The Cross Border Expansion of African LCFIs

1. The Cross Border Expansion of African LCFIs Implications for Stability, Growth and Regulatory reforms by Inutu Lukonga and Kay Chung October 27, 2010 Africa Economic Conference/AfDB Tunis Seminar on Regional Financial Sector Issues February 25, 2010 Washington DC

2. Discussion Outline I. Introduction II. Characteristics of African LCFIs III. Performance and Soundness IV. Risks and Vulnerabilities V. Implications for Regional Financial Stability and Growth VI. Policies to Mitigate the Risks and Ensure Contribution to Growth

3. Part I:Introduction Background to the Study

4. Background • The recent global financial crisis has renewed attention to risks posed by LCFIs and re-ignited policy discussion of “too-big-to-fail” institutions; • It has also drawn attention to how risks from less regulated sector could transmit to banking institutions • The crisis also underscored the two way linkages between the macro economy and the financial sectors.

5. Introduction (cont…) • However, focus has been on LCFIs in industrial countries; • The growth of LCFIs in Africa and their stability implications has escaped scrutiny; • Yet stress in these financial groups can have major destabilizing effects on the region

6. Objectives • To take inventory of the cross border expansion of African LCFIs and their regulatory framework; • To draw attention to the potential risks for financial stability and economic growth; • To identify policies that will contribute to greater stability and ensure sustained improvements to intermediation and growth

7. Part II Characteristics of African LCFIs

8. Banks in Africa have increased their cross-border operations …

9. .. and this expansion occurred mostly during the last three years… Number of countries in which the banks’ have operations

10. …and most of the groups are conglomerates with operations in several sectors ….

11. …other characteristics are….. • Most of the groups have complex corporate structures with multiple holding companies • Diverse and dispersed shareholding structures • Centralized business lines

12. …the sources of earnings are concentrated despite the geographical expansion…

13. …and the larger geographical coverage of the newer LCFIs has not translated into scale…

14. ..but though African LCFIs are small compared to traditional global banks…

15. …their operations in Africa surpass traditional international banks…

16. …and African LCFIs are systemically important in several SSA countries

17. ..and they play a significant role in financial markets and payments systems • Many are primary dealers in t-bill markets ; • Some are market movers in domestic and foreign exchange interbank markets; and • Some participate in the management of foreign exchange reserves (UBA in Nigeria).

18. Part III Performance and Soundness

19. ..African LCFIs registered rapid balance sheet growth prior to the crisis…

20. …and the asset growth was underpinned by strong deposit growth…

21. …as a consequence, leverage ratios are generally low…

22. …the groups have been stable but asset quality is deteriorating and profitability trending down… Barometer of Financial Soundness

23. ….(cont..) Barometer of Financial Soundness

24. ….(cont..) Barometer of Financial Soundness

25. …market sentiment for the newer LCFIs is waning…

26. Part IV Vulnerabilities and Risks for Financial Stability

27. Regulation and supervision has not kept pace with cross-border and cross sector expansion • Groups not supervised on a consolidated basis; • Gaps in cross border supervision • Limitations in supervisory capacity • Deficiencies in regulation of MFIs and NBFIs • Slow progress in harmonizing regulatory standards and practices.

28. ..selected aspects of regulatory frameworks of home countries…

29. ..opaque ownership structures also impede effective supervision… • Most of the banks have complex corporate structures that impede supervision; • Some of the banks are registered in jurisdictions that do not lend themselves to supervisory oversight • Disclosure practices remain poor despite listing on stock exchanges

30. Risk management by commercial banks remains weak… • Internal controls improving but still deficient • Risk management exhibits important gaps, including credit risk management • Board oversight still work in progress

31. ..Surveillance of systemic risk has not received adequate attention • Mapping of financial conglomerates has not been done in any of the countries; • Data on intra-group exposure is not monitored; • Slow progress in harmonizing regulatory standards and supervisory practices • Institutions to facilitate systemic risk analysis just developing

32. In addition…. • Institutions to facilitate systemic risk analysis are mostly not yet in place; • Data inadequate (intragroup exposures; no mapping of financial linkages so far); • Disclosure practices are poor, despite listing on stock exchanges; and • Data integrity remains an issue.

33. ..Crisis management arrangements are evolving, but are still poor

34. …financial Infrastructure require further reforms.. • Insolvency and creditor rights • Credit registries • Accounting and auditing • Deposit insurance schemes exist in few countries

35. Part V Implications for Regional Stability and Growth

36. African LCFIs have potential to cause regional instability and curtail growth … • Broad geographical coverage of the banks increase potential for regional contagion; • Large impact given the systemic importance of the banks in deposit mobilization, lending and in financial markets; • Asset deterioration could lead the banks to curtail credit and focus on big corporates; • Inadequacies in the information sharing thus policy response could be slow;

37. Part VI Mitigating the Risks and Ensuring Sustained Contribution to Growth An Agenda for SSA Countries

38. Strengthening supervision of LCFIs will entail legal reforms and capacity building... • Legal reforms to give supervisors powers to undertake consolidated supervision • Strengthening supervisory capacity in undertaking consolidated supervision; • Enforcing prudential regulations on a consolidated basis • Expanding the regulatory perimeter to strengthen supervision of nonbank financial institutions, in light of the increased linkages; • Improving coordination of domestic regulators

39. Cross border supervision needs to go beyond signing of MOUs.. • Cooperation in the exchange of information • Processes to facilitate the information exchange • Data provision to ensure availability • Expedite harmonization of regulations across the different countries; • Set up joint committees for developing regulations and for inspection of the banks;

40. Enhancing surveillance will require resources and a different skill mix • A mapping of the interconnectedness of the system to understand the risk transmission channels; and • Adequate numbers of staff and staff trained in macro prudential analysis to assess systemic risks.

41. Contingency Crisis Management Arrangements are needed to minimize economic and fiscal costs… • Policies, actions and processes for prevention, management and containment of banking system distress and crisis; • Identification of systemically important LFCs; • Predefined composition and functions of a Crisis Management Unit • Improve bank resolution mechanisms; and • LOLR facility to provide Emergency Liquidity Assistance • Deposit Protection Schemes to protect depositors.

42. Second generation reforms are needed to strengthen financial infrastructures… • Addressing operational constraints with respect to credit registries • Enforcing accounting principles • Insolvency and creditor right regimes need further strengthening

43. Key Messages • The cross border expansion of African LCFIs have contributed to more competitive banking systems and encouraged financial innovation • However, their expansion without commensurate efforts to strengthen consolidated supervision and cross border supervision is a recipe for instability. • To avoid boom and bust cycles and ensure their sustained contribution to growth, efforts should be intensified to strengthen the regulatory oversight and surveillance of these financial groups.

44. End of Presentation • Thank You!! • Please see background paper for more detailed analysis