Opportunities And Risks For African Banks

BMI View: We are optimistic about the prospects for Sub-Saharan Africa banking sectors believing that asset growth will be strong in the years ahead, particularly in those countries where sector penetration remains low. However, asset expansion will not be without its challenges. High interest rates will continue to exclude many would-be borrowers and banks will continue to face difficulties in assessing credit-worthiness. The informal nature of many SSA economies as well as corporate governance weaknesses also present challenges.

The relatively small contribution that financial services make to the majority of African countries' economic output belies banks' important role. Strong private sector credit growth over recent years has helped to finance the expansion of local companies and has fuelled demand for consumer and capital goods. In many cases, domestic banks are the major holders of local government debt and are therefore important sources of budget deficit financing. Banks also often make up large proportions of regional stock exchanges and have therefore played a leading role, both directly and indirectly, in helping to develop African countries' capital markets.

We believe that strong headline economic growth rates and, in most cases, low levels of financial service penetration mean that banks and banking sectors are set for strong growth over the years ahead. We expect the countries in the bottom half of the table above - which is ordered from largest to smallest banking sector as a proportion of GDP - to all grow by 15 - 20% per year in nominal terms over the coming five years. The exception is Zimbabwe, where we believe slow economic growth and ill health for many of the countries' banks mean that asset growth will be far slower than its peers. The chart below shows the growth rate for assets, loans and deposits in year-on-year terms in June 2013.

Banking Sector Growth Remains Strong
Africa - Asset, Credit and Deposit Growth In Banking Sectors Covered By BMI In June 2013, % y-o-y

BMI View: We are optimistic about the prospects for Sub-Saharan Africa banking sectors believing that asset growth will be strong in the years ahead, particularly in those countries where sector penetration remains low. However, asset expansion will not be without its challenges. High interest rates will continue to exclude many would-be borrowers and banks will continue to face difficulties in assessing credit-worthiness. The informal nature of many SSA economies as well as corporate governance weaknesses also present challenges.

The relatively small contribution that financial services make to the majority of African countries' economic output belies banks' important role. Strong private sector credit growth over recent years has helped to finance the expansion of local companies and has fuelled demand for consumer and capital goods. In many cases, domestic banks are the major holders of local government debt and are therefore important sources of budget deficit financing. Banks also often make up large proportions of regional stock exchanges and have therefore played a leading role, both directly and indirectly, in helping to develop African countries' capital markets.

High Growth Potential Almost Across The Board
Assets, % GDP Loans, % GDP Deposit, % GDP Loan to deposit Forecast Asset CAGR to 2018, %
Mauritius 283.8 69.9 194.7 0.4 7.5
South Africa 116.0 88.0 83.3 1.1 6.9
Namibia 72.1 51.2 57.9 0.9 12.0
Kenya 67.9 39.3 50.2 0.8 16.0
Botswana 52.3 31.6 41.9 0.8 12.1
Zimbabwe 52.2 27.5 33.0 0.8 4.5
Mozambique 51.5 30.1 38.7 0.8 20.0
Nigeria 48.9 24.5 33.1 0.7 19.4
Tanzania 38.2 17.7 24.7 0.7 18.0
Ghana 37.6 18.7 21.7 0.9 15.6
Zambia 35.8 15.6 22.1 0.7 17.0
Uganda 25.6 13.7 17.2 0.8 21.2
Source: Central Banks, BMI

We believe that strong headline economic growth rates and, in most cases, low levels of financial service penetration mean that banks and banking sectors are set for strong growth over the years ahead. We expect the countries in the bottom half of the table above - which is ordered from largest to smallest banking sector as a proportion of GDP - to all grow by 15 - 20% per year in nominal terms over the coming five years. The exception is Zimbabwe, where we believe slow economic growth and ill health for many of the countries' banks mean that asset growth will be far slower than its peers. The chart below shows the growth rate for assets, loans and deposits in year-on-year terms in June 2013.

Banking Sector Growth Remains Strong
Africa - Asset, Credit and Deposit Growth In Banking Sectors Covered By BMI In June 2013, % y-o-y

Challenges Abound

Despite the promising outlook, we note that there are significant challenges surrounding banking sector expansion; many of these are consistent in countries across the region. For one thing, the interest rates at which banks are willing to lend to the private sector are extremely high. The chart below shows the prime rate - the rate at which banks will lend to their most credit-worthy customers - of several of the banking sectors we cover. All, with the exception of South Africa and Botswana, are above 10%. This makes banking sector finance unaffordable for many would-be borrowers, which decreases the market size for banks' loan products.

High Borrowing Costs Pervade
Africa - Selected Countries' Commercial Bank Prime Lending Rates, %

High Costs Related To Weak Business Environments And Lack Of Credit Information

Interest rates at these levels are explained by several factors. For one thing, the cost of running a bank in many African countries is higher than in more developed markets with issues such as inadequate national infrastructure, higher security risks and weak internal systems all leading to higher operating expenses. These higher costs are factored into the pricing structure of bank lending rates.

High lending rates also reflect the difficulties that banks face in assessing credit-worthiness of borrowers. In the absence of information on a client's likelihood of default, banks mitigate the effect of potential default by charging higher interest rates across the board. All of the countries in our banking sector universe have introduced credit reference bureaux (CRB) in recent years in a bid to address this issue.

