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IMF Country Report No. 22/309

WEST AFRICAN ECONOMIC AND MONETARY UNION

FINANCIAL SECTOR ASSESSMENT PROGRAM

TECHNICAL NOTE ON SYSTEMIC RISKS AND MACROPRUDENTIAL POLICY FRAMEWORK

September 2022

This technical note on Systemic Risks and Macroprudential Policy Framework was prepared by a staff team of the International Monetary Fund and World Bank in the context of a joint IMF-World Bank Financial Sector Assessment Program (FSAP). It is based on the information available at the time it was completed in September 2022.

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WEST AFRICAN ECONOMIC AND MONETARY UNION

FINANCIAL SECTOR ASSESSMENT PROGRAM

September 7, 2022

TECHNICAL NOTE

SYSTEMIC RISKS AND MACROPRUDENTIAL POLICY FRAMEWORK

Prepared By

Monetary and Capital Markets Department

Contents

• Glossary

• EXECUTIVE SUMMARY

• INTRODUCTION

• SYSTEMIC RISKS

• A. Cyclical Vulnerabilities

• B. Concentration Risks

• C. Contagion Risks Due to Interconnections and Large Common Exposures

• D. Liquidity Risk

• SYSTEMIC RISK MONITORING AND MACROPRUDENTIAL INSTRUMENTS

• A. Monitoring of Systemic Risks

• B. Macroprudential Instruments

• INSTITUTIONAL FRAMEWORK FOR MACROPRUDENTIAL POLICY

• A. Willingness to Act: Financial Stability Mandates

• B. Ability to Act: Financial Stability Decision-Making

• C. Information Sharing, Interaction, and Coordination

• D. Transparency and Communication

• ANNEX

• FIGURES

• 1. Overall Macrofinancial Developments

• 2. Banks’ Solvency and Profitability

• 3. Macrofinancial Dashboard – Spidergrams

• 4. Macrofinancial Dashboard – Heatmaps

• 5. Financial System Heatmap

• 6. Concentration of Banks’ Exposures, End-2020

• 7. Banks’ Sovereign Exposures and Associated Risks

• 8. Structure of Public Debt Holders in WAEMU Member States

• 9. Direct Bank Interconnectedness

• 10. Development of the Interbank Exposure Network (2015-2020)

• 11. Results of the Interbank Contagion Risk Simulations

• 12. Banks’ Sovereign Exposures and Risks to Government Debt Sustainability

• 13. Banks’ Sovereign Exposures, by Country

• 14. Banks’ Common Exposures

• 15. Simulations of Contagion Risk Related to a Sovereign Default

• 16. Concentration of Bank Deposits

• 17. Gradual Approach to Calibrating Additional Capital Requirements for Concentration Risk of Sovereign Exposures

• 18. Architecture of the WAEMU’s Macroprudential Institutional Framework

• TABLE

• 1. Main Recommendations

• References

Glossary

Executive Summary

Since the 2008 Financial Sector Assessment Program (FSAP), the financial sector of the West African Economic and Monetary Union (WAEMU) has undergone major changes that have altered its risk profile. Three structural changes have played a key role since the 2008 FSAP: (i) the financial sector has grown significantly; (ii) regional banking groups have become dominant; and (iii) the high concentration of bank portfolios in sovereign exposures, which accounted for an average of 31 percent of banking assets at end-2020, are almost triple the level observed in 2004. These changes have altered the structure of systemic risks and vulnerabilities and raised the need for implementing reforms to strengthen the effectiveness of the macroprudential policy and banking supervision frameworks.

Cyclical vulnerabilities are contained, but the high concentration of bank credit portfolios and their growing exposure to sovereign risks require closer monitoring. The slowdown in credit growth in recent years points to weak cyclical pressures, with the FSAP’s analysis showing no evidence of excessive credit growth. Despite the improvement in the quality of bank portfolios since 2008, credit risk remains a structural concern in the WAEMU due to the still relatively high levels of nonperforming loans and the high concentration of bank loan portfolios, both focused on a limited number of debtors, including sovereign borrowers, and on certain sectors of activity. The structure of banks and their large common exposures, both to private debtors and to sovereign borrowers, are important vectors of contagion and amplification of credit risk in the union.

The mission recommends introducing additional capital buffer requirements to cover concentration and contagion risks. The solvency of banks has improved over the last three years, in line with the increase in prudential requirements as part of the ongoing transition to the Basel II/Basel III standards. Their excess capital, however, remains limited, given the concentration and contagion risks in the system, in part linked to the high sovereign exposures. Additional capital surcharges should be structured as a nonlinear function of the degree of exposure and portfolio diversification to contain the highest risks. As a buffer requirement, these capital surcharges should be calibrated to ensure that they can be relaxed in periods of stress (to reduce potential procyclicality). They should apply to both government securities holdings and private sector credit, in addition to concentration limits for the latter, and should be introduced gradually, possibly over a three-year period. Additional capital buffer requirements for private credit concentration could factor in the correlations or sectoral risks.

