Regional banks in Africa need to balance risk with financial inclusion
As global banking retreats amid tighter regulations, the continent has to find solutions to remain connected
As an organisation with phenomenal convening power the World Economic Forum (WEF) has the potential to facilitate the germination of ideas and initiatives that can shape the future of the global economy and its related systems. One of its 14 initiatives is on financial and monetary systems that affect the banking sector.
It is more than eight years since the 2008 global financial crisis plunged the world economy into turmoil and triggered policy reactions that continue to have a profound effect today. The theme of the recent WEF Africa meeting — “Achieving inclusive growth” — provided an opportunity to reflect on the regulatory changes put in place since then and what they mean for the future.
Perhaps a nuanced position that allows stronger regulation and financial integration and inclusion to take place simultaneously can emerge.
There is no argument that better regulation was needed. Once the extent of the crisis became known, it was clear there had been reckless lending, as well as a proliferation of investment products whose risk profile was not understood by the banks, regulators, ratings agencies and the insurance firms that were underwriting them. Financial stability moved to the top of the agenda and regulators were given more powers to effect tangible change.
Financial stability regulation centred on four themes: making financial institutions more resilient; ending “too big to fail” — the notion that some large banks cannot be allowed to fail because the consequences would be too disastrous and that they should be propped up by governments rather than failing; making derivatives markets safer; and transforming shadow banking, a term that refers to intermediaries that provide financial services, but are not subject to regulatory oversight.
Arguably the biggest factor affecting the industry was the Basel Committee’s requirement for banks to hold more capital of higher quality. The demands are even higher for those banks the Group of 20 financial stability board regards as systemically important — the appropriately labelled “globally and domestically significant banks”.
COSTS OF COMPLIANCE
The costs of complying with Basel III requirements are significant. According to the Wall Street Journal, in 2013, the six largest US banks spent about $70.2bn on regulatory compliance, double the $34.7bn they spent in 2007, and at JP Morgan, the headcount associated with what it calls controls, which includes many compliance-related staff, has grown to 43,000 in 2015 from 24,000 in 2011.
These costs have an implication for bank customers in the form of banking fees. Not only did the cost of conducting business rise in line with increased regulation, but banks are now incurring large penalties for misconduct. In response, global banks have reduced total assets including derivatives, securitised mortgages and other securities and have shed noncore businesses as they look to strengthen their capital and liquidity positions, reduce risk and restore profitability.
Some were forced to shed assets as a condition for state aid, while others are seeing even tougher legislation down the road and are scaling back operations in anticipation.
If the ultimate policy aim is that no bank should be too big to fail, then there certainly has been progress towards this goal. Assets have shrunk and so have risk-weighted assets as a share of total assets. Banks are less vulnerable and better capitalised, which is positive — but there has been collateral effects starting with the question of whether global banking still has a future. If regulatory reform continues to follow the trajectory we have seen so far, there will soon be no banks that are truly global.
With this retreat of global banks coinciding with increased global connectedness, there is a growing need for banks around the world to remain connected through what is known as “correspondent banking” relationships. These enable the provision of cross-border payments and play an important role in facilitating trade and the transfer of remittances from abroad. This is very common in Africa, where many family income providers live and work outside their own country.
However, at the same time as changes are being made to capital and liquidity rules, policy makers are introducing and tightening measures to stop the illicit flow of funds for the purposes of avoiding tax, money laundering, terrorism and other crimes. These rules are starting to lead to a decline in correspondent banking as banks look to reduce risk in line with KYC (know your customer) rules, anti-money laundering regulations and more. The decline in correspondent banking, therefore, raises a concern about financial exclusion at a time when general exclusion from the global economic system fuels so much of the political turmoil and social discontent we see across the world.
According to an IMF discussion note published in June, Africa is among the emerging-market regions worst affected by the decline in correspondent banking. It says it is mostly small and medium-sized exporters as well as small and medium-sized domestic banks that have been most affected by the withdrawal of correspondent banking relationships. Angola, Liberia and Guinea are among countries in Africa that have been hardest hit by this trend.
With this background, it is clear that regional banks will need to become a bigger feature on the financial services landscape in Africa. With the decline in correspondent banking, regional banks are vital to ensure the continued connectedness of Africa to the global economy as banks across the world find it easier to maintain relationships with fewer groups that have a presence in multiple African countries. In this way, they can continue to ensure a connection into Africa for their clients, but also manage their risk by having to maintain a relationship with fewer banks that they can be comfortable with, that will implement the same policies and controls in all the countries in which they operate.
FINANCING INFRASTRUCTURE
Regional banks are also necessary to effectively and efficiently facilitate regional trade, particularly if Africa is to grow intracontinental trade. It is less onerous for companies with regional expansion ambitions to do business across jurisdictions if they can have one bank across the region instead of many banking relationships that come with an increased administrative and cost burden.
And finally, with the global crisis affecting the ability of global banks to finance infrastructure across Africa, regional banks have had to fill this gap, becoming the largest participants in new syndicates and large bilateral loans to finance infrastructure, according to a 2015 European Investment Bank report on banking trends in sub-Saharan Africa.
However, the question is starting to emerge as to whether regional banks themselves are at risk, and I believe they are. First, just as some banks are classified as globally systemic, we will probably see some of the regional banks being viewed as too big to fail in their region. This means they too will face higher capital requirements, raising costs.
Second, regulations are not consistently implemented and regional banks will often operate out of jurisdictions that have higher regulatory requirements. For example, South African-based banks have to comply with Basel III not only in SA, but in other markets in which they operate, even if those markets have lower regulatory and capital requirements.
Third, the actions and requirement of local regulators or policy makers may affect how regional banks are able to operate and grow. For example, some countries may require that the local operations of a regional bank are ring-fenced from operations in other geographies in an effort to prevent contagion.
There are other complications too. Global anti-money laundering requirements can pit regional banks against jurisdictions in which the political, legislative and judicial systems are weak. This can affect their ability to transact internationally even after making the required investments in compliance. The next question we have to ask, then, is whether regional banks will not have to take the same decision as global banks — retreat where regulation proves too much of an economic hurdle.
There is no doubt the key reasons for enhanced global regulation of the financial sector are all well-intentioned and many banks have become more resilient as a result. It is important to ensure that among all these competing priorities, stakeholders consider the likely end state of the industry. If the outcome is one that is unlikely to benefit consumers in Africa and the rest of the developing world, we have to consider a new set of changes that find equilibrium between managing systemic risk and allowing banking to responsively facilitate economic activity.
If there is no intervention to find this balance, we may inadvertently facilitate further exclusion, the outcome of which is something none of us want.