II. Sub-Saharan African Financial Systems and the Global Financial Shock
- International Monetary Fund. African Dept.
- Published Date:
- April 2009
Financial systems in sub-Saharan African countries have so far been resilient to the global financial crisis. Although the crisis has exerted significant pressures on money, currencies, and capital markets, they have continued to function normally, and financial institutions in most countries have been stable without emergency support from monetary authorities. The relative stability reflects several factors, among them the still limited though increasing integration with global financial markets, minimal exposure to complex financial instruments, relatively high bank liquidity, limited reliance on foreign funding, and low leverage in financial institutions.
However, pressures have intensified and sub-Saharan African countries are being hit hard as the global crisis has deepened and broadened. The spiraling effects of a depressed world economy and the increased risk aversion of investors pose growing risks for sub-Saharan African financial systems. The spillover of the crisis to the real economies has depressed global demand and prices for commodities, contributed to a sudden curtailment of capital flows and remittances, and slowed economic growth prospects throughout the region. This unfavorable economic environment, if prolonged, could have adverse consequences for the financial sector through increased credit risk and reduced liquidity buffers to deal with liquidity shocks.
The crisis, therefore, presents important policy challenges for the sub-Saharan African countries’ financial systems and their efforts to reform them. How can the risks from the ongoing crisis be minimized? How can financial systems be reinforced when the domestic and external environments are deteriorating? These challenges, complicated by uncertainty about how long the shocks will last, underscore the need for sustained sound macroeconomic policies; comprehensive supervision and intensified surveillance of financial systems; better risk management and governance in financial institutions; and continued structural reforms to build up financial infrastructures.
This chapter addresses the following questions:
How has the global environment for sub-Saharan African financial systems worsened and how important are the transmission channels?
How has the global crisis affected financial systems and markets in sub-Saharan Africa?
What risks does the global crisis pose for financial systems in sub-Saharan Africa?
What can be done to minimize dislocations from the global financial crisis and to continue developing the region’s financial systems?
Note: This chapter was prepared by a team from the IMF’s African Department and Monetary and Capital Markets Department: Paulo Drummond, Inutu Lukonga, Yanliang Miao, Gustavo Ramirez, Subramanian Sriram, Jerome Vacher, Jahanara Zaman, with editorial assistance from Martha Bonilla and Anne Grant; and administrative assistance from Natasha Minges.
To facilitate the discussion and acknowledge the heterogeneity of financial systems in sub-Saharan Africa, the analysis is organized around country groupings based on common economic features.
It complements and informs the discussion in Chapter I which focuses on how the global crisis affects the economies and policy responses of countries in the region. However, since the crisis is still evolving, the conclusions of this analysis can only be tentative.
The global crisis has begun to hit Africa, and some countries significantly so. Effects on their financial systems are bound to reflect the evolving nature of the crisis as the deterioration in the global economy deepens, capital flows decline, and domestic economies slow. Thus, while previous macroeconomic and financial sector reforms in sub-Saharan African countries have given their financial systems considerable resilience, no country in the region is immune.
Spillovers of the global financial crisis to the real economy and increased risk aversion by investors could transmit stress to financial systems through their impact on the domestic economy, bank liquidity, and the ability of banks to raise capital. However, the speed of transmission and the magnitude of impact on each country’s financial system will vary because of differences in structure and initial conditions, including how well the country is integrated into global markets; bank funding profiles; the depth and liquidity of domestic markets; vulnerabilities such as risk concentrations; and the capacity of the authorities to respond quickly and comprehensively.
Some reordering of priorities may therefore be required to emphasize short-term measures to minimize contagion and to strengthen crisis resolution tools to mitigate the impact of the global financial crisis. These measures should include intensified surveillance to facilitate early detection of risks; contingency planning to reduce potential runs on banks and protect depositors; improved arrangements for home and host country supervisory relations and contingent crisis management; monetary policy that facilitates flexible provision of liquidity support to the banking system; and stronger bank resolution frameworks to ensure the orderly exit of weak banks.
The short-term priorities, however, should not detract governments from the need for longer-term reform to reinforce and diversify their financial systems. Healthy and diversified financial systems are critical for robust growth, and a stable macroeconomic environment is essential for financial system development and stability. Reforms should therefore be sustained to (i) further strengthen supervision of financial systems and address regulatory gaps, particularly consolidated and cross-border supervision; (ii) address weaknesses in the legal and financial infrastructure to facilitate financial intermediation (auditing and accounting; credit registries; financial safety nets; payment systems; and insolvency procedures); (iii) further develop capital markets and long-term contractual institutional investors, including insurance companies and pension funds to ensure the availability of long-term finance; and (iv) ensure effective financial sector surveillance by addressing deficiencies in the data needed for risk identification and by strengthening monitoring systems.
The Global Environment and Transmission Channels
How Much Worse Can It Get for Sub-Saharan Africa?
The global financial crisis that started with the bursting of the housing bubble in the United States led to general concern about credit quality in advanced economies, unanticipated contagion to other financial assets, and a sharp retrenchment of credit, including to developing countries. Advanced economies have responded with massive liquidity injections by central banks and the mobilization of public resources to recapitalize banks, insure deposits, guarantee money market transactions, and buy back troubled assets. Nevertheless, the April 2009 World Economic Outlook projects a more pronounced global downturn than envisaged just six months ago and a significant decline in commodity prices this year.
Heightened risk aversion has contributed to higher spreads for international borrowing and a steep decline in capital flows to emerging market economies and low-income countries. Credit spreads have widened in riskier asset classes worldwide. Similarly, the price of default insurance for emerging market instruments such as credit default swaps has risen. With the price of sovereign risk increasing, lending such as trade finance has become more expensive, while volumes are expected to decline worldwide both as a result of trade contraction and the deleveraging by banks of advanced economies. The funding difficulties of financial institutions in advanced economies have led investors to cut back on investments in sub-Saharan African countries.
Prospects for a quick recovery appear low. Pressures in mature markets to deleverage as a result of asset price deflation and market pressures to raise capital and shed assets are expected to keep credit tight for some time. Reduced risk tolerance, market pressures requiring higher capital cushions, and the global slowdown suggest that credit growth in mature economies may not follow a normal cyclical recovery until deleveraging has fully run its course.
How Exposed Is the Region to the Crisis?
Sub-Saharan African countries are so heterogeneous that their exposure to the crisis varies greatly, reflecting differences in (i) financial market development; (ii) linkages to global financial markets and institutions; (iii) the initial soundness of their financial systems; and (iv) their capacity to respond to the shocks flexibly and comprehensively. Countries that have a sound financial system, substantial reserves, and fiscal surpluses are better placed to weather the storm; those that are more integrated with global markets are feeling the contagion faster; those with stronger financial systems and with flexible policy frameworks could absorb shocks better and mitigate the effects more effectively.
In terms of financial depth and the degree of capital and financial market development, three distinct groups can be discerned (see Figure 2.1. and Box 2.1). The first consists only of South Africa, an “emerging market” country; the second contains 12 countries now commonly termed “frontier markets”; and the last, the financially developing group, consists of those countries—the majority—with underdeveloped financial systems:
South Africa, as an emerging market country, is vulnerable to changes in market sentiments and to contagion. It is thus subject to potential pressures in financial markets, although strengthened supervision of banks and enhanced risk management by banks are mitigating factors. Stress in South Africa’s financial system could also have regional implications, since several of its financial institutions (banks and insurance companies) have operations elsewhere in the region. Finally, although corporations and sovereigns are less dependent on funding abroad than in other emerging markets, unsettled global markets inevitably affect access to international markets—primarily through increased spreads.
In frontier market countries, the more limited integration of their financial systems with global markets, the size of their financial systems, and linkages within the system suggest that financial stress might be localized or spread more slowly. However, although foreign investors account for a relatively small share of local debt and equity markets, because the markets are relatively shallow, changes in foreign investor sentiment can exert pressures on their debt, equity, currency, and money markets. Unsettled international markets also make it more difficult for issuers to access the markets.
In financially developing countries, the narrow range of financial institutions, their relatively small size, and the lack of access to credit limit the direct impact of the crisis. For these countries, the crisis is likely to arrive through other channels, such as slowing growth or declining commodity exports and prices.
Are sub-Saharan African countries less exposed to the crisis than countries elsewhere? Financial depth indicators (Figure 2.1) for emerging and frontier market countries suggest that their degree of financial depth is approaching that of comparator groups, other than developing Asia. However, financially developing countries continue to lag.
How Important Are Channels of Transmission?
