A bleak assessment from the World Bank financial specialist Samuel Munzele Maimbo on the impact of the financial crisis on African financial systems.
Conventional wisdom has hitherto suggested that the impact of the financial crisis in Africa will be limited because the transmission mechanisms between the financial systems in Africa and the rest of the world are weak. African financial institutions, it has been argued, are not exposed to risks emanating from complex instruments in international financial markets because most of the banks in Sub-Saharan Africa rely on deposits to fund their loan portfolios (which they keep on their books to maturity); most of the inter-bank markets are small; and the markets for securitized or derivative instruments are either small or nonexistent. Exceptions to this position are then made for countries like Nigeria and South Africa which are seen as the only countries having meaningful transmission mechanisms with the global financial systems.
Increasingly, this conventional position is being questioned for the following reasons:
Weakened local investor confidence in equities and bonds on African Stock Exchanges
Expectations that investors weary of the markets in developed countries will seek opportunities in African and other developed economies are misplaced. The small size and illiquidity of Africa’s stock markets (partly a reflection of the low levels of economic activity) is likely going to be amplified rather than overlooked as both international and local investors adopt more cautious investment strategies. Thus, while the price-earnings ratios for many African stock markets were above their sectoral equivalents in mature markets in 2007, the ongoing fallout from the subprime mortgage crisis in the US will dampen investment plans. Already, examples are emerging. The market turnover on Uganda’s bourse dropped 60 percent during the third quarter (Busuulwa, 2008). In South Africa, Kenya and Ghana, the stock markets have also been bearish.
This is disappointing. Up until the recent crisis, African stock markets were displaying resurgence and an energy that had not been seen for years. Prior to 1989, there were just five stock markets in sub-Saharan Africa and three in North Africa. Today there are 19 stock exchanges ranging from starts ups like Uganda and Mozambique stock exchanges to the Nigeria and Johannesburg stock exchanges. With the exception of South Africa, most African stock markets doubled their market capitalization between 1992 and 2002. Total market capitalization for African markets increased from US$113,423 million to US$ 244,672 million between 1992 and 2002. Ghana had five new equity listings in 2004; the Kenya Electricity Generating company IPO in 2006 – the country’s first in five years attracted strong demand and enormous public interest. Since then, the 2008 cellphone company IPO’s of Safaricom and Celtel in Kenya and Zambia respectively have both been oversubscribed. This emerging confidence in the African stock markets is going to be negatively affected by the on-going financial crisis.
Slowdown in private sector lending
Unfortunately, it is not unimaginable that in the near term banks will have seen the results of the sub-prime market and decide to ease their hitherto aggressive loan book expansion. Real private sector credit, in particular, has been growing at an accelerating rate, and its median value has doubled in the past decade. Even as a share of GDP, it has turned the corner, with the median share approaching 18 percent in 2007, about a third higher than at its anemic trough in 1996. Much of this increase was on the back of innovative non-collateralized lending practices. Salary and other cash flow based lending have been on the emergence with positive outcomes for customers in the form of consumer loans. In October 2008, the Pan-African micro-lender Blue Financial’s loan book grew 236 percent and posted earnings growth of 167 percent in the six months to August 2008.
The possibility of overreaching their adoption of conservative credit appraisals processes and procedures does not bode well for the growth of private sector lending on the continent. Trade finance will come under tremendous pressure. With high fuel and food prices, foreign exchange constraints will persist on the continent for a while. A reluctance to lend by commercial banks will make it even harder to find trade financing sources. Of equal concern is the impact of the current crisis on the sources of long term funding. Where credit is still available, banks have already started in increase the cost of long-term finance. Shortening tenure of such loans is equally likely.
This is disappointing after recent years when funds were starting to enter African markets looking for both equity and portfolio investments. This slowdown will increase the need for domestic financing – pensions funds, insurance firms and domestic savings to fill the gap.
