West African Economic and Monetary Union: Selected Issues
Author: International Monetary Fund. African Dept.
Publication Date:
25 Apr 2018
eISBN:
9781484352816
Language:
English
Keywords:
ISCR; CR; WAEMU; WAEMU country; investment; investment efficiency; WAEMU credit institution; problem bank; credit portfolio; bank status; access to the refinancing facility; Credit; Bank credit; Loans; Liquidity
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Selected Issues

Abstract

Selected Issues

WAEMU Banking System’s Soundness and Macro-Financial Linkages1

This paper examines the WAEMU banking system’s soundness and traces its macro-financial linkages. Stress test results confirmed that the banking system can withstand various shocks, but highlighted that default of the largest borrowers and deterioration of the banks’ loan portfolios are the most important risks, particularly for weak public banks. As banks’ appetite for government debt varied in direct proportion to the BCEAO refinancing, their demand for newly issued government debt securities declined significantly after the monetary policy tightening at end-2016.

A. Introduction

1. This paper explores banking sector vulnerabilities and resilience to shocks. Rapid expansion of the WAEMU’s banking system has contributed to economic growth and extended of financial services to population. Using the results of stress tests conducted by the BCEAO, this paper examines the banking system’s resilience to various shocks including deterioration of loan portfolio, liquidity squeeze, and deposit run.

2. The paper traces the main macro-financial linkages of the banking sector and their evolution in recent years. The WAEMU banking system has built up large net claims on the central governments of the zone. In 2015–16, through its refinancing window, the BCEAO provided significant liquidity to the commercial banks against the collateral of government debt securities. This process was reversed in 2017, after the BCEAO tightened monetary policy in December 2016. Banks also have significant net liabilities to households (with more deposits than credits) and net claims on non-financial corporations (where bank loans exceed deposits). The bulk of bank credit goes to the tertiary sector (services), while the credit exposure to industry and agriculture is relatively small. The paper highlights the importance of enforcing compliance with prudential norms, recapitalizing or resolving problem banks, and addressing pockets of vulnerabilities in the banking system

B. Financial Sector Overview

3. WAEMU’s expanding banking system contributes to economic growth and extends the reach of financial services to population. Broad money grew by about 12 percent per year on average over 2012–17 (Figures 1–2). Its growth mostly reflected increase in personal and corporate deposits, while credit to economy and public sector contributed to the WAEMU GDP growth. Gross assets of commercial banks reached 56 percent of the regional GDP at end-2016 as compared with 43 percent at end-2013. Over the same period, the number of clients’ accounts in the banks increased from 7.8 million to 10.3 million. The estimated share of households with a bank account more than doubled from about 7 percent in 2007 to 16 percent in 2016.

Figure 1.
Figure 1.

WAEMU: Broad Money and Its Main Components, 2012–17

(Y/y growth, percent or percentage points)

Citation: IMF Staff Country Reports 2018, 107; 10.5089/9781484352816.002.A002

Source: BCEAO, Integrated Monetary Database
Figure 2.
Figure 2.

WAEMU: Broad Money and Its Main Counterparts, 2012–17

(Y/y growth, percent or percentage points)

Citation: IMF Staff Country Reports 2018, 107; 10.5089/9781484352816.002.A002

Source: BCEAO, Integrated Monetary Database

4. WAEMU credit institutions can be broadly classified by their size, ownership, and bank or non-bank status. WAEMU banking sector counted 140 credit institutions in 2017, of which 125 banks (including 17 bank branches) and 15 non-bank credit institutions (including 4 branches). Excluding branches and classifying credit institutions by their major owner, there were 94 foreign-owned, 12 public, and 13 privately held regional credit institutions. Classifying active credit institutions by size and relative importance, 31 could be considered as large (accounting for more than 10 percent of banking sector assets in their country of operation), 25 as average (more than 5 percent of assets), and the remaining 63 as relatively small.

C. Banking Sector Vulnerabilities

5. The banking sector is broadly stable, but capital margins are thin. The average capital adequacy ratio (CAR) for the banking system declined to 11.4 percent at mid-2017 from 12.6 percent at end-2015. As of end-2016, 12 banks—accounting for nearly 9 percent of the system’s assets—did not meet the minimum CAR of 8 percent (on a Basel I basis; Table 1). Up to 29 banks and credit institutions did not meet the new minimum capital requirement of FCFA 10 billion that became effective at mid-2017 and were given another year (until mid-2018) to comply.

Table 1.