The mission supports the authorities’ efforts to encourage banks to manage liquidity risk internally. Regulators will need to choose objective and verifiable liquidity indicators to determine the high-quality liquid assets (HQLA) that are eligible to be treated as Level 1 assets, and the haircuts, including those for government securities (numerator of the short-term liquidity ratio). If the regulator does not wish to apply different haircuts for different sovereign issuers, a uniform haircut should at least be applied to reflect liquidity constraints across the market. Ultimately, the liquidity coverage ratio (LCR) should take into account the different risk profiles of bank funding under Pillar 2 of Basel III. The mission supports a gradual increase in the requirement to 100 percent by 2028 to take into account the difficulties some banks may have in complying.

The mission recommends improving the monitoring of interest rate risk. The growth of portfolios of securities with relatively long maturities compared to bank resources could lead to an increase in maturity and interest rate mismatches. The monitoring of these risks requires regular reporting on the residual maturities of assets and liabilities, which will help establish a long-term liquidity ratio. The regulator should also introduce additional capital requirements based on the Pillar II supervisory approach of Basel III.

Since the 2008 FSAP, the Central Bank of West African States (BCEAO) has put into place the core elements of a macroprudential policy framework. The Financial Stability Committee of the West African Monetary Union (CSF-UMOA)—established in 2010 and tasked with safeguarding financial stability and strengthening cooperation in macroprudential oversight—plays a key role. The CSF-UMOA, chaired by the governor of the BCEAO, discusses facts relevant to financial stability and issues policy action recommendations, and warnings about financial stability risks. Significant efforts have been made to deepen the BCEAO’s macroprudential surveillance framework. These include close monitoring of a wide range of macroprudential indicators, the development of frameworks for identifying systemically important banking institutions (SIBIs), and banking sector stress testing. The new prudential framework applicable to banks, in force since 2018, introduces important macroprudential instruments related to capital surcharges—countercyclical capital buffers (CCyB), capital conservation buffers, and systemic capital buffers—and borrower-based measures for real estate lending.

The BCEAO plays a central role in defining and implementing macroprudential policy. This is due to its statutory mandate on financial stability, its expertise in this area acquired over time, and the dominance of banks in the financial sector. Accordingly, the BCEAO provides analysis and monitors the main risks and vulnerabilities of the financial system for the CSF-UMOA chairman and secretariat. To strengthen its decision-making process, the BCEAO created a Macroprudential Policy Committee (CPMP) in 2018 composed of senior staff from the BCEAO and the Banking Supervisor (CBU). The CPMP monitors and conducts analysis of systemic risks and has competence to apply macroprudential instruments and implement CSF-UMOA recommendations on banking sector supervision.

Several aspects of the institutional framework should be revised to ensure the effectiveness of macroprudential policy. The CSF-UMOA has been successful in encouraging cooperation and coordination across different institutions. However, the framework’s ability to act could be strengthened by introducing a comply-or-explain mechanism in the monitoring of the implementation of CFS-UMOA recommendations. This would increase the accountability of different institutional members of the CSF-UMOA. The decision-making process inside the CSF-UMOA could also be improved. To this end, the CSF-UMOA voting procedure should be modified to give each institutional member, including all state members collectively, a single vote to ensure a better balance of power in the decision-making process. Though the framework contains a clear mandate of financial stability, the objectives of macroprudential policy are not well-defined. Intermediate macroprudential policy objectives should take into account specific aspects of the regional financial system (e.g., the predominance of regional banking groups and certain structural macroeconomic constraints, such as the weak diversification of economic activities) and regional financial sector development challenges (such as the limited access to financial services). The communication of the systemic risk assessment and of policy decisions in the macroprudential publications could also be improved. This would strengthen the transparency of macroprudential policy.

The systemic risk monitoring framework is well established but would benefit from closing gaps in data and in the monitoring of sectoral vulnerabilities. Improved monitoring of non-financial sector vulnerabilities could benefit from enhanced data collection, including data on credit quality, profitability, debt characteristics (by maturity, rating, and sector), and corporate balance sheets. The BCEAO could achieve this objective by drawing on the ongoing reforms of its public credit registries to establish a permanent system for collecting data on non-financial enterprises and households. Strengthening the collection of granular data on residential real estate will also be critical to identifying and assessing risks in this sector. Finally, the thresholds of the systemic risk indicators being monitored should be calibrated, drawing on the experience of instability in the banking sectors of peer countries and, on the judgement of experts.