While this is a positive step, it is no panacea. CRBs in some countries, such as Kenya, have only been used to build negative information profiles on borrowers; in other words they are helping banks adjudge which borrowers to avoid but not providing positive information on borrowers whose financial history would warrant lower borrowing costs. CRBs also face logistical issues with regard to retail borrowers owing to lack of national identification documents, difficulty verifying physical addresses and variations in names. The Bank of Uganda has introduced a biometric based customer numbering system for each borrower in order to address this problem in what could provide a template for other countries in the region.

The Crowding-Out Factor

Another factor placing upward pressure on lending rates stems from the fact that banks in most, if not all of the countries we cover, are major lenders to the government. In Kenya for instance, commercial banks held around 50% of total outstanding government local debt in January 2014 with government bonds making up around 20% of total Kenyan banking sector assets. At the time, Kenyan three month Treasury Bills were yielding 9.2% while a two year bond issued in December yielded 11.6%. In the context of these attractive risk-free rates, there is little incentive for banks to lend to the relatively riskier private sector at anything but a large premium.

African Banks Compare Favourably To Global Counterparts In Returns On Assets And Equity
Name Main country/region of operation Return on equity, % Return on assets, % Efficiency ratio, % Price to earnings ratio
GHANA COMMERCIAL BANK Ghana 60.3 6.2 56.7 7.1
STANBIC BANK UGANDA Uganda 37.6 4.5 55.3 12.7
GUARANTY TRUST BANK West Africa 34.1 5.3 42.7 8.8
EQUITY BANK Kenya 31.3 5.1 54.7 9.6
KENYA COMMERCIAL BANK East Africa 25.0 3.6 53.9 10.0
ZAMBIA NATIONAL COMMERCIAL BANK Zambia 24.1 3.0 66.6 16.6
BANCO BRADESCO SA-PREF Brazil 17.3 1.3 72.1 9.8
TURKIYE GARANTI BANKASI Turkey 17.0 1.9 54.4 8.0
PKO BANK POLSKI SA Poland 15.8 1.6 46.5 16.6
MAURITIUS COMMERCIAL BANK Mauritius 15.5 2.1 45.3 11.8
ABC Bank Southern Africa 15.3 1.8 62.5 5.3
ECOBANK TRANSNATIONAL Pan-Africa 14.9 1.7 71.9 5.4
GRUPO FINANCIERO BANORTE-O Mexico 14.3 1.4 65.3 16.8
WELLS FARGO USA 14.0 1.5 57.9 12.0
VTB BANK Russia 12.6 1.0 53.3 7.4
HSBC Global 8.2 0.6 62.4 12.4
Source: Bloomberg, BMI

The final reason why African banks charge high levels of interest is simply because they can. Surveys in a variety of African countries cite firms' lack of access to capital as a major impediment to operations, indicating that there is a mismatch between supply of and demand for financing. This inevitably increases the cost of such financing, a fact borne out by the high rates of return on equity and assets achieved by African banks relative to global and other emerging market benchmarks, as the table above illustrates.

Informal Economy Passed Over

The high proportion of informal and small-scale enterprises in many African countries is also problematic for banks as these would-be clients are either difficult to assess or are not deemed credit-worthy. An example of this is in Nigeria, where agriculture, comprised mainly of small-scale and subsistence farmers, made up almost 40% of nominal GDP in 2012. However, agriculture accounted for less than 5.0% of total outstanding credit at the same time. In Zimbabwe, the uncertainty over land ownership following a massive land redistribution exercise during the early 2000s has left many banks wary of lending where land is used as collateral. This has deprived farmers of access to capital and banks of a large potential market.

Agriculture: Low Credit Allocation Despite Economic Importance
Nigeria- Breakdown of Nominal GDP (LHS) & Outstanding Credit By Sector (RHS) In 2012

Lending To Friends

A lot of African banks face significant corporate governance issues. The absence of strong institutions in many African countries means the line between politics and business is often blurred. In the case of banks, this often leads to loans being made to the politically and economically well-connected which, in turn, results in higher incidence of loan non-performance that is un- or underreported in some cases. The Nigerian banking sector has come under scrutiny for its lending practices in recent years while some of our contacts in Kenya believe that the banking sector there underreports NPLs. A significant rise in NPLs in Zimbabwe over recent months has been blamed on, among other things, insider lending.

Mobile Money: More Of An Opportunity Than A Threat

The proliferation of mobile money services in many countries has also raised uncertainty for the banking sector as these services are essentially competing with banks for deposits. However, given that mobile money platforms are unable to provide the loans and other financial services that customers will eventually demand, they should be seen as a gateway to the financial system rather than an alternative to commercial banks. In fact, we believe that the profusion of mobile money services will accelerate the spread of financial literacy and build customers' confidence in dealing with financial institutions

Use of these services may also speed demand for credit from both private customers and small business owners who are now able to save up deposits. Cooperation between banks and mobile money providers could further accelerate this process. It is even possible that mobile money records could be used as a form of credit history to help address the credit-worthiness issue highlighted above.

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Sector: Country Risk
Geography: Africa
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