Crises

The biggest risk highlighted in many of these cases was the weak quality of banks’ assets. While capital adequacy ratios were typically high, this reflected a high exposure to sovereign debt—which has zero risk weighting—even though governments were directly or indirectly a major source of risk. From a microeconomic perspective, financial liberalization has been identified as a cause of banking crises in some countries. Like the experience in other regions, financial liberalization preceded crisis episodes given that such reforms were implemented while deficient regulatory frameworks were in place (Mozambique, Zambia). Crises were often caused by governance problems at both the bank level and the regulatory level or simply by bad banking practices (Honohan and Beck 2007). Banking crises were also frequent in fragile states featuring political instability, as exemplified by the banking system in Côte d’Ivoire, which suffered from political turmoil and governance deficiencies (Beck and others 2011).

Dampening Procyclicality and Cross-Sectional Risk

Efforts to mitigate the procyclical bias of the financial system are closely linked to the enhancement of surveillance, meaning that if the emergence of systemic risks can be identified early enough in the economic cycle, it may be possible to counter them with preemptive policy measures. As discussed in the previous section, however, monetary and fiscal policy are often weak instruments in the context of low-income countries, with macroprudential policies becoming key to containing systemic risk.

The search for policy measures that might complement the role of monetary policy have so far concentrated on these five (see Drehmann and others 2010):

  • Countercyclical capital requirements, which would add a “buffer” to capital requirements based on the current cyclical position of the economy.

  • Variable risk weights that would raise capital requirements for specific types of lending, such as real estate.

  • Forward-looking provisioning to link loss provisions to the credit cycle, so banks are forced to put money to one side for their potential losses when credit is growing strongly.

  • Collateral requirements that impose higher collateral restrictions on some activities (examples include loan-to-value limits on secured lending and minimum haircuts or margins on securities financing transactions).

  • Quantitative credit controls and reserve requirements, which either limit lending directly or indirectly limit it by increasing short-term liquidity requirements.

None of these measures have yet been adopted, or even considered, in the Senegalese context, though many emerging markets have adopted them.

To this point, the use of countercyclical capital buffers has found the most support globally. The Basel Committee on Banking Supervision has agreed, in principle, to two capital buffers. The first is a capital conservation buffer, to be set as a fixed proportion of risk-weighted assets. This buffer may be run down during periods of stress, lessening the pressure on banks to restrict credit. But its primary objective is to prevent banks that are losing money and approaching their minimum capital requirements from paying out capital and further depleting their reserves.

The second buffer is an additional countercyclical buffer, to be imposed in periods of rapid credit growth if national authorities judge that this is aggravating system-wide risk. Conversely, this capital could be released in the downturn of the cycle to reduce the risk that the supply of credit might be constrained by regulatory capital requirements. The Basel Committee on Banking Supervision anticipates that the ratio of credit to GDP would serve as a common reference in the buildup phase, but with a broader set of indicators taken into account, including asset prices. Together, these two capital conservation buffers could help counter the procyclical tendencies within the financial system by smoothing out the flow of credit through the economic cycle.

While a consensus has yet to emerge around the value of other countercyclical measures, some already have strong supporters. In India, the central bank has used differential weighting in capital regulation to slow the growth of bank credit to housing and commercial real estate. The use of loan-to-value ratios and restrictions on mortgage lending is also quite common in Asia. Latin American countries such as Colombia and Peru have adopted dynamic provisioning (see Wezel, Chan Lau, and Columba 2012).

Threats to the financial system can never be eliminated. As a result, there is a need to enhance the resilience of the financial system so that it can more comfortably ride out periods of stress, including the occasional failure of financial institutions. This prospect has generated a wide-ranging debate over exactly which institutions should be the subject of the most attention, that is, which are the systemically important financial institutions—those of such a size or market presence that their failure would almost certainly jeopardize the smooth functioning of the global financial system.

Measures to enhance the resilience of the financial system need to be calibrated so that they reflect the threat that each institution represents to the financial system as a whole rather than to risk on a stand-alone basis. The Financial Stability Board and the Basel Committee on Banking Supervision have therefore explored measures to deal with systemically important financial institutions. Two measures that have been agreed to so far are that these institutions should have higher loss-absorbing capacity, with a higher common capital buffer, and that they should be subject to a higher degree of supervisory oversight than would otherwise apply.7

Although macroprudential measures could play a very useful role in a heterogeneous region like WAEMU, more urgent tasks for the authorities include (1) developing a monitoring system, which is a prerequisite, and (2) improving microprudential regulation and supervision. Good microprudential regulation is a prerequisite for using macroprudential regulation in an effective way. As already highlighted by Imam and Kolerus (2013), there is room to strengthen both compliance with microprudential norms and the regulatory standards to raise them over time to international standards. The concentration risk levels appear too high and should be moved to 25 percent, while the definition of nonperforming loans should be tightened to 90 days of nonpayment, in line with global norms. Allowing a sovereign-risk weighting of zero is questionable, given the riskiness of sovereign nonpayment in the region. There is a need to broaden the application of capital requirements to include market and operational risks, while the regulatory net must be cast wide enough to encompass all key risks.

