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Central Banks In Africa Are Guiding Banks Through COVID-19’s Economic Fallout

Banks operating across Africa will face challenges for the foreseeable future as they steer through the ill-effects of the coronavirus pandemic and the collapse of oil prices in 2020. Support from governments could help, but their responses are constrained by limited fiscal space and hinge on sources of external support. Conversely, central banks have been proactive, swiftly cutting interest rates and injecting liquidity. Some African economies are particularly vulnerable to the current crisis because of their reliance on commodity exports, tourism, and remittances, as well as external financing needs.

S&P Global Ratings rates nearly 30 financial institutions across Africa. We see three main risks for African banks as the COVID-19-led economic crisis unfolds:

  • Rising economic imbalances stemming from significant exposures to sectors most affected by pandemic-related shocks and external capital flows.
  • Higher credit losses, particularly for households and small and midsize enterprises (SMEs).
  • Funding and liquidity gaps, exacerbated by capital outflows and lower remittances.

We have taken negative rating actions on banks in South Africa, Tunisia, and Nigeria because of COVID-19 impacts on their economies. We lowered our credit ratings on South African banks to 'BB-' to reflect the sharp economic contraction in 2020 and related higher impairments charges. We also lowered our ratings on Tunisian banks to 'B-' on expected weaker financial profiles aggravated by the pandemic. Lastly, we downgraded Nigerian banks to 'B-' in March because of the dual shock of the slump in oil prices and COVID-19-related setbacks on economic growth prospects.

Rising economic imbalances are hindering credit to the private sector

Credit conditions will remain tight despite central bank cuts in interest rates. That's because their efficacy is largely blunted by weak transmission mechanisms in most African countries, due to low financial intermediation (see chart 1) and a lack of well-functioning money markets. The pandemic-induced global recession has led to market dislocations and record investment outflows in emerging markets. In Africa, the yield curves for government debt have steepened and the cost of domestic borrowing has risen against a backdrop of increasing financing needs. Unprecedented stimulus support measures in developed economies and very low or negative interest rates have alleviated the liquidity tensions that erupted in March 2020. We have observed a slight improvement in investors' sentiment and market conditions lately, but the access will not be easy for every issuer.

Chart 1

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Chart 2

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South Africa and Egypt are the most vulnerable to investment outflows. While South Africa undergoes knock-on effects on the exchange rate, Egypt is exposed to ups and downs in foreign exchange reserves.

We expect investment flows to remain volatile. This is against the backdrop of lower oil prices ($30 per barrel in 2020), which could heighten the sensitivity of foreign exchange reserves and local currency exchange rates. Risks of currency devaluation could reemerge in Nigeria and might weaken banks' capitalization. Similarly, countries relying on tourism receipts, such as Egypt and Tunisia, will see their foreign exchanges reserves decrease due to the travel restrictions and the economic standstill. Economic imbalances stemming from the oil price shock, currency depreciation, and portfolio flows volatility exacerbate credit and liquidity risks in banking sectors, particularly where foreign currency lending is significant, like in Nigeria.

Meanwhile, central banks have used their monetary flexibility to swiftly lower interest rates by 300 basis points (bps), as we saw at the Central Bank of Egypt, while others have adopted a more gradual approach, like the South African Reserve Bank's cutting of 275 bps between March and May 2020 (see chart 3). All central banks have been attempting to calibrate their actions with government fiscal support measures while preserving their inflation targets. Governments, which generally have limited fiscal flexibility because of large deficits, are still finalizing their responses to lessen the economic repercussions. Morocco and South Africa have announced measures that range from wage subsidies, corporate tax suspension, guarantee loan schemes, social contributions suspension for SMEs, to payment loan holidays to help clients cope with temporary cash flow shortfalls during economic lockdowns.

Chart 3

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Recent global developments will continue to curb credit growth in Nigeria, South Africa, Tunisia, and Kenya (see chart 4). Lending opportunities to corporates, including SMEs, have been scarce in recent years, largely due to the prolonged effect of the 2016 recession in Nigeria, the introduction of the cap on interest rates in Kenya, and sluggish economic growth in South Africa. In Morocco and Tunisia, we expect reduced credit volumes as corporates curtail capital spending plans in 2020. Lower transfers from Moroccan nonresidents, which represent almost 20% of the deposit base, will also tighten banks' lending capacity. In Egypt, private sector lending will remain constrained in real terms because of high inflation.