The channels through which the current crisis can be transmitted to financial systems in the region are both direct, through financial linkages with local debt and equity markets and effects on currency markets, and indirect through effects on the real economy, as on demand and confidence. Chapter I discussed the effects on the economy of such indirect channels as lower foreign demand, changes in commodity prices, and changes in aid. These effects clearly overlap and may feed each other: spillovers to the real economy, tighter global credit conditions, and increasing risk aversion are likely to combine to affect financial systems in sub-Saharan Africa in two ways:
Figure 2.1.Sub-Saharan Africa and Comparator Groups: Financial Depth Indicators
Source: IMF, International Financial Statistics and World Economic Outlook.
Box 2.1.Financial Systems in Sub-Saharan Africa: One Size Does Not Fit All
Financial market structure and degree of development vary significantly across sub-Saharan African countries so the nature and pace of risk transmission also differ. Three groups of countries can be identified on the basis of financial depth indicators and capital market development1 (see Table 2.A1):
Emerging markets: South Africa, the only emerging market in the region, has a well-developed financial system with a full continuum of market segments that are interconnected and integrated with global markets. The financial system includes subsidiaries of foreign-owned banks and insurance companies; large domestic financial conglomerates, asset management firms, insurance companies, and pension funds, many with significant cross-border operations in sub-Saharan Africa and other regions; and nonresident and institutional investors (pensions, insurance, hedge funds) that invest heavily in equities and debt markets. Sovereign and corporate debt issuers are active in both domestic and international markets, and may issue in South Africa’s own currency in developed off shore markets.
Frontier market countries: This group consists of five middle-income countries (Botswana, Cape Verde, Mauritius, Namibia, and Seychelles) and seven low-income countries (Ghana, Kenya, Mozambique, Nigeria, Tanzania, Uganda, and Zambia). Though they vary in their degree of financial development, the linkages between financial segments and with global markets are fewer than in emerging markets. Foreign investors have increasingly participated in local and debt markets. Financial products are becoming increasingly sophisticated and this group has made initial forays in accessing international capital markets.
Financially developing countries: The other 31 sub-Saharan African countries have narrow financial sectors, in which most segments are underdeveloped, and few financial instruments. Access to global financial markets has been nonexistent or severely limited; where capital markets exist, they lack depth and liquidity. Systemic and institutional constraints have also contributed to a low level of intermediation and limited availability of financing for productive investments.2
Sub-Saharan Africa: Financial Indicators
Source: IMF, African Department database.
|Sub-Saharan Africa:||South Africa||Frontier Markets||Financially Developing|
|Private sector credit/GDP||27.4||29.4||33.8||55.6||63.5||72.1||11.1||14.0||18.4||10.9||9.8||10.5|
Lower foreign inflows (direct effect), specifically lower foreign direct investment (FDI) and portfolio flows into domestic equity and debt markets. This has several immediate impacts on the financial sector. The decline in equity prices has an impact on banks in terms of credit risk when customers have been actively engaged in borrowing for equity purchases directly (Nigeria and Uganda; see Box 2.2 on Nigeria) or through equity derivatives (South Africa). It also greatly limits their ability to raise funds to increase their tier 1 capital when they need it, and their ability to deal with large shocks. Currency depreciations affect bank balance sheets directly when there are currency mismatches. The hardening of terms and reduction in lending volumes—especially for trade finance—affect the liquidity of banks, especially when rollover risks are major or when maturity mismatches are large. Together these developments reduce banking system liquidity, curtailing banks’ capacity to lend and reducing the buffers they have available to deal with liquidity shocks.
Weakened banking systems (second round effects), undermined by a combination of increased direct credit risk due to sectoral developments (e.g., falling commodity prices, especially when risk concentration is high) or substantial pressures on household income and balance sheets, and indirect credit risk through the effects of currency depreciation on some borrowers or of increased interest rates. These effects can be compounded by major supervisory gaps. The spillover of the crisis to the real economy could erode bank profitability and soundness, further affect market sentiment, and—when there are doubts on the soundness and liquidity of individual institutions—potentially trigger financial instability.
The Impact of the Crisis on Financial Markets and Institutions
Before the crisis, banks—which dominate the financial systems in sub-Saharan Africa—were increasingly better capitalized and more profitable and liquid, though there were some significant exceptions.1 Capital markets recorded major gains, and frontier countries (Ghana, Kenya, Nigeria, Uganda, and Zambia) managed to attract substantial numbers of foreign investors into their debt and equity markets. High liquidity in money markets was reflected in low interest rates and appreciation pressures in foreign currency markets.
The financial crisis that originated in the United States subprime market in 2007 initially had little impact on sub-Saharan African financial systems because their direct exposure to adverse developments in the United States and European financial markets was minimal.2 As in other emerging or developing economies, this reflects the relative lack of sophistication of the banking sector, limited off-balance sheet operations, and in some cases the effects of exchange controls.
However, pressures on domestic capital and financial markets intensified as the crisis deepened and broadened to affect the functioning of interbank markets in the United States and Europe. Off shore investors began to divest themselves of African government securities and holding in equity markets to meet liquidity needs, and their risk aversion grew. The confluence of these factors was reflected in major equity corrections, currency depreciations, and higher interbank rates. In South Africa, the money markets were little affected, however, and most of the tensions have been reflected in the slide of the rand and of equity prices. Though the market for securitization dried up, banks were less dependent on it for their funding than those in more advanced economies. Some countries (Botswana, Kenya, Namibia, Nigeria, and South Africa) with relatively developed pension funds that are invested in local markets have also recorded a deterioration in the financial performance of these funds. In some countries (e.g., Ghana and Nigeria), trade finance has already been affected, with upward pressure on costs (see Box 2.3).
Figure 2.2.Selected African Countries: Stock Market Index
(Jan.1, 2008 = 100)
After rallies lasting over two years in which markets yielded double digit returns, equity markets across the region experienced a sharp correction in the wake of the Lehman Brothers collapse (Figure 2.2). Stock indices for Botswana, Kenya, Namibia, Nigeria, South Africa, Uganda, and Zambia registered large declines in dollar terms last year and only three markets (Ghana, Malawi, and Tanzania) closed in 2008 with positive returns. Although the pressures are closely linked to the financial crisis, for some countries the financial turmoil merely compounded underlying vulnerabilities. In Kenya, for example, the correction began before September due to political uncertainties and conflicts. In Nigeria, the decline in equity prices was further accentuated by the practice of lending for share purchases.
The impact of the stock market declines on the rest of the financial system and on wealth has been mostly limited, in large part because equity markets are small and prudential regulations limit the direct exposures of banks to equities. The few countries where declines in local equities have affected the banking sector include Kenya, Nigeria, South Africa, and Uganda. In some of these countries, the share of financials in stock market capitalization is high (Table 2.1). The impact has been most pronounced in Nigeria, where banks had increased their reliance on equity markets to raise capital and engaged in lending for share purchase. The retreat of investors and the associated poor performance of equity markets are likely to slow the expansion plans of Nigerian banks.
(Share of financials in percent)
|Zambia||17.9|Box 2.2.Nigeria’s Financial System and the Spillovers from the Global Crisis
Nigeria’s economy is severely affected by the global financial crisis and recession, mostly through the decline in the price of oil, which accounts for most exports and three-fourths of government revenues. As a result, the fiscal and external current account balances are projected to swing from a sizable surplus to a large deficit. The global credit crunch has also resulted in tighter terms on the international credit available to banks and withdrawal of foreign investment from the domestic stock market.
The fall in oil export receipts has dented confidence and, together with the increased cost and shortened tenor of foreign trade-related credit, put pressure on the foreign exchange market and caused some banks to experience liquidity problems. In response, the authorities took a number of measures to inject liquidity into the system, and allowed a depreciation of the U.S. dollar exchange rate. More recently, authorities have considerably tightened access to the foreign exchange market and reverted to a retail Dutch auction system; while the rate against the U.S. dollar has been broadly stable since mid-February 2009, a sizable parallel market premium has emerged. The oil reference price for the 2009 budget has been reduced to US$45 per barrel (from US$59 in 2008), which will contain public spending.
The direct fallout from the global financial crisis on the Nigerian financial sector has been significant but not destabilizing. Nigerian banks are not exposed to complex domestic or foreign financial instruments; foreign ownership of banks is very low; reliance on foreign funding is limited; and the pace of capital outflows has been restrained, partly due to capital account restrictions on the repatriation of proceeds from the sales of domestic securities.
Nevertheless, the financial sector is exposed to major domestic risks following a period of rapid credit growth in the past two to three years (see first figure). The successful bank consolidation in 2005 led to a welcome strengthening of bank intermediation and was followed by rapid credit growth as banks sought to increase their return on capital. There is a significant risk that an increasing share of bank loan portfolios could become nonperforming, especially in the context of declining equity prices (see second figure), falling oil prices, and weaker growth. Although Nigerian banks report very strong capital positions, the authorities should continue to step up monitoring of the banks to assess evolving risks.
Nigeria: Private Sector Credit Growth
Source: Central Bank of Nigeria.