While macroprudential tools have been tried around the world, their effectiveness is still being evaluated. In the absence of an accepted analytical framework linking a given instrument to a policy objective, the objective is typically defined by the instrument at hand. The focus on limits to open foreign exchange positions, limits to the concentration of credit, and liquidity buffers reflects the traditional prudential nature of these tools, which have been used for a number of years in developing countries and emerging market economies. Note that in countries in Asia and the Western Hemisphere, concentration limits are the preferred tool, unlike in sub-Saharan Africa, where the focus is on limits to net open foreign exchange positions. This reflects widespread experience with recent crises. Also, loan-to-value ratios are not part of the macroprudential toolkit in sub-Saharan Africa, whereas their use is popular in half of the emerging markets that responded to the IMF’s 2013 survey, again a reflection of the more developed market, notably for housing.

Existing macroprudential tools, when they are present in low-income countries, seek to address mainly credit and liquidity risks. Based on the information provided to the macroprudential survey conducted by the IMF in 2013 among its member countries, the most popular instruments used by 18 sub-Saharan African countries—the countries that responded to the survey and that are among the more advanced economies in the region—are (1) limits to open foreign exchange positions (15 countries), (2) limits to the concentration of credit (11 countries), and (3) liquidity buffers (10 countries). Other common instruments include leverage ratios, limits to loans in domestic currency, limits to interbank exposures, taxes on specific assets or liabilities, and reserve requirements. Thus, sub-Saharan African countries appear to implement the microprudential toolkit mainly to contain credit risks (directly or indirectly via foreign currency credits) and liquidity risks.8

Application to Senegal

Through the regional Banking Commission, Senegal has a narrow range of prudential instruments that fall into the macroprudential domain, which the authorities may want to broaden. Reserve requirements are presently the only instrument available to the authorities (see Table 11.3). Even these are constrained in their usage, as the rates have been harmonized across the currency union and therefore cannot be used to address asymmetric shocks within WAEMU. The authorities may need to consider broadening their toolkit. While many of the microprudential instruments will continue to be used as in the past, the usage of some may be broadened to take a system-wide approach.

TABLE 11.3Intensity of Use of Macroprudential Tools
Caps on Loan-to-Value RatiosCaps on Debt-/Loan-to-income RatiosCaps on Foreign Currency LendingCeiling on Credit or Credit GrowthLimits on Net Open Currency Positions/ Currency MismatchLimits on Maturity MismatchReserve RequirementsCountercyclical Capital RequirementTime-Varying/Dynamic ProvisioningRestrictions on Profit Distribution
BeninScore is 0
Burkina FasoScore is 1
Côte d’IvoireScore is 2
Guinea-BissauScore is 3
MaliScore is 4
NigerScore is 5
TogoScore is 6
Sources: Imam and Kolerus 2013; and author’s compilation.Note: 0 represents no use of instruments, and 1 denotes the use of a single instrument. For each of the following attributes (that is, multiple, targeted, time varying, discretionary, and used in coordination with other policies), the value of 1 is added.
Sources: Imam and Kolerus 2013; and author’s compilation.Note: 0 represents no use of instruments, and 1 denotes the use of a single instrument. For each of the following attributes (that is, multiple, targeted, time varying, discretionary, and used in coordination with other policies), the value of 1 is added.
  • Diminishing time-series risks. Given the limited correlation between macroeconomic variables and financial ones—business cycles in WAEMU countries are often driven by weather-related or political shocks that cannot be forecast—introducing instruments to address these time-series risks (such as countercyclical capital requirements) would not necessarily be effective and therefore not be a priority at this juncture. However, the future will not mirror the past, and instruments to diminish time-series risk, as described earlier, will have to be part of the reflection given that it is bound to become ever more important.

  • Introducing cross-sectional macroprudential tools. Introducing cross-sectional macroprudential tools is higher on the priority list from a risk perspective. Strengthening the buffers of the biggest banks until more information about the risks is available is defensible on prudential grounds. The capitalization ratio is often not a major issue for most banks—but this reflects the exposure to the sovereign that has zero risk weighting. Protecting banks from a symbiotic relationship with the government may be warranted, as may be reducing the concentration exposure, a prime reason banks fail in the region.