Chart 4

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Weaker asset quality will largely stem from households and SMEs

The pandemic will dull the asset quality of banking systems in Africa, such as in Morocco where we expect nonperforming loan (NPL) ratios to hover around 9%-10% (see chart 5). The crisis will test banks' creditworthiness, but the extent will vary depending on the strengths of each bank's balance sheet, including capitalization. We expect a deterioration of loans books across segments with the view that retail and SMEs will likely underperform corporate loans across the systems we rate. In our opinion, some industries will take longer to recover to financial performance levels seen prior to the drop in oil prices and the onset of the COVID-19 pandemic. We expect credit losses will average 2.5% of total loans across the system in scope (see chart 6). That said, there is a disparity between banks in North Africa and Sub-Sahara Africa (excluding South Africa) where banking systems in the latter region tend to be subject to short credit cycles with higher levels of credit losses.

Chart 5

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Chart 6

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In Tunisia, asset quality indicators will markedly deteriorate in 2021 despite support measures for SMEs, including a payment moratorium. The crisis will have a long-lasting effect on households and SMEs. Tourism and hospitality, which represent an important share of the Tunisian economy, will likely be among the most affected sectors because of internal and external restrictions. Transport and export-oriented industries, upon which the economy is highly dependent, will also suffer as a result of the recession in Europe, Tunisia's main trading partner.

In Morocco, vulnerabilities will stem from the construction, steel, automotive, and textile industries. Due to the lull in tourism, we expect the hospitality sector to take a hit. Moroccan banks' exposures to the rest of Africa will also yield additional impairments, particularly in countries with limited stimulus measures.

For South Africa, the strain on asset quality in 2020 will mainly stem from unsecured retail lending and SMEs, amid continued weak economic growth. Household debt is likely to rise and affordability will narrow because of loss of income. There will be more signs of stress in the commercial real estate sector because of the strict economic lockdown and work-from-home measures.

In Nigeria, the main risks relate to the oil sector and any potential depreciation of the naira that is subject to availability of foreign currency liquidity. We believe that banks are less willing to extend credit to oil and gas companies downstream because these exposures are denominated in U.S. dollars in a context of tight liquidity, and some of these loans are tied to government subsidies. The upstream sector's attractiveness will depend on the pace of the recovery of oil prices. More positively, these large borrowers tend to be hedged. Single-name and industry concentrations remain high in Nigeria, with most of the large banks serving the same corporate borrowers. Nigerian banks will likely focus on manufacturing and retail lending, including SMEs, whose exposures are denominated in local currency.

In Kenya, consumer lending and SMEs will hurt, particularly those operating and servicing the tourism and manufacturing sectors affected by the supply chain disruption earlier this year. We also anticipate some payment arrears, linked to government projects, will cause additional restructuring. Payments moratorium will help households cope with the economic shock and loss of income. We expect credit losses to rise to a high 2.5% in 2020 as a result of their vulnerability to cyclical sectors and households hit by the economic lockdown.

In Egypt, the crystallization of credit risk will emanate from the elevated concentration risks. Banks' exposures to cyclical sectors such as tourism will likely suffer because of extended travel bans and decelerated tourism in 2020. Credit risks are further exacerbated by the high level of foreign currency lending, the second highest after Nigerian banks (see chart 7).

Chart 7

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The crisis has exposed funding and liquidity gaps

Central banks in most African countries have acted as a backstop for banks' liquidity shortfalls in local currency. However, higher funding costs, the risk of capital outflows, and potentially broader liquidity tensions will characterize the dynamics of funding for African banks. South African banks are the most vulnerable to investment outflows, but their refinancing risks are limited (see chart 8) because most of their funding is in local currency, and the central bank has provided effective support to money market and interbank markets.

Chart 8

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In Morocco and Tunisia, the conversion of remittances in local currency limits the size of foreign currency deposits and support broader funding stability. The dollarization in Nigeria banking sector may point to volatility of non-resident deposits in time of stress but these deposits have largely been stable (see chart 9) as customers use them as a natural hedge against the naira depreciation to the U.S. dollar. However, the financing of oil and gas exposures and trade finance flows have led to increasing levels of external refinancing risk in times of stress since U.S. dollar liquidity tends to be constrained. The lack of large and deep domestic capital markets in Africa is a limitation on funding and liquidity and has pushed Nigerian banks to raise money on the international capital markets.