WAEMU: Financial Soundness Indicators, 2012–20171

article image
Source: BCEAO.

Indicators do not account for the additional provisions required by the WAEMU Banking Commission.

Excluding tax on bank operations.

Including saving accounts.

6. WAEMU banking sector is characterized by high concentration and segmentation as well as elevated exposure to a few largest borrowers. At end-September 2017, 27 bank groups operated in the zone, the same as at end-2016. Among them, 12 leading groups accounted for about ¾ of the market share, total assets, and clients’ accounts. The ratio of loans to the top-5 borrowers in total loans dropped to 90 percent at mid-2017 from 101 percent at mid-2016.

7. NPLs in WAEMU banks remain relatively large. After dipping to 13.8 percent at end-2016, the ratio of NPLs to total loans increased again to 14.6 percent at mid-2017 and to 15.1 percent at end-September. On the positive side, provisions cover about 63 percent of the NPLs. NPLs net of provisions accounted for 5.9 percent of total loans at mid-2017 and 6.2 percent at end-September.

8. Public banks are mostly weak. Out of 12 public banks in WAEMU, 7 were undercapitalized, and some of them had significantly negative capital. Moreover, one of them was classified as large and another as medium-sized in their countries of operations, which pointed to their systemic importance. Capital shortfall of undercapitalized WAEMU banks equaled to about 0.4 percent of the zone’s GDP, of which about 2/3 came from the capital shortfall in public banks.

9. The structural liquidity deficits in the banking system increased in 2015–16. Though the situation of individual banks varies considerably, net aggregate liquidity of the banking system has been negative since 2014. It deteriorated considerably since mid-2015 and reached about FCFA 3,000 billion at end-2016, which is about 5 percent of the zone’s GDP (Figure 3). To maintain their gross liquidity at the sufficient level, banks had to increasingly rely on the BCEAO liquidity support. Among other things, this implied liquidity mismatches in the balance sheets, as banks financed longer-term holdings of government securities and credit to economy with short-term central bank refinancing.

Figure 3.
Figure 3.

WAEMU: Commercial Bank’s Liquidity Position, 2012–17

(Billions of CFA Francs)

Citation: IMF Staff Country Reports 2018, 107; 10.5089/9781484352816.002.A002

Source: BCEAO, Integrated Monetary Database

10. Monetary policy tightening by the BCEAO in December 2016 initiated an unwinding of the banks’ excessive net negative liquidity positions. The BCEAO limited banks’ access to the refinancing facility to twice their own capital effective from June 2017, which gave banks about 6 months to adjust their balance sheets. However, some banks faced challenges in maintaining their liquidity position without BCEAO support. To shore up banking stability, BCEAO lowered the obligatory reserve requirement ratio from 5 percent to 3 percent in March 2017. Overall, the BCEAO’s actions resulted in the reduction of the banking system’s net liquidity position by about FCFA 600 billion over the first half of 2017.

11. In late 2017, banks’ demand for BCEAO refinancing increased again, in part because of seasonal factors. As a sign of building liquidity pressures, banks took all allotted BCEAO refinancing, average interest rate on refinancing operations hit the 4.5 percent ceiling of the BCEAO policy corridor, and the interbank market rate went well above it (Figures 4–5). Responding to pressures, BCEAO re-injected liquidity into the system, increasing its gross claims on banks. Alongside, banks drew down on their deposits with the BCEAO. As an outcome, banking system’s net liquidity position vis-à-vis the BCEAO widened by about FCFA 500 billion. Overall, the banking system’s net liquidity deficit covered by the BCEAO refinancing came to around FCFA 2,900 billion at end-2017, somewhat below its end-2016 level (Figure 3).

Figure 4.
Figure 4.

WAEMU: Oversubscription for the BCEAO 7-Day Refinancing Operations, 2015–17

(Billions of CFA Francs)

Citation: IMF Staff Country Reports 2018, 107; 10.5089/9781484352816.002.A002

Source: BCEAO; and IMF staff estimates
Figure 5.
Figure 5.

WAEMU: BCEAO and Money Market Rates, 2016–17

(Percent)

Citation: IMF Staff Country Reports 2018, 107; 10.5089/9781484352816.002.A002

Source: BCEAO

12. Banks’ appetite for government debt varied in direct proportion to the availability of the BCEAO refinancing. In 2015–16, when the refinancing was relatively easily available, government debt issuances were typically oversubscribed in the regional debt market dominated by banks. This changed after the BCEAO policy tightening. In February 2017, subscription for debt issuance dipped to about 66 percent (Figure 6), which corresponded to a spike in banks’ demand for BCEAO refinancing (Figures 4–5). As the banks’ liquidity situation normalized in the middle of the year, their demand for the BCEAO refinancing moderated, and the subscription coverage of debt issuance rebounded to nearly 100 percent. The banks’ liquidity situation tightened again in the last months of 2017, which corresponded to a steady drop in subscription for the government debt issuance to 41 percent in December.