  • Guarding against too-big-to-fail risk. None of the Senegalese banks fit the definition of being too big to fail, suggesting that this form of cross-sectional systemic risk is contained. However, if we were to apply the notion of systemic risk at the regional level, there might be a need to push some banks—notably pan-African banks—to have stronger buffers (Imam and Kolerus 2013). Regionally, some financial institutions qualify as systemically important financial institutions—institutions whose eventual demise would create havoc for the rest of the financial system because of their size, interconnectedness, complexity, international linkages, and/or the lack of available substitutes for the services they provide. Finally, at the global level, Société Générale and BNP Paribas, which have subsidiaries in Senegal, have already been designated as systemically important financial institutions by the Financial Stability Board.

  • Rethinking the uniform application of WAEMU rules. It may be warranted to rethink the uniform application of macroprudential tools across the WAEMU countries. As is the case in the euro zone, in the WAEMU region countries do not have a synchronized financial cycle, so it is conceivable that the banking system in one country could provide excessive credit while credit is stagnant in other countries. Under these circumstances, changing uniformly macroprudential regulations across WAEMU may be less effective, by reducing the benefit—excess credit growth is not contained sufficiently.

Crisis Management

Notwithstanding the best efforts of the supervisory authorities to identify and mitigate threats to their financial system, there will still be episodes of financial crisis. Finance is by definition uncertain and involves risks—these may be idiosyncratic episodes involving a single distressed financial institution, as a result of mismanagement, or they may be systemic, involving multiple institutions, following an unanticipated economic or financial shock. How the authorities respond to these events will have an important bearing on the overall stability of the financial system, since any failure to contain and resolve problems quickly can rapidly undermine confidence in the financial sector more generally.

Emerging market economies and some low-income countries need no coaching on the importance of a well-designed crisis management framework. Over the course of the 1980s and 1990s, they were confronted with major bank failures, and the gross fiscal cost of these crises are estimated as several percentage points of GDP in many countries (Laeven and Valencia 2008). Not surprisingly, this experience triggered an overhaul of the regulatory architecture in many countries. While crisis management varies from country to country, it tends to share the following characteristics: a clear understanding of the limits to emergency liquidity assistance from the central bank and the existence of adequate powers to ensure that the authorities are able to resolve and restructure a distressed institution to keep it operating (an “open-resolution” outcome) or to close a distressed institution in an orderly way (a “closed-resolution” outcome).

The crises of the 1980s and 1990s led to the acknowledgment that effective crisis management arrangements require a very high degree of interagency cooperation, involving government, the central bank, and financial regulators. Each should have a specific role that is clear at the outset, since a crisis will not allow time for the development of protocols and procedures for the speedy and effective resolution of problems. There is also an important cross-border dimension to crisis management arrangements, reflecting the global reach of many of the largest financial institutions.

While the size, scale, and complexity of their international financial transactions have increased over the years, the resolution tools for dealing with cross-border institutions have changed very little. By and large, national resolution frameworks remain focused on dealing with failures in a way that minimizes losses to domestic stakeholders—a perspective that can too easily lead to “ring-fencing” measures in one country that exacerbate the problems of another. Following the global financial crisis, there has been a much better appreciation of the need to improve resolution procedures so that the interests of home and host countries are better aligned (Basel Committee on Banking Supervision 2010).

Emergency Liquidity Assistance

The provision of emergency liquidity assistance—referred to commonly as the lender-of-last-resort facility—to individual financial institutions and to the market as a whole is an instrument invariably in the hands of the central bank. It is a common feature in most emerging markets. Emergency liquidity assistance is distinguished from the provision of liquidity to individual firms under the central bank’s standing facilities, which are available on demand and the rules of access of which are clear beforehand. Emergency liquidity assistance, on the other hand, is typically available only in exceptional circumstances at the discretion of the central bank (Hall and Imam 2013).9 One constraint faced by emerging market central banks—though this legacy is gradually dissipating—is the credibility of the central bank and the impact that an emergency liquidity assistance measure can have on confidence in the currency.

There is a long-standing, well-tested principle concerning the best way to provide emergency liquidity assistance to individual financial institutions: Central banks should lend only to solvent institutions against good collateral, without limit but at penalty rates (so that banks cannot use the loans to fund their current operations). In practice, applications for emergency liquidity assistance materialize only once a financial institution has exhausted its “eligible” collateral through standing facilities. This means that central banks will have to provide any emergency liquidity support on an unsecured basis or secured against lower-quality assets. In addition, the solvency of a distressed institution may be hard to verify in times of economic and financial turbulence, the more so if the central bank is not a prudential regulator and must rely on another agency for advice. This means that the distinction between illiquidity and insolvency is often less than clear-cut.