Chart 9

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Central bank intervention is particularly prevalent in countries like Tunisia, where funding gaps exist even before the pandemic outbreak. The Central Bank of Tunisia injected Tunisian dinar (TND) 11.1 billion ($3.88 billion) as of April 1, 2020, with the hope that banks will support the economy, raising banks' ratio of loans to deposits above 120%. Meanwhile, the Central Bank of Nigeria introduced a minimum ratio of loans to deposits of 65%, forcing banks to lend more while the cash reserve requirement is at a record high of 27.5%. Nonetheless, because of tough operating conditions, we expect Egyptian and, to some extent, Kenyan banks to use excess liquidity to invest in government securities in order to limit their credit risk exposures.

The crisis could accelerate cost optimization but spur operational risks

Earnings optimization has been challenging in recent years as banking sectors in Nigeria, Tunisia, and South Africa have been up against significant economic hardship. That said, core earnings (net income before noncontrolling interest - nonrecurring income +/- other adjustments) averaged almost 2% of average S&P Global Ratings-adjusted assets among rated banks in Africa in 2019, supported by a combination or some element of a high base effect (Nigeria, Ghanaand Kenya), low cost of risk (South Africa, Morocco, and Egypt) and transactional banking fees (South Africa, Kenya, Nigeria and Ghana). Leading banks have embarked on technological transformation to improve efficiency and meet changing customer needs in response to increasing strain on revenue. They have been pursuing digital transformation to mitigate overall revenue pressure, relying increasingly on noninterest revenues thanks to rising volumes of mobile payments like in Ghana, Kenya, and Nigeria. Banks' transformations into more agile institutions will also help lower their cost base as customers on boarding and product distribution are streamlined through digital channels. Nonetheless, these improvements will take some time to materialize through banks' cost to income ratios; they remain quite high averaging 55% in 2019 for rated banks due to significant and costly physical infrastructure as they have also been supporting financial inclusion in remote areas (see chart 10).

Chart 10

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The economic lockdown and strict quarantine measures introduced in a few African countries have fully tested banks' business continuity plans. Operational risks, including cyber risks, will be on the rise as the rapidity and strict lockdown measures have prompted bank managers to send staff home almost overnight without testing the scalability of their security protocols. We estimate that on average 75% of bank staff have been working remotely during the lockdown in countries like South Africa and Nigeria. Disaster recovery plans are generally catered to support one major site at the time rather than nationwide and cross-borders networks of regional and pan-African banking groups. In addition, power outage and broadband speed limit could hamper the efficiency and integrity of security protocols.

Still, in our view, banks' digital capabilities will facilitate their transition into agile credit organizations by controlling operational and credit costs. We also believe digital capabilities will be a critical differentiator in banks' creditworthiness over the medium term. Despite higher credit losses, we expect this crisis to be an earnings, rather than a capital, event for most systems. We do not exclude solvency issues for some banks in Tunisia and Nigeria, particularly if the naira weakens by more than 20% while we consider that South African and Moroccan banks' excess capital buffers should absorb unexpected losses. The recapitalization and cleaning efforts undertaken in recent years in Ghana will come up against challenges, while we expect Kenya's top-tier banks capitalization to sustain the stress. Banks' creditworthiness ultimately will remain a function of the pace and shape of the economies they serve. Countries that have entered the crisis with structurally fragile economies--like South Africa, Tunisia, and Nigeria--will likely face a deeper economic contraction than others like Morocco or Kenya. Forbearance measures that allow for weaker provisioning may limit credit losses in the short term, but the long-term stress will, over time, mean weaker profitability for banks.

RELATED RESEARCH

This report does not constitute a rating action.

Primary Credit Analyst: Samira Mensah, Johannesburg (27) 11-214-4869;
samira.mensah@spglobal.com
Secondary Contacts: Dhruv Roy, Dubai (971) 4-372-7169;
dhruv.roy@spglobal.com
Mohamed Damak, Dubai (971) 4-372-7153;
mohamed.damak@spglobal.com
Ravi Bhatia, London (44) 20-7176-7113;
ravi.bhatia@spglobal.com
Regina Argenio, Milan (39) 02-72111-208;
regina.argenio@spglobal.com

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