Figure 6.
Figure 6.

Coverage of Government Debt Issuance in the WAEMU Regional Market, 2017

Citation: IMF Staff Country Reports 2018, 107; 10.5089/9781484352816.002.A002

Source: UMOA-Titres; and IMF staff estimates.

D. Analysis of Vulnerability Scenarios

13. Stress tests regularly conducted by the BCEAO modelled the impact of several shocks on the banking system. The stress scenarios tested banks’ resilience to hypothetical shocks such as a steep deterioration of the credit portfolio, default of the largest borrower, and deposit run (Annex 1). Their results confirmed that the banking system can withstand many such shocks, particularly with support from the BCEAO. At the same time, they accentuated what type of shocks could be particularly severe and which banks would be most vulnerable to them.

14. High loan concentration ratios make WAEMU banks particularly vulnerable to default of their largest borrowers. In the stress test scenario of the largest borrower default in each bank, the number of undercapitalize banks in the zone would increase to 76 (from 15 before the shocks), with combined capital shortfall 1.6 percent of the zone’s GDP. And in the most extreme scenario of default by the two largest borrowers, 91 banks would fall below the minimum capital requirement of 8 percent, with their capital shortfall amounting to 2.7 percent of the zone’s GDP.

15. Deterioration of banks’ loan portfolios is another source of risk. The number of undercapitalized banks would rise sharply in extreme scenarios of NPLs increasing by 50–75 percent or deterioration of the banks’ loan portfolio with 15 percent of standard healthy loans migrating into the NPL category (Tables 2 and 3). As the public banks exhibited significant weaknesses before the tests, they are strongly affected by the stress test scenarios. Furthermore, in the case of a sustained deposit run on banks, with progressive withdrawal of up to 35 percent of demand deposits and 19 percent of term deposits over 5 days, up to 79 banks would need liquidity support.

Table 2.

Stress Test Results for the WAEMU Commercial Banks: Credit Portfolio Tests

(Data as of June 30, 2017)

article image
Sources: BCEAO; and IMF staff estimates.
Table 3.

WAEMU: Stress Test Results for the WAEMU Commercial Banks: Liquidity Test

(Data as of June 30, 2017)

article image
Sources: BCEAO; and IMF staff estimates.

E. Macro-Financial Linkages

16. Banking sector has exposure to all the main sectors of the economy. As normal for a banking sector, it operates by transforming deposits into loans. As of end-2017, commercial banks attracted household deposits of about 11.3 percent of regional GDP and returned 6.6 percent of GDP as credits to the households. Banks attracted deposits of about 15.4 percent of GDP from private companies while providing credits of about 18.7 percent of GDP to them, which resulted in net claims on the private non-financial companies of about 3.4 percent of GDP. Banks’ credit to public non-financial companies of 2.1 percent of GDP slightly exceeded their deposits of 1.7 percent of GDP. Commercial banks have accumulated net claims of 10.2 percent of GDP on the central governments of the zone. Commercial banks’ net claims on the governments was partly made possible by the net liquidity support from BCEAO of about 4.7 percent of GDP, which was provided largely under collateral of government debt securities (Figure 7).

17. Banks’ credit to economy is concentrated in trade and other services sectors. As of mid-2017, retail and wholesale trade, restaurants and hotels accounted for nearly 1/3 of the outstanding bank credit. Together with credit to transportation and communication, insurance, real estate, and other services, banking exposure to services sectors accounted for nearly 2/3 of all bank credit to economy. Bank credit to productive sectors—agriculture, manufacturing, electricity, water and gas, extractive industries and construction—together accounted for the remaining 1/3 of the total (Figure 8). This composition of credit remained broadly stable over the last five years, with most significant changes being an increase in credit share of construction and reduction of that of manufacturing.