To promote market discipline and avoid moral hazard, central banks often restrict emergency liquidity support to systemically important financial institutions. This assessment of systemic importance may not be straightforward, since it will depend on the specifics of the individual financial institution and the general environment at the time. For each financial institution, these factors include

  • The institution’s size and nature.

  • Its share of the deposit and lending markets.

  • Its participation in the payments system.

  • Its participation in the interbank market and in derivative markets.

  • Its interconnectedness within the financial system.

  • Its likely effects on market confidence, domestically and internationally.

  • Its potential impact on the provision of credit in the market.

  • Its potential impact on asset prices and the real economy, both nationally and within relevant regions and economic sectors.

On the basis of these criteria, the overall size of an institution is obviously a key consideration, but the prevailing economic conditions at the time will also play an important role. This is because in a weak economic environment, when confidence in the financial system may be fragile, the failure of even quite small institutions may undermine financial stability.

Application to Senegal

In a financial crisis, the first port of call for liquidity support for a bank based in Senegal would be the BCEAO. The BCEAO currently does not have an explicit mandate to provide emergency liquidity assistance, and the ambiguity arising from this situation may be a double-edged sword. Although the absence of a mandate in principle protects the BCEAO’s balance sheet, historical evidence suggests that it is hard for a central bank to avoid getting involved in a systemic liquidity crisis. Once this happens, the risk to the central bank’s balance sheet might actually be much more difficult to contain.

To avoid a situation that puts the BCEAO’s balance sheet at risk, it would be desirable to be more explicit about the limits of emergency liquidity assistance intervention. For the BCEAO and the national governments, this means discussing in advance how the BCEAO could get involved in the provision of emergency liquidity assistance and how it would be indemnified by the governments for this activity should losses arise. Further strengthening explicit limits to the BCEAO’s emergency liquidity support is imperative to avoid running the risk that the central bank is too easily cast in the role of contingent creditor in times of financial crisis.

Banks are the financial institutions most likely to qualify for emergency liquidity assistance. This reflects a number of their systemically important characteristics, notably their critical role in the payments and settlement systems and as credit providers to the broader economy. Nonetheless, in principle there are no reasons for withholding emergency liquidity assistance from nonbank financial institutions, providing they meet the same tests of systemic importance and solvency. This, in turn, highlights the importance of making sure that all systemically important financial institutions—including nonbank ones—are appropriately regulated and supervised and subject to explicit liquidity standards.

Recovery, Resolution, and Financial Safety Net

Where a financial institution’s problems extend beyond short-term liquidity and are more deep-seated, the authorities in most emerging markets draw on two related strategies within their crisis management plans: a recovery strategy, in which regulators and management work together to address the underlying problems and so maintain the firm as a going concern, and, if that fails, a resolution strategy to close the firm in a structured and orderly way. The objective in each case will be to minimize the impact on the rest of the financial system and by doing so help sustain the provision of essential services to the economy. Almost inevitably, the authorities will come under pressure to intervene to keep the firm open, since stakeholders (owners, creditors) have much to lose from bankruptcy. However, for moral hazard in the financial system to be contained, it is vital that open resolution does not become the default option in every financial crisis. The authorities must be able to close a distressed financial institution whose orderly demise would neither undermine confidence in the financial system nor damage the broader economy. The toolkit for doing so needs to provide the authorities with the legal authority to intervene promptly when they detect a distressed institution and then to close, recapitalize, or sell it (see Ĉihák and Nier 2009).

The experience from the global financial crisis suggests that authorities will find it easier to proceed with the closure of nonviable institutions if there is a financial safety net to protect depositors and small investors from losses. In a well-regulated financial sector, funds exist for compensating small investors of failed securities companies, futures companies, and the policyholders of insurance companies.


A strong supervisory framework is one that detects problems among financial institutions at their formative stage so that the authorities can take preemptive actions. In many countries, this approach is formally incorporated into an early intervention system known as prompt corrective action. This system aims to return a financial institution to health by restoring capital and liquidity (depending on the nature of the problem) as soon as the first signs of deterioration in balance sheet strength are detected. This does not mean a firm will emerge unscathed from prompt corrective action, since to avert failure radical options may be required, such as exiting particular lines of business, selling subsidiaries, or raising capital. In some circumstances, management and board may need to be replaced.

Prompt corrective action systems work effectively only if the trigger points for intervention are set high enough. This is because capital is an accounting concept that is a lagging rather than a leading indicator of financial strength. Hence, if triggers are set low, there is a real risk that any enforcement actions will be late rather than prompt. But even if triggers are raised, which would be consistent with the global shift toward higher minimum capital requirements under Basel III, prompt corrective action may still be ineffective.