Table 1.

WAEMU: Main Recommendations

¹I – immediate (less than 1 year); ST – short term (1 to 2 years); MT – medium term (3 to 5 years).

Table 1.

WAEMU: Main Recommendations

Recommendations	Authorities	Timeline1
Monitoring of systemic risks
Calibrate systemic risk thresholds for monitored macroprudential indicators, drawing on the experience of instability in the banking sectors of peer countries and on expert judgment.	BCEAO	ST
Improve the capacity to monitor vulnerabilities and risks in the non-financial corporate and household sectors.	BCEAO	MT
Fill in the remaining data gaps, including those for the non-financial corporate, household, and real estate sectors.	CSF-UMOA/BCEAO	ST
Operational framework for macroprudential policy
Gradually introduce additional non-linear capital requirements to cover concentration, interest rate, and contagion risks arising from excessive concentration, including those for bank sovereign exposures.	BCEAO/CBU	ST
Introduce Basel-type liquidity ratios to strengthen resilience to liquidity shocks. Introduce a haircut for government securities, count banks’ required reserves toward Level 1 high-quality liquid assets (HQLA), and consider bank funding stability to impose higher LCR requirements under Pillar 2 of Basel III.	BCEAO/CBU	ST
Improve the monitoring of maturity mismatches and interest rate risk based on regular reporting of the residual maturities of bank assets and liabilities, as well as their interest rates.	BCEAO/CBU	ST
Institutional framework for macroprudential policy
Designate the BCEAO as the "macroprudential authority" responsible, inter alia, for activating the countercyclical capital buffer (CCyB), while introducing a suitable mechanism for national authorities to raise concerns if policies set by the BCEAO are ill-suited for their situation.	CSF-UMOA/BCEAO	I
Strengthen the implementation of CSF-UMOA recommendations by introducing a "comply or explain" mechanism in the follow-up to these recommendations; specify the deadlines within which institutional members of the Financial Stability Committee of the WAEMU (CSF-UMOA) are required to provide explanations for a failure to implement CSF-UMOA recommendations.	CSF-UMOA	I
Establish a comprehensive communication strategy for systemic risk assessments and macroprudential policy decisions.	CSF-UMOA/BCEAO	ST

¹I – immediate (less than 1 year); ST – short term (1 to 2 years); MT – medium term (3 to 5 years).

View Table

Table 1.

WAEMU: Main Recommendations

Recommendations	Authorities	Timeline1
Monitoring of systemic risks
Calibrate systemic risk thresholds for monitored macroprudential indicators, drawing on the experience of instability in the banking sectors of peer countries and on expert judgment.	BCEAO	ST
Improve the capacity to monitor vulnerabilities and risks in the non-financial corporate and household sectors.	BCEAO	MT
Fill in the remaining data gaps, including those for the non-financial corporate, household, and real estate sectors.	CSF-UMOA/BCEAO	ST
Operational framework for macroprudential policy
Gradually introduce additional non-linear capital requirements to cover concentration, interest rate, and contagion risks arising from excessive concentration, including those for bank sovereign exposures.	BCEAO/CBU	ST
Introduce Basel-type liquidity ratios to strengthen resilience to liquidity shocks. Introduce a haircut for government securities, count banks’ required reserves toward Level 1 high-quality liquid assets (HQLA), and consider bank funding stability to impose higher LCR requirements under Pillar 2 of Basel III.	BCEAO/CBU	ST
Improve the monitoring of maturity mismatches and interest rate risk based on regular reporting of the residual maturities of bank assets and liabilities, as well as their interest rates.	BCEAO/CBU	ST
Institutional framework for macroprudential policy
Designate the BCEAO as the "macroprudential authority" responsible, inter alia, for activating the countercyclical capital buffer (CCyB), while introducing a suitable mechanism for national authorities to raise concerns if policies set by the BCEAO are ill-suited for their situation.	CSF-UMOA/BCEAO	I
Strengthen the implementation of CSF-UMOA recommendations by introducing a "comply or explain" mechanism in the follow-up to these recommendations; specify the deadlines within which institutional members of the Financial Stability Committee of the WAEMU (CSF-UMOA) are required to provide explanations for a failure to implement CSF-UMOA recommendations.	CSF-UMOA	I
Establish a comprehensive communication strategy for systemic risk assessments and macroprudential policy decisions.	CSF-UMOA/BCEAO	ST

¹I – immediate (less than 1 year); ST – short term (1 to 2 years); MT – medium term (3 to 5 years).