F. Evolution of Macro-Financial Flows in 2016–17

18. In 2016, monetary expansion coincided with significant international reserves decline. That year, consolidated central government’s fiscal deficit amounted to about 4½ percent of GDP, and most of it was financed from the regional debt market. In this market, regional banks are the most important buyers of the government debt holding about 90 percent of the outstanding debt securities. In 2016, BCEAO injected liquidity equivalent to about 2.7 percent of GDP in the banking system through its refinancing window. This liquidity helped banks expand their lending to all sectors of economy, but most notably, commercial banks extended net credit to government by 3.6 percent of GDP, further increasing their exposure to this sector (Figure 9). With sovereigns financing their fiscal deficits primarily in the regional market, official international reserves declined significantly over the year.

Figure 7.
Figure 7.

WAEMU Banking System’s Main Macro-Financial Linkages, 2017

(End-period stocks; percent of GDP)

Citation: IMF Staff Country Reports 2018, 107; 10.5089/9781484352816.002.A002

Sources: BCEAO; and IMF staff estimates.
Figure 8.
Figure 8.

WAEMU: Composition of Bank Credit to Economy, June 2017

(Percent)

Citation: IMF Staff Country Reports 2018, 107; 10.5089/9781484352816.002.A002

Source: BCEAO; and IMF staff estimates
Figure 9.
Figure 9.

WAEMU: Banking System’s Main Macro-Financial Flows, 2016

(Flows over 2016; percent of GDP)

Citation: IMF Staff Country Reports 2018, 107; 10.5089/9781484352816.002.A002

Sources: BCEAO; and IMF staff estimates.

19. The imbalances accumulated in 2016 began to unwind in 2017, after the BCEAO’s monetary policy tightening. The policies that enabled the international reserves’ depletion and pushed banks’ own net liquidity deep into the negative territory had to be reversed. The policy tightening implemented by the BCEAO in December 2016 limited the refinancing that the banks could get from the BCEAO to twice their own capital. As many banks were above that limit at the time, BCEAO gave banks until June 2017 to comply. Effectively, this required commercial banks to repay a part of the refinancing previously received from the BCEAO, which they did by reducing the net credit from the central bank by about 0.2 percent of GDP in 2017. In part because of it, the BCEAO was able to replenish its FX reserves in 2017. For banks, the need to repay BCEAO’s financing reduced their potential for extending credit to other sectors of economy. Most notably, the banks provided new net credit to governments of only 0.8 percent of GDP in 2017, which was much less than 3.6 percent of GDP provided in 2016 (Figure 10).

Figure 10.
Figure 10.

WAEMU: Banking System’s Main Macro-Financial Flows, 2017

(Flows over 2017, percent of GDP)

Citation: IMF Staff Country Reports 2018, 107; 10.5089/9781484352816.002.A002

Sources: BCEAO; and IMF staff estimates.

20. Because of tighter liquidity conditions, domestic credit expansion slowed down in 2017 and its composition changed. The pace of domestic credit expansion decelerated from 15–20 percent prevailing in 2016 and previous years to less than 10 percent at end-2017. The contribution of the net credit to government declined to 2 percentage points in 2017 (from 11.2 percentage points in 2016). At the same time, the contribution of the credit to economy remained steady at about 8 percentage points at end-2017, about the same as at end-2016 (Figure 11).

Figure 11.
Figure 11.

WAEMU: Domestic Credit and Its Components, 2012–17

(Y/y growth, percent or percentage points)

Citation: IMF Staff Country Reports 2018, 107; 10.5089/9781484352816.002.A002

Source: BCEAO, Integrated Monetary Database

G. Addressing Banking Sector Vulnerabilities

21. Enforcing compliance with prudential regulations is key to addressing banking sector weaknesses. There are weak banks in the zone, including public banks, that did not meet certain prudential requirements for years. In some cases, they expanded their business while under provisional administration and enhanced supervision of the regional authorities. There is a broad range of sanctions that the supervisor can impose on non-compliant banks. It ranges from simple warnings to fines and imposing limits on certain type of operations and transactions to putting the bank under provisional administration and eventually withdrawing its banking license. For example, the supervisor can prohibit weak banks from expanding their business (providing new loans and accepting new deposits) and distributing profits to owners until the identified weakness are resolved.

22. New prudential rules aligned with the Basel II/III principles and phased in from 2018 should help consolidate banks’ balance sheets and address vulnerabilities. The reforms involve gradually increasing the minimum capital requirements over several years, introducing new accounting rules, and moving to consolidated supervision of bank groups. Embracing new standards will help improve the quality of banks’ credit portfolio, boost their capital and liquidity buffers, and eventually increase the banking system’s resilience to shocks. Initially, the CAR will increase from 8.0 percent (under Basel I rules) to 8.6 percent of risk-weighted assets by end-2018. For problem loans, lowering the threshold for classifying loans as NPLs from 180 days of payment delay to the internationally accepted 90 days would increase the reported NPLs.