Nigeria: Equity Price Developments
(1/1/2007 = 100)
Box 2.3.The Impact of the Global Crisis on Sub-Saharan African Financial Systems: A Closer Look at Emerging and Frontier Markets
This box focuses on four frontier and emerging market economies in Africa (Ghana, Kenya, Nigeria, and South Africa). It summarizes how financial flows to the four countries have been affected, and how changes in external financial conditions have affected domestic financial systems and corporations. The box finds that portfolio and external borrowing have largely dried up and trade financing has become more costly and scarce. While nonperforming loans are still manageable, they are expected to rise with a slowing in economic activity. Credit conditions have tightened, in particular credit to small- and medium-sized enterprises.
There has been considerable effect on portfolio flows and external borrowing by banks:
The sizable inflows to equity and (in some cases) bond markets in recent years have come to a halt (South Africa) or have been substantially reversed (Ghana, Kenya, Nigeria).
Credit lines to domestic banks from international banks have come under significant pressure, (with reduced limits, repricing with higher spreads, and some cancellations).
Conditions for trade finance have become less favorable but without yet causing significant disruptions of trade:
Costs (interest costs, confirmation charges) have risen, and there is increasing pressure in some countries for letters of credit to be cash-collateralized.1
Financing is generally taking place through larger well-established local banks.
There has been only modest contagion to local subsidiaries of international banks.
Subsidiaries of major international banks do not depend on funding from parents, and rely instead on solid domestic deposit bases.
In some cases lending policies have become more cautious because of regulatory requirements and scarcity of capital in the home country.
There have been no unusual capital transfers from subsidiaries to parents.
Credit conditions have tightened:
Banks are imposing stricter lending criteria (collateral, deposit requirements) and focusing their lending on high-quality core clients.
Banks have limited appetite for new business.
Lending margins have widened significantly, most notably on foreign exchange-denominated loans but also on local currency lending.
Nonperforming loans are at manageable levels, with no notable disruptions from sizable exchange rate changes, but are expected to rise as economies slow:
Banks generally see a “normal but intense” credit cycle, without systemic disruptions. But it is still early in the downturn.
Stress on credit will also reflect in some cases rising interest rates, credit concentration in economic sectors, and a more challenging macroeconomic situation.
In Kenya and Uganda, the impact has been modest, with some banks reporting balance sheet losses due to nonperforming loans associated with the practice of lending for stock purchases. In South Africa, two banks had losses due to the inability of some investors to meet margin calls on equity derivatives (single stock futures and contracts for differences). Unfavorable developments in domestic equity markets are also likely to undermine the performance of large South African institutional investors, primarily pension funds and life insurance companies.
As liquidity in global credit markets declined, the bond markets of several sub-Saharan African countries came under intense pressure. Nigeria, South Africa, Uganda, and Zambia registered significant net outflows from their local debt markets. In addition, several countries (Kenya, Uganda, and Zambia) had to postpone issuing bonds because international capital market conditions were unfavorable (Table 2.2). South Africa, although not depending much on international borrowing, is affected by the increase in spreads (Figure 2.3 and Box 2.4). Meanwhile, the market for structured finance has dried up.
(Millions of U.S. dollars)
|South Africa||1,697||2,681||4,699||9,814||1,533|Figure 2.3.Emerging Markets CDS and EMBI Spreads
In South Africa, total asset-backed securities issued in 2008 were R5.3 billion—one-eighth of the large volumes issued in 2007.3 As corporate bond issuance slowed substantially, firms turned to the commercial paper market as a fall-back option.
In some instances, portfolio outflows may have been limited by capital controls—a disincentive for foreign participation in the first place. Foreign participation in Nigerian debt markets is restricted to long-term bonds, which may limit rollover risk and capital flight. Uganda and Zambia have fully liberalized their capital accounts but other countries (Nigeria and Ghana) have residual capital controls.4
Foreign Exchange Markets
Exchange rate pressures emerged as increased risk aversion and deleveraging triggered outflows, and in some cases, the unwinding of carry trades.5 The currencies of the relatively open economies of Kenya, Mauritius, South Africa, Uganda, and Zambia have come under particular pressure, and most currencies depreciated against the dollar (Figure 2.4).
Figure 2.4.Selected African Countries: Exchange Rates
(Jan.1, 2008 = 100; National currency per U.S. dollar)
Money Markets and Interest Rates
Money markets continued to function normally with pressures mainly reflected in increased interbank rates and shortening of maturities. To manage the potential impact, several countries (e.g., Uganda) eased their monetary policy stance and made net liquidity injections through monetary operations. In Nigeria, where pressures were most pronounced because of reduced access to short-term dollar borrowing abroad, the Central Bank of Nigeria has had to use various measures to inject liquidity into the banking system, including lowering the reserve requirements.
The absence of generalized liquidity pressures notably reflects (i) the lack of a developed interbank market where contagion could spread, (ii) limited funding from abroad and from wholesale markets, and (iii) the large share of treasury bills and other liquid assets in the balance sheets of banks before the crisis.6 In past years, high commodity prices, increased remittances, portfolio capital, FDI, and budgetary aid coupled with limited lending opportunities allowed the banking systems of sub-Saharan African countries to accumulate substantial liquidity buffers, which often took the form of foreign assets.7 There are preliminary indications that banks in the region have started drawing down these foreign assets (Figure 2.5).
Box 2.4.South Africa and the Impact of the Global Financial Crisis
The financial sector fallout from the global crisis has been manageable for South Africa so far, but the macroeconomic impact is likely to be significant, particularly as the current account adjusts.
The global financial crisis has seriously weakened the rand, the stock market, and international measures of credit risk. Like other emerging market currencies, the rand depreciated sharply in October 2008, but has retraced some of its losses. The main stock market index had declined considerably: weakness in financials has been compounded by weakness in manufacturing and mining equities. Credit default swap and EMBI spreads have widened, signaling an elevated perception of risk among investors. Net portfolio inflows have turned negative, with some limited FDI inflows, nonresident deposits, and bank foreign asset repatriation financing the large current account deficit.
By contrast, local bond and money markets have continued to operate without major strain, and financial institutions remain stable and well capitalized, despite some impairment of asset quality. Bond yields have dropped from their 2008 peaks in anticipation of large cuts in the policy interest rate, but have picked up lately in reaction to the widening public sector borrowing requirement. Interbank interest rate volatility has been low, reflecting adequate liquidity and confidence between domestic market participants. The South African Reserve Bank has not provided exceptional liquidity support. Banks have remained relatively insulated from global liquidity tensions, given the low level of foreign funding—representing less than 6 percent of their liabilities—and limited reliance on securitization. Dollar liquidity has remained adequate, helped by the deep foreign exchange swap market and the relatively low dollar funding needs of banks. Low dollarization also makes balance sheets throughout the economy resilient to exchange rate depreciation. Financial institutions remain well capitalized, and exposure to foreign asset classes and institutions in distress is low. However, nonperforming loans are rapidly rising (from a low base), calling for higher bank provisioning with the corresponding negative effect on profitability.
South Africa: Recent Developments in Financial Markets
South Africa: Government Bond Yields
South Africa: Interest Rates
The impact of the crisis is being felt mainly through the economic slowdown, commodity price decline, and the likely adjustment of the current account deficit as external financing becomes constrained. Growth in Q4 2008 turned negative at –1.8 percent (seasonally adjusted annualized rate), with private consumption and investment contracting. Most analysts see GDP declining slightly in 2009, underpinned only by the public investment program. Both the growth of export and import volumes are slowing rapidly, pulled down by low partner country and domestic demand. The sharp drop in the prices of platinum and coal is rendering marginal mines un profitable, reducing mining sector output and employment. External financing is likely to be limited if global financial market conditions remain fragile.Note: This box was prepared by Nikolay Gueorguiev and Jerome Vacher.
Figure 2.5.Total Foreign Assets and Foreign Liabilities of Deposit Money Banks in the African Region, 2005–08
(Billions of U.S. dollars)
Source: IMF, International Financial Statistics.
Financial institutions in sub-Saharan African countries have been resilient. Banking systems, which account for the bulk of the financial system, have so far reported no incidences of insolvencies associated with contagion effects, nor of government-led bank recapitalizations, which would be directly due to the ongoing turmoil.
The relative resilience of banks reflects a variety of factors, including the limited degree of sophistication of banking products. Although sub-Saharan African countries are home to subsidiaries of internationally active banks, including those that have been directly affected by the crisis, the local subsidiaries have little exposure to subprime mortgage products or to derivative products. Except for South Africa, which relies heavily on domestic wholesale depositors, banks in sub-Saharan Africa predominantly rely on low-cost retail deposits for funding and there is little borrowing from international markets or from parent institutions. The banks have low leverage and moderate loan-to-deposit ratios.