The global financial crisis has undermined confidence in prompt corrective action as a tool for managing distressed but solvent institutions. Instead, that experience has highlighted two points. The first relates to the value of stress testing, which seeks to assess the adequacy of capital in anticipation of a crisis, so that the balance sheet can be strengthened accordingly. The second has reinforced the benefits of introducing triggers that allow the authorities to take full control of a financial institution well ahead of the point of insolvency. The lagging nature of capital means that by the time information on near-insolvency is reported, the residual capital may already be depleted. Financial assets, in particular, can lose their value extremely rapidly. This suggests that capital triggers may ultimately be more useful in signaling a need for forceful intervention in the form of resolution planning than as a form of early intervention in the context of prompt corrective action.

Another lesson from the global financial crisis for emerging markets has been the importance of complementing prompt corrective action with the preparation of recovery plans, which identify and document the potential remedial actions available to firms in times of crisis (Hall and Imam 2013). This planning is intended to include a detailed outline of the actions available for reducing risk exposures (derisking) in a very short time. It should also identify the businesses and subsidiaries that can be sold to third parties without damaging the core business. The sharing of information technology and other corporate services is often a key constraint on separation. This pre-positioning work is vital in the case of large, complex financial institutions, since in a fast-moving crisis there is no time to disentangle businesses and identify those that could be easily sold in support of the core franchise. Similarly, a recovery plan should outline contingent funding arrangements to cope with the drying up of any one funding source. Doing so encourages firms to diversify their funding base so that they will need to rely less on emergency liquidity assistance in times of trouble.


If recovery plans fail to turn the problems around and save the firm, then the firm will need to be “resolved” in an orderly way. Sometimes the best course will be liquidation, with retail depositors receiving a payout from a deposit insurance fund. On other occasions, resolution may involve selling the deposit book to another bank. Good assets might go with the deposits or be transferred elsewhere, and bad (or at least unsalable) assets might be placed in runoff. Since these solutions might take time to organize, an interim step may be to establish a bridge bank—a temporary institution established by the resolution authorities to take over the operation of a failing institution to preserve its value as a going concern.

However, those outcomes might not appeal to the existing shareholders, who may attempt to block options that would dilute their stake—a course of action open to them whenever bank resolution is based on general insolvency law administered by courts. To overcome this potential obstacle, many countries have introduced special resolution regimes for banks that allow the authorities to take control of the financial institution at an early stage of its financial difficulties through “official administration”; use a wide range of tools to deal with a failing institution, without the consent of shareholders or creditors; and operate within a specialized framework for liquidation, with limited judicial review, whenever this is in the interest of depositors or there is an overriding public policy objective, such as the preservation of financial stability.

In a systemic crisis, however, the authorities may doubt their ability to implement such a closed resolution, particularly for large and complex institutions, without jeopardizing the supply of credit to the broader economy. They may opt instead for an open-resolution outcome, in which public funds are used to prop up the institution. This is not a decision to be taken lightly, since it may turn out to be very expensive. At the same time, the moral hazard in the financial system will be fueled by perceptions that some financial institutions are simply “too large to fail” and will always be the beneficiaries of government support. There are four broad components to this work:

  • Strengthening national resolution regimes by giving a designated resolution authority a broad range of powers and tools to resolve a financial institution that is no longer viable and including them in a new international standard.

  • Introducing cross-border cooperation arrangements to enable resolution authorities to act collectively to resolve specific cross-border institutions in a more orderly and less costly way.

  • Removing obstacles to resolution, such as those arising from complex firm structures and business practices.

  • Improving resolution planning by firms and authorities based on ex ante resolvability assessments that should inform the preparation of recovery and resolution plans.

Public Sector Intervention

The Financial Stability Board’s “Key Attributes of Effective Resolution Regimes for Financial Institutions” (Table 11.4) do not rule out public sector intervention, but they cast it very much in last-resort terms for the sole and overarching purpose of maintaining financial stability. For this reason, some countries may decide to retain powers to temporarily place a firm in public ownership so that critical operations can continue, pending sale or merger with a private sector partner. When countries do equip themselves with these powers, they are expected to make provision for any losses incurred by the state to be recouped from unsecured creditors, or, if need be, from the financial system more generally.