23. Alongside, bank supervision is shifting to a more risk-sensitive and consolidated approach. The regional Banking Commission is adopting new supervision criteria aligned with Pillar 2 of Basel II/III standards. It has also launched the consolidated supervision of cross-border groups and has readied its tools to that end.

24. Moreover, the Banking Commission has got new bank resolution powers in late 2017. The amendment to the Banking Commission’s Statutes ensures that all member countries are committed to cooperate with this institution, based on its independent resolution decision-making. In particular, this should help accelerate progress in the resolution of problem banks with persistent negative capital.

Annex I. Description of Stress Test Scenarios

Stress tests conducted by the BCEAO modelled the impact of several shocks on the banking system. They tested banks’ resilience to shocks such as a steep deterioration of the credit portfolio, default of the largest borrower, and large deposit outflows. Parameters of each shock are summarized in Table 4. These shocks were modelled using bank-by-bank data as of end-June 2017.

Table 1.

Description of Stress Test Scenarios

article image
Source: BCEAO
1

Prepared by Michael Gorbanyov (EUR). Comments from Jad Khallouf (MCM) and Monique Newiak (EUR) are gratefully acknowledged. The author wishes to thank BCEAO staff for the very constructive discussions of the banking sector topics and stress tests conducted by the BCEAO, which contributed to this paper.

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Cover IMF Staff Country Reports
West African Economic and Monetary Union (WAEMU): Selected Issues
Author: International Monetary Fund. African Dept.
Volume/Issue:
Volume 2018: Issue 107
Publisher:
International Monetary Fund
ISBN:
9781484352816
ISSN:
1934-7685
Pages:
84
DOI:
https://doi.org/10.5089/9781484352816.002
  • View in gallery

    WAEMU: Broad Money and Its Main Components, 2012–17

    (Y/y growth, percent or percentage points)

  • View in gallery

    WAEMU: Broad Money and Its Main Counterparts, 2012–17

    (Y/y growth, percent or percentage points)

  • View in gallery

    WAEMU: Commercial Bank’s Liquidity Position, 2012–17

    (Billions of CFA Francs)

  • View in gallery

    WAEMU: Oversubscription for the BCEAO 7-Day Refinancing Operations, 2015–17

    (Billions of CFA Francs)

  • View in gallery

    WAEMU: BCEAO and Money Market Rates, 2016–17

    (Percent)

  • View in gallery

    Coverage of Government Debt Issuance in the WAEMU Regional Market, 2017

  • View in gallery

    WAEMU Banking System’s Main Macro-Financial Linkages, 2017

    (End-period stocks; percent of GDP)

  • View in gallery

    WAEMU: Composition of Bank Credit to Economy, June 2017

    (Percent)

  • View in gallery

    WAEMU: Banking System’s Main Macro-Financial Flows, 2016

    (Flows over 2016; percent of GDP)

  • View in gallery

    WAEMU: Banking System’s Main Macro-Financial Flows, 2017

    (Flows over 2017, percent of GDP)

  • View in gallery

    WAEMU: Domestic Credit and Its Components, 2012–17

    (Y/y growth, percent or percentage points)

WAEMU: Broad Money and Its Main Components, 2012–17

(Y/y growth, percent or percentage points)

WAEMU: Broad Money and Its Main Counterparts, 2012–17

(Y/y growth, percent or percentage points)

WAEMU: Commercial Bank’s Liquidity Position, 2012–17

(Billions of CFA Francs)

WAEMU: Oversubscription for the BCEAO 7-Day Refinancing Operations, 2015–17

(Billions of CFA Francs)

WAEMU: BCEAO and Money Market Rates, 2016–17

(Percent)

Coverage of Government Debt Issuance in the WAEMU Regional Market, 2017

WAEMU Banking System’s Main Macro-Financial Linkages, 2017

(End-period stocks; percent of GDP)

WAEMU: Composition of Bank Credit to Economy, June 2017

(Percent)

WAEMU: Banking System’s Main Macro-Financial Flows, 2016

(Flows over 2016; percent of GDP)

WAEMU: Banking System’s Main Macro-Financial Flows, 2017

(Flows over 2017, percent of GDP)

WAEMU: Domestic Credit and Its Components, 2012–17

(Y/y growth, percent or percentage points)