Risks and Vulnerabilities
The spillover of the financial crisis to the real sector has increased the risk of an adverse feedback loop between the real economy and the financial sector. Deterioration in domestic economies, if prolonged, could substantially increase credit risk and lower liquidity from domestic sources (households and corporations)—in the wake of decreased foreign sources of liquidity (lower export earnings, portfolio inflows, and remittances). The banks’ problem might be compounded by the effects of policy-induced macro-imbalances (e.g., those associated with fiscal pressures) and greater exchange rate volatility.
The impact of the economic slowdown combined with adverse changes in commodity prices is likely to be the most important effect in a number of countries. While historical data in most countries do not allow a forward-looking quantification of the credit risk of a potentially protracted economic slowdown, it would ultimately be significant in most countries by affecting the corporate sector and households, as well as the sovereign sector. The quality of bank asset portfolios is likely to erode. Credit risks will also reflect the projected fall in commodity prices, affecting especially oil exporters and exporters of nongold commodities (see Chapter I).
The potential deterioration in asset quality is magnified by substantial risk concentration that prevails in a number of domestic economies. Such is the case in WAEMU and CEMAC countries, where large exposure limits are regularly and substantially breached.8 For WAEMU, single exposures are limited by regulation to a generous 75 percent of capital, but the largest individual exposures often amount to several times a bank’s capital. Sectoral developments, perhaps due to a shift in commodity prices or difficulties in some large corporate balance sheets, could therefore have serious implications for financial system soundness.
Contagion by Deleveraging and Rollover Risks
Countries where foreign banks have large claims on domestic banks are also vulnerable. The region as a whole has net claims on banks reporting to the Bank for International Settlements (BIS), but few African countries have significant outstanding liabilities to banks abroad (Figure 2.6, and Tables 2.A2 and 2.A3 for country-specific data on gross claims and liabilities). To the extent that these liabilities need to be rolled over, those countries may find it difficult to refinance or may be charged higher interest rates.
Figure 2.6.Sub-Saharan Africa: Net Claims of BIS Reporting Banks, End-September 2008
(Percent of GDP)
Sources: Bank for International Settlements and International Monetary Fund.
Note: “Net claims” is defined as BIS reporting bank claims on minus liabilities to individual countries. Data for Cape Verde (–73.5), Liberia (380.6), and Seychelles (–366.4) are truncated in the figures.
Transmission channels through which foreign bank ownership might adversely affect sub-Saharan Africa are threefold: (i) parent banks might be less willing to provide liquidity to their subsidiaries; (ii) parent banks might be tempted to try to repatriate capital from sub-Saharan Africa due to balance-sheet losses at home; and (iii) parent banks might be unwilling or unable to inject additional needed capital into sub-Saharan African subsidiaries or branches.
The predominance of foreign-owned banks in sub-Saharan African financial systems exposes the region to capital repatriation if these banks were to deleverage or close their local operations. In about 20 sub-Saharan African countries, the majority of banking assets are foreign-owned (see Table 2.3.), and French banks are active in the CFA franc zone (see Box 2.5), as are U.K. banks (Barclays and Standard Chartered) in southern Africa. The main exceptions are Nigeria, where foreign-owned banks account for a small percentage of bank assets, and South Africa.
|Host Country||Assets Held by Foreign Banks (percent)||Largest Foreign Banks||Home Countries of the Largest Foreign Banks|
|Angola||68||Angolan Development Bank||Portugal|
|Espiritu Santo Bank of Angola (BESA)||Portugal|
|Totta Angola Bank (BTA)||Portugal|
|Botswana||99||Barclays Bank of Botswana||United Kingdom|
|Standard Chartered Bank Botswana||United Kingdom|
|First National Bank of Botswana||South Africa|
|Cape Verde||74||Banco Comercial Atlantico||Portugal|
|Banco Caboverdiano de negocios||Portugal|
|Chad||75||Société Générale Tchadienne de Banque (SGTB)||France|
|Commercial Bank Tchad||Cameroon|
|Comoros||92||Banque pour l’Industrie et le Commerce (BIC)||France|
|EXIM Bank Tanzania||Tanzania|
|Congo, Dem. Rep. of||90||Banque Congolaise||United States|
|Banque commerciale du Congo (BCDC)||Belgium|
|Congo, Republic of||57||BGFI-Congo||Gabon|
|Banque Marocaine du Commerce Exterieur (BMCE)||Morocco|
|Côte d’Ivoire||56||Société Générale||France|
|Banque Internationale pour le Commerce & l’Industrie en Cote d’Ivoire (BICICI)||Belgium|
|Ghana||55||Barclays Bank||United Kingdom|
|Standard Chartered Bank||United Kingdom|
|Lesotho||97||Standard Bank||South Africa|
|Madagascar||71||Mauritius Commercial Bank (MCB)||Mauritius|
|Banque Malgache de L’Océan Indien (BMOI)||France|
|BFV-Société Générale (SG)||France|
|Mauritius||72||Barclays Bank||United Kingdom|
|Hong Kong and Shanghai Banking Corporation (HSBC) Mauritius Ltd.||United Kingdom|
|Standard Chartered Bank||United Kingdom|
|Mozambique||100||Banco Internacional de Mocambique (BIM)||Portugal|
|Standard Bank||South Africa|
|Namibia||73||Standard Bank Namibia||South Africa|
|First National Bank||South Africa|
|São Tomé & Príncipe||100||Banco Internacional de STP (BISTP)||Portugal|
|Afriland First Bank||Cameroon|
|Seychelles||56||Barclays Bank||United Kingdom|
|Mauritius Commercial Bank (MCB)||Mauritius|
|Bank of Baroda||India|
|Swaziland||70||Standard Chartered Bank of Swaziland Ltd.||United Kingdom|
|NedBank Swaziland Ltd.||South Africa|
|First National Bank Swaziland Ltd.||South Africa|
|Tanzania||52||NBC Ltd.||United Kingdom|
|Barclays Bank||United Kingdom|
Nonetheless, even if those risks are real, there are a number of mitigating factors compared to other regions. The first risk, cuts in funding, is mitigated because in many countries subsidiaries have been able to raise deposits locally, rather than parents providing funding for them. The second risk, repatriation of capital, is mitigated because most foreign bank operations have been profitable while at the same time representing a small share of the assets of parent banks. The third risk, lack of capacity to increase capital buffers, is likely to materialize in a number of countries and could be quite challenging for supervisory authorities—in particular, where the amount of capital in the system was already low.
Increasing cross-border intraregional banking ownership may raise risks. Potential benefits of financial integration, such as increased opportunities for risk-sharing and diversification, better allocation of capital among investment opportunities, and potential for higher growth, are widely recognized. However, greater cross-border banking ownership—one of the more visible signs of financial integration—could make the sub-Saharan African banking system as a whole more vulnerable to crises if those institutions are not properly supervised. Some banking systems have close ties to regional hubs, South Africa and Nigeria. Countries such as Lesotho, Namibia, and Swaziland have banking systems that are largely owned by South African banks. Nigerian financial institutions have also rapidly developed their operations, notably in West Africa (Benin and Côte d’Ivoire).9
Credit Retrenchment and Lower Funding
The growing liquidity that was experienced in many sub-Saharan African countries—often in the wake of high commodity prices—stimulated rapid credit growth in several countries (Figure 2.7). The concern is for countries where precrisis credit growth was relatively rapid and credit retrenchment could turn out to be severe, resulting in a “hard landing” with potential feedback effects on the economy (see Box 2.6). Banks in the region do not generally rely on foreign borrowing to fund their local operations (Figure 2.8). But in some countries, the high pace of growth in private sector credit has been fueled by a reliance on foreign funding.
Figure 2.7.Sub-Saharan Africa: Private Credit by Deposit Money Banks
(Percent of GDP)
Sources: IMF, International Financial Statistics, and World Economic Outlook.
Figure 2.8.Sub-Saharan Africa: Bank Credit to the Private Sector and Deposits
(Change from 2004 to 2007, percentage points of GDP)
Sources: IMF, International Financial Statistics; and World Economic Outlook.
Risks of Flow Reversals
In many countries, both foreign assets held by sub-Saharan African residents and foreign liabilities held by residents have risen as a share of GDP, with an overall decline of net foreign liabilities (Figure 2.9). However, the composition of the international investment position (IIP) is important for assessing the risks associated with financial openness. Figure 2.10 discriminates between countries in the region according to their net direct investment position, which in principle represents the less liquid part of the IIP and the net position of other components. In most sub-Saharan African countries, external liabilities exceed external claims, the exceptions being Botswana and Nigeria.10
Figure 2.9.Sub-Saharan Africa: Gross Assets and Liabilities, 2001–06
(Percent of GDP)
Source: IMF, International Investment Position database.
Figure 2.10.Sub-Saharan Africa: Net Direct Investment and Other Assets and Liabilities (net) Positions, as of 2006
(Billions of U.S. dollars)
Source: IMF, International Investment Position database.