TABLE 11.4Financial Stability Board Key Attributes of Effective Resolution Regimes for Financial Institutions: Which Ones Are Available in WAEMU?
Essential Features for Resolution RegimesEnsure continuity of systemically important financial services and payment clearing, and settlement functions.Protect, where applicable and in coordination with the relevant insurance schemes and arrangements, such depositors, insurance policy holders, and investors as are covered by such schemes and arrangements and ensure the rapid return of segregated client assets.Allocate losses to firm owners [shareholders) and unsecured and uninsured creditors in a manner that respects the hierarchy of claim.Do not rely on public solvency support and do not create an expectation that such support will be available.
WAEMUNot ClearNoYesNo
Essential Features for Resolution RegimesAvoid unnecessary destruction of value, and therefore seek to minimize the overall costs of resolution in home and host jurisdictions and, where consistent with the other objectives, losses for creditors.Provide for speed and transparency and as much predictability as possible through legal and procedural clarity and advance planning for orderly resolution.Provide a mandate in law for cooperation, information exchange, and coordination domestically and with relevant foreign resolution authorities before and during a resolution.Ensure that nonviable firms can exit the market in an orderly way.
WAEMUNoNoNoNot Clear
Essential Features for Resolution RegimesBe credible, and thereby enhance market discipline and provide incentives for market-based solutions.Stabilization options that achieve continuity of systemically important functions by way of a sale or transfer of the shares in the firm or of all or parts of the firm’s business to a third party, either directly or through a bridge institution, and/or an officially mandated creditor-financed recapitalization of the entity that continues providing the critical functions.Liquidation options that provide for the orderly closure and wind-down of all or parts of the firm’s business in a manner that protects insured depositors, insurance policy holders, and other retail customers.
Source: Financial Stability Board 2011.Note: WAEMU = West African Economic and Monetary Union.
Source: Financial Stability Board 2011.Note: WAEMU = West African Economic and Monetary Union.

Many emerging markets have crisis management arrangements that are already closely aligned with the Financial Stability Board’s key attributes, but the authorities are aware that there is more work to be done. The extension of recovery and resolution regimes to a wider range of domestic financial institutions in order to improve their preexisting resolvability should also be considered. This is because WAEMU countries have limited fiscal space—which reduces the ability of the government to backstop the financial system—that will mitigate against any generosity. Any future calls on the public purse in support of the financial system will need to be very carefully contained indeed. This objective has a better chance of success if the authorities have “living wills” in place that will allow them to keep the core business of a distressed institution intact. In pulling together all of the interwoven elements of an effective resolution regime, it is vitally important that the right balance be struck between stability and efficiency. While stability can be obtained in the short term through generous public intervention, such an intervention will ultimately lead to a damaging increase in moral hazard and prolong the existence of inefficient intermediaries.

Application to Senegal (and the WAEMU Countries)

Reliance on prompt and forceful corrective action is not yet fully practiced by the Banking Commission. An effective supervisory framework requires that problems be detected early on and followed by early intervention in the form of prompt corrective action to restore an institution’s health. As discussed earlier, the authorities in Senegal need to use financial and prudential information from institutions much more actively so as to be able to better anticipate problems and move to risk-based supervision; this will also require better reporting. Their track record suggests that problems have been permitted to persist longer than desirable; banks are not (systematically) punished for violating prudential ratios or constrained to rectify their actions, and to close banks takes years (see Imam and Kolerus 2013).

The resolution framework depends on a clear sharing of responsibilities between national and regional bodies. The national directorate of the BCEAO—which is regularly collecting data on various financial indicators and carries out off-site supervision—is typically the first body to detect difficulties at a financial institution. It flags potential operational and stability concerns to the Banking Commission, with the concerned national authority kept informed. The Banking Commission is responsible for on-site supervision. When concerns arise, joint inspections comprising members of both the Banking Commission and the BCEAO national directorate intensify the supervision of the institution. Evidence from on-site and off-site inspections guides the Banking Commission’s decision on possible prompt corrective actions or possible sanctions. In case of solvency concerns, the Banking Commission can recommend the closing of an institution. The Banking Commission informs the Ministry of Finance, which is the body that has to formally rescind the institution’s banking license. The Minister of Finance, however, has the option of appealing to the Council of Ministers, where a simple majority could overrule the Banking Commission’s decision.

Traditionally, therefore, politics makes it difficult to implement the decision by the Banking Commission to close down a bank in the WAEMU region, including Senegal, with national authorities having displayed a strong preference for responding to financial distress with open-resolution outcomes for deposit-taking institutions. This appears to reflect the belief that the lack of a deposit insurance system and the implied loss of savings are a recipe for social discontent and should be avoided. The result has been to keep banks alive, sometimes with the help of the public purse, without much prospect for success, explaining the inability to shut down banks in the region.

As a result, many banks in WAEMU have often been insolvent for long periods without being resolved, hurting the profitability and health of the rest of the banking system. Most of these banks are typically national banks and have the support of local politicians, making it hard to close them down. These “zombie banks” have incentives to gamble for their resurrection, which can have an adverse impact on other banks. There is an implicit understanding that a bank that is in trouble will have to be bailed out by the national authorities where it is located, since the national authorities are the ones that provide the license. However, this understanding might not apply to pan-African banks located in WAEMU. For the latter, an assumption exists that the parent company will bail out the local subsidiary (see also Enoch and others 2015). To avoid the presence of zombie banks, more forceful action is desirable in the future, including with a view to reducing intervention costs. Absent a robust and effective resolution regime, WAEMU authorities have little choice but to bail out such banks at great public expense, which perpetuates moral hazard.

