By R. Daumont, F. Le Gall and F. Leroux (IMF)
http://www.imf.org/external/pubs/ft/wp/2004/wp0455.pdf
Abstract
This paper analyzes the causes behind the banking crises that took place in 10 countries in Sub-Saharan Africa (SSA) between 1985 and 1995. It builds on frameworks that have been used to understand banking crises in other regions of the World and highlights the differences and commonalities that Sub-Saharan crises had with other banking crises.
Key takeaways from this paper are:
- Banking systems in several SSA countries suffered crises of an endemic nature. Although they were highly insolvent, they continued to operate for a few years
- Similar to other banking crises, SSA banking systems were hit by external shocks, operated in a deteriorating macroeconomic environment, followed inadequate practices and were built on weak institutional and legal frameworks
- Government interference in the operating environment affected the banking structure and contributed to creating fragile institutions (i.e. lack of supervision and regulation, created perverse incentives that made banks accumulate huge risks, etc)
Summary
According to the definition of systemic banking crisis, whereby non performing loans are at least 5 to 10% of total assets and thus sufficient to wipe out most or all of the banking systems’ capital, many Sub-Saharan African countries were in crises during 1985-1995. Banking systems faced a ‘silent form of distress’, in which a significant portion of the system was insolvent (sometimes reaching 50% of non-performing loans/total banking loans), but still remained open.
The sources of distress behind the banking crises are categorized in three groups:
A. Operating Environment
The feeble macroeconomic environment contributed to the weak performance of the banking sector. Concentration in the banking sector reflected the economies’ high dependency on agriculture exports, and their vulnerability to commodity price volatility. Fiscal policy in these countries had little room to react to shocks and depended heavily on export taxes. Moreover, those countries belonging to the CFA franc zone had additionally lost control of their monetary policy.
During the 1980’s SSA is hit by a series of external shocks, which adversely affected the region’s terms of trade. For some countries, terms of trade fell by more than 50%. Additionally, countries in the CFA Franc zone suffered an appreciation of their currency against the US dollar, loosing competitiveness. Countries outside the CFA franc zone devalued their currencies, managing to grow, but faced another challenge: inflation, eroding banks’ capital in real terms.
The legal environment in SSA failed to meet the basic requirements of banks. Banks efforts to pursue defaulters or to enforce agreements were mitigated by a judiciary that was unable to bring action against defaulting borrowers.
Accounting and disclosure standards were very weak among study countries and there was no regulatory body implementing any real control. Supervisors were unable to tell the true condition of the banks. This lack of effective supervision allowed banks to continue to operate under very bad conditions.
Banking regulation was deficient. Some countries, like Tanzania, lacked an authority that could properly regulate the sector. In others, like Ghana, the Banking Act did not give clear guidelines on issues such as capital requirements, risk exposure, prudential lending, etc. Similarly, in the CFA franc zone countries, there was ambiguity on which government institution had the responsibility over the banking sector and supervision was very inefficient and sporadic.
Interest rate controls affected the banks’ balance sheets and created perverse incentives for banks, since riskier sectors were receiving preferential rates. Also, financial market development was very narrow in most countries, with 9 of the 10 countries having assets which accounted for less than 3 blln US dollars. This implied that commercial banks could not diversify their sources of funding, could not achieve greater efficiency or cost effectiveness.
B. Market Structure and Government Imprints
Ownership of the banking sector was dominated by the government, owning a significant share of the systems’ assets. It owned commercial banks, which usually performed poorly; and development banks, which were highly exposed to the risks affecting the specific sector they worked with (ie Agriculture, Housing, etc). Government authorities intervened frequently in their operations and pressured them to provide loans to struggling public enterprises or to influential people.
Local commercial banks played a significant role in Kenya, Nigeria and Uganda, where investors took advantage of profitable opportunities derived from the liberalization of financial and currency market operations. Many of them operated soundly between 1985 and 1995, but many took inherently risky activities, which left them at a precarious position.
Foreign banks were thought to have had a beneficial effect on the banking systems. They had a stronger capital base than domestic banks and could be recapitalized, if needed, by the parent bank. Also, they had easier access to external forces of liquidity, more conservative credit policies and were more independent from government pressure.
Entry conditions helped destabilize the banking sector. In countries where tight entry conditions prevailed, banks performing poorly were protected and allowed to continue operating, while in Kenya and Nigeria, where conditions were lax, it was easy for incompetent applicants to join in.
C. Unsound Conduct of Banks
Banks’ loan decisions were not based on proper assessment of risk and return. Their credit policy had serious weaknesses. The appraisal process lacked a systemic examination of the subject, nor was the collateral verified. Credit monitoring lacked the capacity to identify problem loans at the early stages and was unable to assess an adequate level of loan loss reserves. Internal controls were missing and Management Information Systems were inadequate to provide coordination between lending groups.
Also, with the aim to receive political favors or as a response to political favors, banks portfolios had a high concentration of risk. Several banks ended up financing operating deficits of public enterprises with little or no prospect of repayment. Sometimes loans went to the government itself, and after a change in government the loans would not be recognized by the new administration.
In sum, the causes behind the banking crises in SSA had several of the ‘usual suspects’, such as macroeconomic imbalances, external shocks, weak legal and institutional environment, unsound lending practices, etc. But also, had a particular endemic feature: Heavy government intervention and little diversification.