Box 2.5.The WAEMU’s Financial Sector in the Face of Global Crisis
The global financial crisis poses risks to the banking sector of the West African Economic and Monetary Union (WAEMU). Home to sub-Saharan Africa’s larger regional banking groups (Ecobank and Bank of Africa) and to many foreign-owned banks and subsidiaries, WAEMU has significant financial linkages with Africa and the world. The share of foreign capital in the banking system varies by country but it was at least one-half in December 2006 with about one-third of total banking capital owned by foreign non-WAEMU entities. Should banks operating in the region face losses abroad, they might repatriate capital and become increasingly risk-averse, resulting in a contraction of credit in WAEMU. This contagion risk adds to the vulnerabilities of banks in the region.
Foreign Share of Capital
Liquidity Injections by BCEAO in 2008
Although the banking sector has undergone major restructuring in recent years, banks in the region are still exposed to sectoral shocks and to relatively large state-owned enterprises. Furthermore, the level of nonperforming loans is still relatively high, especially in Benin, Mali, and Togo. While WAEMU banks have historically held substantial excess liquidity, these margins diminished in 2008, leaving banks vulnerable to a potential contraction in liquidity. Indeed, the demand for BCEAO liquidity injections through a new facility, introduced in the last quarter of 2007, has been increasing. Cross-border interbank lending also increased significantly between the fourth quarters of 2007 and 2008.
An intensified liquidity squeeze would have repercussions for WAEMU economies. The banking sector plays a critical role in prefinancing agricultural production and trade. In Benin, Togo, and Mali, for example, cotton production is often prefinanced by domestic banks; a decrease in prefinancing could have a serious impact on production and exports of cotton. Although there are no hard data yet on recent changes in total trade financing, there is a fear that trade finance, in particular commodity finance—e.g., for cotton and cocoa—could already be under pressure as international banks limit their exposure.Note: This box was prepared by Jihad Dagher.
Box 2.6.Rapid Credit Growth in Sub-Saharan Africa: Risks and Policy Responses
Financial deepening has accompanied the pickup in economic growth in sub-Saharan Africa since the mid-1990s. In 2003–07, a number of sub-Saharan African countries experienced average annual growth of real bank private sector credit of more than 20 percent, nearly doubling the ratio of bank private sector credit to non-oil GDP.1 In general, these are countries with low initial levels of financial development, in which the acceleration of bank credit occurred in the aftermath of macroeconomic stabilization and was accompanied by robust economic growth.
Rapid credit growth generally entails prudential and macroeconomic risks. Greater credit availability can fuel internal and external imbalances, including goods and asset price inflation, widening current account deficits, and a higher external debt burden. On the prudential side, rapid credit growth can compromise credit quality as bank management and operations are strained by increased business. Furthermore, the rising asset prices that often accompany credit expansion increase collateral valuations, making loans appear better provisioned and encouraging banks and their clients to take more risk. A reversal of asset markets can lead to an abrupt deterioration in loan quality. These intertwined macroeconomic and financial risks reinforce each other, with the majority of credit booms2 in emerging markets preceding currency or banking crises.
The global financial crisis has significantly slowed credit growth in most sub-Saharan African countries. These countries have been negatively affected by the precipitous drop in global demand for their exports and the drying up of external financial flows. As a result, credit growth, which is procyclical, has begun to slow significantly.
Per Capita GDP Growth and Private Sector Credit, 1997–07
Median ratio of private sector bank credit to non-oil GDP (Percent)
Source: IMF, International Financial Statistics and World Economic Outlook.
Median Growth of Real Private Sector Bank Credit
Source: IMF, World Economic Outlook.
How vulnerable are sub-Saharan African countries to a sudden halt in credit growth? The verdict is still out whether the deceleration of credit growth will overshoot its equilibrium response to worsening fundamentals. On the positive side, most sub-Saharan African countries where credit has grown rapidly do not have excessive internal or external imbalances; their current account and fiscal balances and external debt (in ratio to non-oil GDP) are similar to those in the rest of sub-Saharan Africa. They have also generally avoided riskier funding sources, relying instead on domestic deposits and their faster turnover into new loans. On the negative side, the global crisis may yet trigger financial sector losses linked to deteriorating credit quality that can further slow down credit. A hard landing cannot be ruled out in countries with pronounced macroeconomic imbalances and weak financial sectors.
Policy responses: If the deceleration is orderly and in line with fundamentals, no policy action may be necessary. On the other hand, in countries where there are concerns about a credit crunch, financial sector losses, or both, policymakers should prepare contingency plans for shoring up the real and financial sectors.
The availability of monetary and fiscal space for proactive economic and supervisory policies would facilitate the responses and enhance their effectiveness. However, in countries with continued strong credit growth, the choice of policies to contain its negative effects would depend on the underlying causes. Tightening of monetary or fiscal policies or both is the preferred response when there are macroeconomic causes or when macroeconomic stability is at risk. Prudential measures should be strengthened when financial stability is at risk—to maintain the quality of credit, control risk exposures, and ensure adequate capital to absorb potential losses.
Note: This box was prepared by Plamen Iossifov and is based on Iossifov (2009).1 Rapid credit growth countries are Angola, Dem. Rep. of Congo, Equatorial Guinea, Ghana, Guinea-Bissau, Liberia, Malawi, Nigeria, São Tomé and Príncipe, Sierra Leone, Swaziland, Tanzania, and Zambia.2 Credit booms are defined as periods of extreme deviations of the log of real credit from its trend.
For the region as a whole, portfolio flows have averaged about 0.2 percent of GDP annually since 2000. However, in Gabon, Ghana, Kenya, South Africa, and Togo they reached more than 0.5 percent of GDP. Yet except for South Africa, markets in these countries are relatively illiquid. Some countries (mostly middle-income Gabon, Seychelles, and South Africa, but also Ghana and Nigeria) have tapped international capital markets in recent years. Before the crisis, countries where nonresident investors held more than 10 percent of total government debt included Ghana, Malawi, Nigeria, Uganda, and Zambia.
How Vulnerable Are the Financial Systems’ Balance Sheets?
While the capital and liquidity of banking systems, which dominate financial systems in most sub-Saharan African countries, are generally strong, vulnerabilities persist that could transmit and aggravate financial stress. Among them are high credit risk and concentrations in loan portfolios of banks, risk management by financial institutions that has not kept pace with innovations, and continuing gaps in supervision and financial sector surveillance (Table 2.4. and Figure 2.11).
Banking systems are generally stronger than in the 1990s, when the continent experienced a number of banking crises, with sustained levels of capitalization and liquidity in recent years (Figures 2.12 and 2.13, and Table 2.A4).
However, some countries have a large share of nonperforming loans and low capital adequacy ratios (e.g., some countries in WAEMU, CEMAC, and some postconflict countries). While countries with less diversified financial systems should ideally have higher capital adequacy ratios (CARs) to reflect higher credit risk, few sub-Saharan African countries set minimum CARs above 8 percent. Moreover, measured soundness indicators, besides being backward looking, may overstate actual portfolio quality, given weaknesses in accounting, auditing, and internal controls, and differences in compliance with the Basel Core Principles for Effective Bank Supervision.
|Sub-Saharan Africa||Emerging Market||Frontier Market||Developing|
|Nonperforming loans (percent of gross loans)|
|Regulatory capital/risk-weighted assets (percent)|
|Liquid asset ts (percent of total assets)|
Several mitigating factors are at play. First, sub-Saharan African banking systems have little exposure to complex financial instruments; thus, the potential losses are fewer than in mature and emerging markets. Second, abundant low-cost domestic deposits and liquidity have allowed banks to fund themselves without resorting to market borrowings and thereby minimize wholesale leverage on their balance sheet. Third, many banks have capital buffers, partly reflecting high profit margins and limited competition.
In sum, this discussion suggests four main conclusions:
While financial markets in sub-Saharan Africa may not be subject to the same kind of financial market turbulence seen in advanced economies, direct effects on banks and other financial institutions are likely to be more pronounced where financial systems are deeper and more developed. But financially less-developed economies are also at risk.
Second-round effects of the crisis will affect all countries through a worsening of the economic environment and less economic growth. Effects may occur with a lag. While there are some mitigating factors, sub-Saharan African financial systems are vulnerable.
In view of the unique nature of the global crisis, the increasing integration of many financial markets and institutions in Africa into the global economy, and the relatively small size of domestic markets, the potential impact of investors withdrawing can have a significant impact on the financial systems of some countries.
The crisis has limited the ability of some African countries to access international capital markets, a problem that is likely to continue as long as international markets are constrained by aversion to risk and high spreads.
Figure 2.11.Sub-Saharan Africa: Nonperforming Loans, 2004 and 2007
(Percent of gross loans)
Source: IMF, African Department financial sector survey questionnaires.