As in other countries following the recent crisis, in Senegal the authorities should consider expanding the resolution toolkit so that closed-resolution outcomes become a viable option for dealing with banks. This will require a series of policy initiatives. The authorities need to be able to intervene promptly on the first signs of distress at a bank; to have the financial resources and skills at hand that will allow them to keep a troubled bank operating pending its sale, transfer, or closure; and to have a deposit insurance scheme to provide depositors with quick access to their funds if closure is the chosen resolution outcome. Taken together, this combination of resolution tools will help contain moral hazard in the financial system and also protect the public purse from budgetary surprises.

In case a bank cannot be recovered, it must be closed down, but the WAEMU resolution regime lacks key attributes recommended by the Financial Stability Board (see Table 11.4). Adopting some of the Financial Stability Board recommendations would require strengthening the powers of the regulator. For instance, the Banking Commission, acting within a well-defined framework that protects the rights of depositors and creditors, would be able without undue delay to order the transfer of assets and liabilities, undertake mergers, and decide on changes in shareholders.

Some of the difficulties of resolving banks could reflect coordination failures between the regional and national authorities. The resolution of a bank involves the Banking Commission, which makes the decision, and the concerned national government, which needs to approve that decision. In case of a disagreement, the government can appeal to the WAEMU Council of Ministers to reverse the decision. Preexisting burden-sharing arrangements could be designed to overcome some of the issues of delaying bank resolution. The authorities should also pursue explicit support from parent companies with respect to their branches or subsidiaries when a request for a banking license is examined, with a view to obtaining substantial resources for intervention from shareholders should the need arise. And since public banks in some of the countries have often been a source of problems, privatization may also be worth considering.

To avoid moral-hazard problems, a systematic investigation of the responsibilities of directors, shareholders, and auditors involved in a bankruptcy should be conducted. This should be particularly the case in instances in which public funds were engaged. Conclusions should be drawn from investigations with regard to the suitability of the concerned stakeholders for future jobs in the financial sector. Inappropriate behavior should be prosecuted to the full extent of the law.

Special consideration also needs to be given to how to resolve systemically important financial institutions. Because the region is the home of one regional systemically important financial institution—EcoBank—like the Group of Twenty (G20) and emerging market economies, WAEMU needs to find ways to resolve and address potential problems among its largest banks without threatening financial stability—an issue that will increase in importance as the complexity and range of their activities continues to increase.

The lessons from the euro crisis must also be learned, to ensure that distorted incentives and sovereign-bank links do not become sources of concern. The euro crisis highlights that without common resolution, safety nets, and credible backstops, the vicious sovereign-bank link may not be easily broken. A single resolution authority with clear preexisting burden-sharing mechanisms and no political interference is required. Moreover, national authorities are likely to favor their national banking systems, regardless of any spillovers this may create on other countries in WAEMU. For instance, in bad times they may encourage a reduction in cross-border activities, which would exacerbate financial fragmentation.

Financial Safety Nets

Well-designed financial safety nets are critical to an effective crisis management system. Their mere existence may go a long way toward stabilizing financial systems in times of stress. Without them it is difficult to keep systemically important financial institutions in business without early and expensive recourse to the taxpayer and equally difficult to close any institution unless depositors and small investors are protected from loss. It is particularly important that depositors have quick access to their transactional balances to avoid financial hardship. The ability to compensate small investors in failed securities companies and the policyholders of insurance companies will also bolster confidence in the financial system, although the speed of compensation is less pressing.

A deposit insurance system tends to have important limitations in a crisis. Most deposit insurance funds can absorb only limited losses among their insured pool, that is, they are targeted at smaller, idiosyncratic banking crises, not at systemic ones. During systemic crisis, when a large segment, or even all, of the banking sector is at risk of failure, a deposit insurance fund will lack the resources to inspire confidence on its own. Unless the government throws its own resources behind the banking sector, the key objective of promoting confidence will be lost. A deposit insurance system should have all funding mechanisms available, including the possibility of supplementary backup funding during a crisis.

The WAEMU authorities have given considerable thought to the introduction of a deposit insurance scheme in WAEMU and should accelerate this work.10 The design features should incorporate the principles being developed by the International Association of Deposit Insurers. The authorities also need to decide on the institutional structure of the resolution framework best suited to WAEMU. They are still considering some aspects of coverage, payouts, and funding but expect the system to be launched in the near future. It would cover deposits with banks and microfinance institutions.