Weakened balance sheets and possible bank failures resulting from economic slowdown
In countries where the fall in investments is simultaneous coupled with drops in export earnings, a slowdown in GDP growth, and a sharp drop in domestic asset prices e.g. a local housing market correction, weakened bank balance sheets could result, including in some cases, bank failures. As the financial crisis surges into all parts of the real economy in developed economies, African countries will experience a substantial decline in exports as the rapid pace of trade expansion in this decade decelerates sharply. The IMF now projects that growth in world trade volumes in 2009 will be 4.1 percent compared to 9.3 percent in 2006. A notable part of this fall will be African. In Zambia for example, the economy is likely to take a hit from a share decline in copper prices (-24%ytd).
In this environment, large projects in Africa that require external financing to complement shorter term bank financing will face difficulties in attaining these finances, and where they do, will face higher interest rates, because of flight to safety and greater risk aversion of lenders. At the same time, portfolio outflows will put pressure on currencies for devaluations. Reduction in ODA, remittances and tourism receipts will also have a negative impact on the economy. As investments falls, some projects will not be completed making them unproductive and saddling bank’s balance sheets with non-performing loans. Lower commodity prices, combined with a credit crunch and increased risk aversion will make it more difficult to finance and develop capital investments. The economic downturn will result in pressure on the balance sheet of some of the weaker banks in the systems as non-performing loans in some sectors increase. For some banks, failures will occur.
Renewed debate on the role of governments in the financial system
The government bailout of financial institutions in developed countries will be abused by those keen to entrench government involvement in the financial sector – even when such entrenchment is detrimental to the financial system. While many government led programs in the financial sector have been well intentioned, the unintended consequences have often been severe on the level of interest of the private sector in investing in the financial sector as well as the credit culture of beneficiaries. Global experience suggests that despite the seeming advantages of government intervention in broadening access to credit, especially through government-owed banks, public banking services in developing countries have generally not been successful.
There is a close association between such participation and lower levels of financial development, less credit to the private sector, wider intermediation spreads, greater credit concentration, slower economic growth and recurrent fiscal drains. Despite these arguments, the recent massive government purchase of shares in financial institutions will in some cases not be seen as a short term remedial measure, but rather a long term repudiation of government exclusion from the sector – the unintended consequences of this position in the 1970’s and 1980s may yet again revisit the continent if this view finds traction with policy makers for existing and planned government owned financial institutions (Scott, 2007).
The present financial crisis will affect financial systems in African countries differently depending on the present quality of the financial sector. To each there is a litany of policy and technical options for the governments on the continent to consider. These include implementing: management takeovers ; blanket guarantees on all deposits reduce reserve requirements; offering to buy bad loans from commercial banks and revise deposit insurance guidelines to name but a few that were exercised by various governments during the month of October 2008 alone. Most of these options are for countries that are directly affected by the crisis and are in need of immediate assistance. For longer term financial sector reform options, the governments in Africa may wish to consider longer term options.
Three such options include: (i) strengthening local investor confidence in equities and bonds on African Stock Exchanges by enhancing, though legislative reforms, the participation of local institutional investor. Pension funds, especially state control pension funds will need to be instrumental in sustaining the development of the market; (ii) encouraging private sector lending, especially for SMEs, by attracting new sources of trade finance by, in some cases, rethinking support for new and existing export promotion facilities, and facilitating Risk sharing facilities in a bid to not only restore confidence in the financial sector, but also sustaining private sector enterprise, and; (iii) putting in government ownership policies that ensure that such ownership only takes place when; it is necessary to strengthen the capital base of banks to remove fears of insolvency; the managers have proved unable to raise equity capital from private sources; the bank is essential for the payments and credit systems, and the bank can reasonably be expected to be made viable in the long term. Importantly, governments must have policies in place that ensure that the government’s ownership is temporary and aimed at disposing of the investment once the financial system returns to normal operations and when it is commercially suitable.