Figure 2.12.Sub-Saharan Africa: Liquid Assets, 2004 and 2007
(Percent of total assets)
Source: IMF, African Department financial sector survey questionnaires.
Figure 2.13.Sub-Saharan Africa: Regulatory Capital, 2004 and 2007
(Percent of risk-weighted assets)
Source: IMF, African Department financial sector survey questionnaires. Note: For Swaziland, data refer to regulatory tier 1 capital.
Policy Challenges and Issues
The financial crisis presents policy challenges for sub-Saharan African financial systems and for efforts to reform them; these include, primarily, how to (i) minimize contagion from the ongoing global financial crisis that has now spread to the broader economy; and (ii) continue developing and reinforcing financial systems in a significantly less-supportive domestic and external environment.
To deal with these challenges authorities will have to reorder policy priorities and improve their coordination with main players and counterparts. While sub-Saharan African countries should continue reforming their financial systems, they should take into account (i) the emerging lessons from the crisis and give priority to measures that mitigate its current and potential impact; and (ii) the need to coordinate financial sector and macroeconomic policies to ensure that developments in the financial sector do not fuel macroeconomic imbalances and that macroeconomic policies do not exacerbate financial sector vulnerabilities.
Short-Term Mitigation Policies
Policies to minimize contagion should be preventive and complemented by crisis management frameworks. Preventive measures include actions to (i) rapidly intensify surveillance to facilitate early detection of risks and improved monitoring; (ii) ensure that adequate liquidity is available in the financial system; and (iii) instill public confidence in the functioning of markets and institutions. Crisis management and resolution measures involve (i) strengthening financial safety measures; (ii) establishing effective bank resolution mechanisms; and (iii) setting up procedures for coordination with other supervisory and monetary authorities.
Financial system surveillance needs to facilitate early detection of stress in institutions and minimize the potential for system-wide crises. The pace of strengthening regulatory and supervisory frameworks—including establishing off-site surveillance systems—has been uneven across the region. Even in countries that have made significant progress, gaps remain with respect to stress-testing frameworks and high-frequency data for regular risk monitoring. Also, there has been limited mapping of the interlinkages in the financial system and limited knowledge of specific risks in corporate or household balance sheets.
Intensified surveillance for sub-Saharan African countries would involve a number of steps such as (i) developing higher-frequency financial risk indicators, such as data on the liquidity position of banks, interbank exposures, cross-border credit lines, and off-balance-sheet contingent claims; (ii) analyzing financial sector developments; (iii) collecting data on household and corporate balance sheets and indebtedness; and (iv) strengthening stress-testing frameworks to cover macroeconomic risks more comprehensively. A starting point for the improvements in surveillance is often the creation of financial stability committees within the central bank and, more broadly, regular working groups that would associate other supervisors (e.g., ministries of finance or other supervisory bodies in charge of nonbank financial institutions).
Strengthening Risk Management in Banks
Risk management in banks has progressed relatively slowly and should advance in tandem with improvements in supervision. Most financial institutions do not systematically undertake macroeconomic scenario stress-testing of their balance sheets. Financial institutions should therefore be encouraged to undertake stress-testing of the potential impact of the crisis and share those findings with the regulatory authorities. The stress-testing could be designed by regulatory bodies to ensure that the findings can inform policymakers adequately. Subsidiaries of foreign banks should also be encouraged by both their home and host supervisors to draw on the stress-testing capacity available in parent banks, which has been significantly expanded with the implementation of Basel II.
Coordinating with Other Countries
Cross-border supervisory arrangements within the sub-Saharan African region remain weak despite the rapid growth of regional banking groups and the regional integration of financial markets. Monetary authorities and other regulatory bodies should also cooperate with their international counterparts to prevent crises that originate in an individual institution or banking system from translating into a regional crisis. This is particularly relevant for the monitoring of regional banking groups—which have developed and rapidly expanded their operations in the region—and all the more important when supervisory capacity has some weaknesses with cross-border issues. This would include improvements in a number of areas, including information on risk assessments of institutions, regulations, liquidity provisions, and burden-sharing.
Several countries in sub-Saharan Africa have signed memoranda of understanding and have initiated efforts to strengthen cross-border supervisory arrangements; but increased coordination and information sharing are needed, especially in times of global turmoil. Home-host supervisory authorities should be ready to engage more actively in the sharing of information, as a way to improve surveillance but also to prepare the most adequate response should the situation deteriorate in the financial systems they supervise.
Preparing for Crises
Early intervention with a comprehensive and credible plan can help avoid a systemic crisis or manage its potential adverse effects (see Box 2.7). Although experience with past episodes of financial crises have helped some sub-Saharan African countries improve their banking resolution frameworks, the process is far from complete and progress is uneven across the region. Thus, it is important that countries stipulate clear principles, policies, and procedures for handling a systemic crisis or a large individual bank failure. This is especially important as fiscal authorities—with stretched capacity—may be called upon in the absence of other sources of capital or liquidity. An ex ante identification of which failures would constitute a systemic risk (e.g., depending on the size and potential for contagion of the institution) with an associated cost benefit analysis of potential needs for recapitalization would help in this regard.
Plans should provide for orderly market exits and, where feasible, appropriate protection for depositors to ensure continuing confidence in the financial system (Box 2.8). The legal and regulatory frameworks should be reviewed to ensure that they provide the necessary tools to allow authorities to support and if necessary, intervene in banks under their supervision and to ensure that there are no disruptions to the payments systems.
Central banks should have in place flexible policy frameworks to inject liquidity in the system and ensure that markets continue to function. It is important that countries review their monetary and legal frameworks to ensure that the central bank can act as lender of last resort and adapt their collateralization framework. Three basic instruments are typically used by central banks to provide emergency liquidity support to a financial institution. In order of decreasing preference, they are (i) repo against a list of eligible securities or use of foreign exchange swaps; (ii) collateralized lending against a list of eligible assets (nonsecuritized assets cannot be used for repo operations); and (iii) lending against whatever collateral the bank has. During a crisis, it is important that (i) banks have ample flexibility to use their reserves at the central bank for short-term liquidity management; and (ii) changes be made to emergency lending instruments and the pool of counterparties if necessary. 11 To prevent current pressures from leading to instability in currency markets, countries should ensure adequate dollar liquidity in the system. In this regard, the framework should be reviewed to determine the extent to which it gives legal authority to the central bank to enter into swap arrangements with other central banks.
Box 2.7.Lessons for Sub-Saharan Africa on How to Manage a Banking Crisis
Recent work has identified a total of 124 systemic banking crises across the world since 1970, of which 40 in sub-Saharan Africa.1 While each crisis is different, the study has yielded important insights. This box reviews lessons for crisis management drawn from recent episodes.2
A systemic crisis emerges when problems in one or more banks are large enough to affect the functioning of the banking system. Often triggered by external shocks, concerns with the solvency and liquidity of some institutions can sometimes lead to runs by depositors. Moreover, the crisis can cause a credit crunch, a fall in asset values, and multiple bank failures.
Crisis management aims to restore confidence, protect the payment system, and improve solvency. Regulators have identified three aspects of crisis management:
Crisis containment: The first step is to stop runs, which usually requires liquidity injections. However, liquidity provision should be limited to solvent institutions, while nonsystemic insolvent ones should be closed early on to limit the risk of moral hazard. Administrative measures such as deposit freezes or bank holidays may be required, but these can cause major disruptions and should be viewed as a last resort.
Bank restructuring: The second step is to restore profitability and solvency. Viable but undercapitalized banks must present acceptable restructuring plans and nonviable banks must be resolved. Authorities must also determine how bank losses should be shared by shareholders, creditors, and taxpayers.
Asset management: At this stage, banks need to restructure or liquidate nonperforming loans, or assets can be transferred to a resolution institution. Political interference with the restructuring process must be avoided.
Coordination with macroeconomic policies is essential. Liquidity injections must be consistent with inflation and exchange rate objectives. In some cases, abandoning an unsustainable peg may be required. Alternatively, authorities may consider temporary capital controls, although there is no clear consensus on whether these are effective.