The authorities should consider giving a role to the deposit insurance system in bank recovery, as is the case in a number of countries. This might allow the final cost to be reduced, since recovery is often less expensive than liquidation. Whatever institutional structure the authorities opt for, it is important that they now move ahead quickly, since comprehensive and well-thought-out resolution arrangements are an integral part of an effective financial stability framework.

In addition, as a result of the currency union arrangement, the authorities in Senegal are working on a Financial Stability Fund, whose main goal would be to avoid possible debt payment incidents by sovereigns facing liquidity problems. Work is still ongoing on a number of key issues, such as financing of the fund and terms of its financing. While this is laudable, a number of issues need to be considered, such as the identification of the nature of shocks (whether they are temporary or permanent, something particularly difficult to assess in the case of political instability), how to address moral hazard (Is there a role for conditionality? Should financing be provided on market or concessional terms?), and the seniority of Financial Stability Fund financing, which could raise issues if a restructuring is eventually needed.


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This chapter draws on Imam and Kolerus 2013 and Hall and Imam 2013.

Formal arrangements that are set out in law and are more visible to the public can help coordinate strategies for communicating about the risks across the agencies, creating a single message. More formal arrangements may enable the issuance of public warnings on the part of the committee as well as recommendations to take action that are issued to constituent agencies. This can foster effective use of macroprudential policy instruments even where such recommendations are not binding on the agency (Nier and others 2011).

While the banks are nominally part of a banking union, in practice banking is mostly conducted within national borders. Cross-border flows within WAEMU are largely in the form of syndicated loans involving a sister bank located in the country of the client. The limited integration is also reflected in the large differences in deposit and lending rates across the region (see Imam and Kolerus 2013).

Monetary policy will have an important role to play in this regard, but there will be limits to this support so long as the primary objective of monetary policy is price stability. In a heterogeneous currency union like WAEMU, monetary policy may even end up being procyclical if business cycles diverge—with interest rates being too low for booming countries and too high for countries that are slowing down—and hence end up being a destabilizing force for financial stability.

Dollarization is one form of cross-sectional risk that poses a problem in some sub-Saharan African countries, but not in Senegal/WAEMU, owing to regulatory reasons and the strong credibility of the exchange rate (see Corrales and others 2016). This means that the risks to the balance sheet of financial institutions are a priori contained.

While leverage—whether of households, firms, banks, or the sovereign—within the Senegalese economy is generally moderate and manageable, vigilance is required given the susceptibility to shocks, which can easily lead to a worsening of the risk profile (Imam and Kolerus 2013).

This approach has been followed in the euro area. The European Systemic Risk Board (ESRB) was established in December 2010, charged with providing macroprudential oversight of the EU financial system as a whole. In addition, in January 2011 the Committee of European Banking Supervisors, the Committee of European Insurance and Occupational Pensions Supervisors, and the Committee of European Securities Regulators were replaced by European Supervisory Authorities to create a new European System of Financial Supervision. The ESRB is tasked with monitoring, identifying, and predicting potential systemic risks and issuing recommendations. At the same time, the ESRB collaborates with European Supervisory Authorities, providing them with the necessary macroprudential input to assist them in carrying out their supervisory functions. One of the ESRB’s first decisions was to recommend the establishment of an efficient macroprudential policy framework in each EU member state. The recommendation was for each member state to designate an authority, through national legislation, to conduct macroprudential policy. Cooperation between the national macroprudential authorities and the ESRB would be warranted, particularly to enable the timely identification and subsequent discussion of relevant cross-border issues.

There were important failures in corporate governance in many countries in the lead-up to the global financial crisis. Poorly structured remuneration and incentive schemes were pervasive and contributed significantly to the buildup of systemic risk. For example, compensation practices among many financial firms often tied bonuses to short-term results, which contributed to excessive risk taking by rewarding the short-term expansion of (risky) trades rather than the long-term profitability of investments. To address these types of problems, regulatory agencies in many countries are now subjecting compensation practices at banking institutions to supervisory review.

See Mendoza 2016 for a discussion on the complexity due to potential nonlinearity responses of using macroprudential tools.

Nonetheless, regular and emergency liquidity supports are not independent. The broader (narrower) the facilities and the types of collateral accepted under standing facilities, the less (more) likely is the need for emergency liquidity assistance. Similarly, emergency liquidity assistance to the market must be distinguished from an easing of monetary policy. Emergency assistance to the market is provided temporarily to relieve market pressures following an adverse exogenous shock, while changes in monetary policy are directed at maintaining longer-term price stability.

The authorities are also working on an insurance fund to guarantee all payments made through the real-time gross settlement system.

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