Banking crises can be very costly, especially for taxpayers. Costs include liquidity support, bonds issued for recapitalization purposes, payout of deposit guarantees, and losses on purchased nonperforming loans. Revenues from asset recovery are often small. According to recent evidence, higher costs are associated with open-ended liquidity support and the provision of blanket guarantees—a government announcement that it will honor all bank liabilities except capital.3
In sub-Saharan African countries, in principle, given the relatively small size of most banking systems in the region (see Table 2.A1), potential fiscal costs from rescuing banks may be smaller than in recent crises in emerging markets, which have ranged from 8 percent to 50 percent of GDP. However, given the considerable tightening in external financing available for the region and the implications for debt sustainability, many countries may not have the fiscal space necessary to rescue even a few banks, unless there are undesirable sizable fiscal adjustments in other key public spending areas. Large bailouts should therefore be avoided—unless they are deemed of the utmost importance to protect depositors or to avoid a systemic crisis and come after a comprehensive cost benefit analysis—as well as open ended liquidity support and the provision of blanket guarantees. Other options will need to be explored, e.g., that private funds be the first source for recapitalization, which may require reducing impediments to foreign investment in the sector.Note: This box was prepared by Rafael Portillo.1 See Laeven and Valencia (2008). All sub-Saharan African banking crises but one occurred between 1982 and 1995, often because of pervasive financial repression and large macroeconomic imbalances. Thus, these crises may be less relevant to the current context.2 This box is based on Hoelscher and Quintyn (2003)3 See Honohan and Klingebiel (2003)
Box 2.8.Deposit Insurance in Sub-Saharan Africa
The primary purpose of deposit insurance is to preserve financial stability by providing protection to the depositors from loss of deposit values up to a prespecified level in the event of bank failure. As such it differs from other types of deposit protection such as blanket guarantees and implicit deposit protection. Blanket guarantees—increasingly used during the current turmoil—are applied when a loss of confidence spreads to otherwise sound institutions and the resulting runs must be halted quickly. So far, no country in sub-Saharan Africa has had to implement a blanket guarantee.
So far, only four countries in sub-Saharan Africa (Kenya, Nigeria, Tanzania, and Uganda) have an explicit deposit insurance system in place (see table). However, a number have contemplated establishing such a scheme. Implementation lags for deposit insurance systems are often long, especially when a regional agreement needs to be reached (e.g., the CEMAC deposit insurance project started in 1999 but has not yet been implemented).
Successful features for the operation of deposit insurance schemes usually include (i) strong bank supervision, (ii) limited scope and coverage to limit moral hazard, and (iii) use of risk-adjusted insurance premiums aligned to the relative risk of failure. Difficulties for the systems currently operating in sub-Saharan Africa notably include implementation of a risk-based premium system—which is difficult in the absence of adequate data and surveillance—and ensuring sufficient funds for the scheme to cover banking failures on a large scale.
Sub-Saharan Africa: Deposit Insurance Systems
|Types of deposits covered||All||All except foreign currency||All except foreign and interbank||All except foreign and interbank|
|Coverage limits NC (US$)||K Sh 100,000 ($1366)||N 50,000 ($425)||T Sh 500,000 ($390)||U Sh 3 million ($1823)|
|Annual premiums||0.15% of||0.9375% of deposits||0.1% of deposits||0.2% of deposits|
|Premium assessment base||deposits Deposit liability||Deposit liability||Deposit liability||…|
|Risk adjusted premium||No||No||No||No|
|Operational independence||Within Central Bank||Independent agency||Within Central Bank||Independent agency|
Maintaining Public Confidence
While sub-Saharan African countries have not experienced runs on their banks as a result of the global crisis, significant depreciation pressures on domestic currencies have been felt in a number of these countries. If unabated, these pressures could have wider ramifications for financial systems, especially if market players perceive an elevated settlement risk or risk of a dollar shortage. Therefore, to maintain financial stability in markets, communication of policymakers with market participants should be strengthened.
Communication efforts should indicate the ability and willingness of the government to forestall disruptions in markets, including standing behind solvent institutions that encounter temporary liquidity difficulties. Depositors should be assured that when a bank is resolved, they will have immediate, or almost immediate, access to liquidity and continued access to banking services and their deposits. This is particularly important since most sub-Saharan African countries do not have deposit protection schemes, relying on implicit deposit guarantees, and many banking systems remain susceptible to rumors in the presence of important information asymmetries.
Medium-Term Policies for Financial Systems
Short-term measures to mitigate the impact of the crisis should not detract from efforts to enhance resilience to crises. This not only includes financial sector reforms but also the continuation of sound macroeconomic policies. Although the ultimate goals are similar to short-term measures, some policies entail relatively long implementation lags (see Box 2.9 for a discussion of the reform agenda post-global crisis). These policies would include addressing any gaps in the regulatory and supervisory frameworks; reinforcing the supporting financial infrastructure; and building on short-term policies to prevent crises to improve financial system surveillance and risk management in banks. In addition, policies should also deal with shortcomings in the operating environment of financial institutions, such as improving access to credit or enhancing the transparency and disclosure by financial intermediaries. Sustained efforts to deepen domestic capital markets for enhanced mobilization of savings are now even more necessary. Those countries that do manage to deepen local financial markets are likely to be able not only to lessen the impact of domestic government funding from crowding out the private sector but also to attract local institutional investors to participate in the financing of crucially needed infrastructure investments.
Addressing Gaps in Regulation and Supervision
Consistent with the systemic importance of banking systems in sub-Saharan African financial systems, reforms have largely focused on strengthening the regulatory and supervisory framework for banks while other sectors (capital markets, insurance, pensions, and microfinance) are only now beginning to receive attention. Regulation and supervision across the entire spectrum of the financial sector should be strengthened to minimize potential spillover effects from unregulated or poorly regulated sectors (Box 2.10). Consolidated and cross-border supervision for complex financial conglomerates need to be enhanced.12 There is also a general need to ensure that supervision keeps pace with innovation in the industry.
Box 2.9.The Financial Sector Reform Agenda in Sub-Saharan Africa: What Has Changed with the Crisis?
The precrisis financial sector reform agenda was broad-based and included a large set of measures to address both financial stability and development issues. The ongoing global turmoil has already led to some refocusing and prioritization of the agenda. Efforts to sequence reforms are notably giving immediate priority to (i) intensifying surveillance; (ii) limiting the most direct impacts from the turmoil—e.g., from the slide in equity markets—through targeted regulatory improvements; and (iii) improving the frameworks for systemic liquidity and crisis preparedness.
The emphasis has long been on improving supervisory frameworks, and the issues for reform are well known.1 Although the short-term priorities may have changed with the intensification of the global turmoil, the agenda and its implementation for the medium term remains broadly similar: (i) addressing gaps in regulation and supervision; (ii) strengthening institutional infrastructure for financial systems and markets; (iii) strengthening risk management in banks and nonbank financial institutions; (iv) improving the business and operating environment for financial institutions; and (iv) improving access and the diversification of the asset and funding base for financial institutions.
In fact, the crisis might have further accelerated the need for substantial reforms and the case for a broad-based agenda. In particular, the recovery from the eventual effects of the crisis will be facilitated if an adequate framework is already in place. Improving transparency and information on borrowers are important for the medium-term objective of facilitating access to credit. In less favorable times, such as during the current turmoil, they facilitate bank resolutions, while helping in the recovery of the financial system after an episode of credit crunch or protracted crisis. Risk concentration—both on the lending and funding side—is a long-standing issue, which is likely to come to light during the current turmoil and needs to be dealt with on a medium-term basis. There are no easy solutions to a problem that lies essentially in the concentration of economic activity. Developing the liquidity and depth of domestic markets to address some of the pitfalls of risk concentration in bank portfolios has become challenging but remains an important priority (e.g., in the WAEMU and CEMAC regions, but also in most countries relying on a few economic activities such as commodity exports).
The lack of capital and liquidity worldwide, combined with the adverse effects of the rapid slowdown of economic activity in advanced economies, also means that the rooms for maneuver for decisive financial sector reforms has considerably narrowed for the time to come. Such is the case where authorities are involved in large-scale bank restructurings (e.g., Togo) and in which foreign bank participation was expected to be an important component of a successful exit strategy for troubled institutions notably by including a substantial transfer of technology and know-how. It also poses serious challenges in the case of banking systems where a number of individual institutions need quick action to replenish their capital levels as they fall below minimum requirements. In a situation where government finances are already frail, the low availability of foreign capital and interest largely complicates the task of recapitalizing banks (such is the case in a number of WAEMU countries).
Although the role of the government in the banking sector may remain substantial, great care should be taken in replicating policy responses that have been implemented in advanced economies or previously in sub-Saharan Africa with limited success (such as a large expansion of state-owned development banks). This is notably true as the capacity of governments and related agencies is limited and often not sufficient to deal effectively with private sector challenges. There is a risk that governments engage in troubled banks that are nonsystemic or that supervisory authorities loosen prudential regulations in response to the crisis.Note: This box was prepared by Jerome Vacher of the IMF’s Monetary and Capital Markets Department.1 See, for example, “Making Finance Work for Africa,” World Bank, and published conclusions from FSAPs in sub-Saharan Africa, notably in the last three years (CEMAC, Cameroon, Madagascar, Mauritius, Namibia, South Africa. Available at www.imf.org/external/np/fsap/fsap.asp#cp.
Box 2.10.Pyramid, Ponzi, and Other Fraudulent Financial Schemes
While no pyramid or Ponzi schemes have been detected in sub-Saharan Africa in the aftermath of the global crisis, they are difficult to identify and can be a source of vulnerability.
Both types of schemes tend to involve large sections of the population, especially in countries with more shallow financial systems. Ponzies and pyramids are not limited to unsophisticated victims nor are they most prevalent in shallow financial systems. These schemes are difficult to identify when some financial trappings are added to make the deal or scheme appear more sophisticated and legitimate. Both typically have no true business activity or investments to generate the promised high returns, although some business, product, or service may be used as a front.
Although sometimes devastating to the defrauded individuals, typically such frauds are only a nuisance to the broad economy and not a systemic threat. However, when fraudulent schemes operate on a large scale, as in Albania in 1996 or Lesotho in 2007, they can cause or threaten major damage. At their peak in Albania, the nominal value of the fraudulent schemes’ liabilities amounted to almost half of GDP. Collapse of the schemes led to rioting, fall of the government, and near civil conflict. At the end of 2007, the Central Bank of Lesotho took action to suspend the operations of an unlicensed financial institution alleged to be operating as a Ponzi scheme (estimated to have grown to about 8 percent of GDP) before it was shut down. The entity offered several schemes for almost seven years.
Both types of schemes tend to operate in gaps of regulatory purview. Improved communications technology, increased complexity of financial products, and multiple country operations have enhanced the opportunities for committing financial fraud. It is a challenge for regulators to prove that scheme operators are doing something that is illegal or requires a license—and little information may be available to the authorities on institutions not applying for licenses or charters. Also, closing down pyramid, and particularly Ponzi, schemes can be politically difficult—especially if politically connected individuals are subscribers to the scheme. Ponzi operators may establish themselves as pillars of their communities by ostentatious charitable and political contributions, and pretentious demonstrations of their or their scheme’s wealth.
|Pyramid schemes—usually do not grow enough to pose systemic risks.||Ponzi schemes—can pose systemic risks.|
|Pay a subscription price to join the scheme.||Promise to pay relatively high rates of returns for fixed-term investments.|
|Existing members recruit more members. The promised large reward draws in members and the number of recruits required to be ultimately rewarded grows exponentially.||Existing members do not have to recruit new members. The Ponzi operator makes initial promised payouts from subsequent subscribers. Scheme payouts to initial investors build credibility for the schemes to attract more and more investors.|
|Normally, fairly quickly exceeds the target population, leaving most members empty-handed.||“Rollover” of funds allows schemes to operate for many years. While simple arithmetic shows that the schemes will eventually collapse, successful Ponzi operators have used selected payouts to build credibility and get investors to re-invest rather than take payouts.|
|The individual schemes collapse fairly quickly as they run out of subscribers.||Accumulation of liabilities to investors—both principal and promised interest or yields—can grow large enough to be systemic.|
Developing methods of thwarting fraudulent financial schemes and dealing with unlicensed financial institutions is a priority for financial regulators. To resolve any insolvent financial institutions, assets must be seized and sold, and claims against the institutions addressed. Under any circumstances, this can be both time-consuming and complex. Resolving financial frauds can be more difficult as financial records are poor and validation of claims, problematic. Typically there are few assets to seize, sell off, and share among legitimate claimants. Given that such schemes take advantage of fragmented financial regulations and regulatory arbitrage within and across countries, combating them requires effective collaboration among finance supervisory agencies and, often, other law enforcement agencies on a regional basis. Active public education programs also play an important role in deterring the operation of these schemes.Note: This box was prepared by Philip Bartholomew, Wipada Soonthornsima, and Mary Zephirin.
Strengthening Institutional Infrastructure for Financial Systems and Markets
Even before the crisis, weaknesses in the operating environment of financial institutions and associated infrastructure (e.g., payment systems) were a source of vulnerability. While many countries have made significant progress, more needs to be done to improve the implementation of (i) auditing and accounting standards; (ii) credit information systems including credit registries and credit bureaus; (iii) payment and settlement systems; and (iv) capacity for enforcing creditor rights and bankruptcies.
Reinforcing Risk Management in Financial Institutions
While capital buffers had been building up before the global turmoil, risk management is still weak and lags behind innovations in the industry. Thus, systems and controls in financial institutions need attention, especially bank lending standards, considering that the recent expansion in credit was followed by a rapid deterioration in the economic environment for banks. Prior to the crisis, new forms of lending had started to develop across sub-Saharan Africa, particularly for households (mortgages and unsecured lending, such as credit cards). It is increasingly important that banks become fully equipped to properly assess household credit risk and that debt collection mechanisms be strengthened.
|Country Classification1||Capital Market Development2||Deposit Money Bank Assets/GDP (percent)3||Commercial Banks’ Assets/GDP (percent)4|
|Emerging Market Countries|
|Frontier Market Countries|
|Financially Developing Countries|
|Sâo Tomé and Príncipe||Low-income||0||66.4||74.0||2007|
|Central African Republic||Low-income||0||8.8||12.0||2007|
|Congo, Dem. Rep. of||Low-income||1||3.6||11.9||2007|
|Congo, Rep. of||Middle-income||0||2.8||…||…|
|(Billions of U.S. dollars)||(Percent of total)|
|Central African Republic||0.1||0.1||0.1||0.1||0.1||0.1||0.1||0.0||0.0||0.0||0.0||0.1|
|Congo, Dem. Rep. of||0.9||0.9||1.3||1.3||1.3||1.3||0.8||0.6||0.7||0.7||0.6||0.7|
|Congo, Rep. of||0.4||0.6||0.7||0.8||0.9||0.8||0.4||0.3||0.4||0.4||0.4||0.4|
|São Tomé & Príncipe||0.0||0.1||0.1||0.1||0.1||0.1||0.0||0.0||0.0||0.0||0.0||0.1|
(Billions of U.S. dollars)
|Total||of which: Non-Banks|
|Central African Republic||0.0||0.0||0.0||0.0||0.0||0.0||…||…||…||0.0||…||…|
|Congo, Dem. Rep. of||0.4||0.4||0.6||0.5||0.5||0.5||0.0||0.0||0.0||0.0||0.0||0.0|
|Congo, Rep. of||0.5||0.4||0.3||0.3||0.3||0.3||0.0||0.0||0.0||0.0||0.0||0.0|
|São Tomé & Príncipe||0.0||0.0||0.0||0.0||0.1||0.0||0.0||0.0||n.a.||0.0||…||…|
|2004||2005||2006||2007||2008||Latest Data (2008)|
|Emerging market countries|
|South Africa||14.0||12.7||12.3||12.8||12.5||2nd qtr.|
|Frontier market countries|
|Burkina Faso||11.0||…||10.2||13.0||13.0||2nd qtr.|
|Central African Republic||…||12.4||10.8||15.4||…||…|
|Congo, Dem. Rep. of||6.8||7.7||10.5||12.6||11.7||3rd qtr.|
|Congo, Rep. of||4.0||12.0||14.0||16.0||…||…|
|Côte d’Ivoire||17.0||13.7||12.4||9.5||10.0||2nd qtr.|
|Mali||7.4||9.7||9.2||7.2||7.4||Year as a whole|
|São Tomé and Príncipe||41.5||33.4||39.4||62.2||40.5||2nd qtr.|
|Sierra Leone1||36.0||35.7||36.0||38.7||46.0||3rd qtr.|
In some countries, institutional arrangements and limited enforcement powers hamper enforcement of prudential regulations.
South African banks, for instance, had very limited exposure to the “toxic products” issued in the United States or Europe.
The slowdown in securitization activity (primarily mortgages and auto loans) was already becoming apparent with the effects of the interest rate tightening cycle—which started in June 2006.
In South Africa, the remaining restrictions are primarily aimed at residents’ investments and transfers. Those restrictions, combined with other factors—such as close supervision from the central bank—are likely to have limited South African banks and corporates’ exposures to “toxic products” in the United States and Europe.
CFA zone countries have been insulated, reflecting their pegged regime and their more restrictive capital account framework.
In South Africa money markets are well developed, but confidence was maintained between market participants, and there were no specific tensions related to excess demand for foreign currency liquidity.
In the WAEMU region, the accumulation of liquidity has mostly taken the form of excess reserves at the central bank and investment in treasury bills and bonds. Excess reserves began to decline in 2007—before the global turmoil intensified.
See, for instance, IMF (2006).
Ecobank, Nedbank, and Standard Bank, all African owned, have recently expanded their operations in sub-Saharan African countries.
A country-by-country analysis is beyond the scope of this chapter. It would require the breakdown of assets and liabilities by counterpart countries (risk of contagion) and the structure of the IIP itself.
There is no “one-size-fits-all best practice” when designing a collateral policy, but rather a set of options along with commensurate safeguards. The type of collateral for liquidity provision depends on the existing institutional and legal framework for banking crisis prevention and resolution and on the degree of financial market development. See, for example, IMF (2008a).
See for instance the recommendations of the recent South Africa FSAP Update, IMF (2008d).