African Financial Sectors and the European Debt Crisis: Will Trouble Blow across the Sahara?

Mar 09, 2012
Michael Fuchs , Lead Consultant, Long-Term Finance Initiative
African financial sectors have received much recognition for their steady growth performance and resilience during and after the 2008 global financial crisis. So – as the European debt crisis continues to unfold – policy makers are asking: Will African financial sectors continue to stay out of harm’s way? On balance, evidence suggest that the impact of the European debt crisis – assuming a crisis scenario characterized by a significant deleveraging of the European banking sector, a reduction in trade with Europe and a significant but still contained decline in global investor confidence – will pose some challenges to financial sector development in Africa, but not on a systemic scale. Remarkably, the growing depth of domestic financial markets has reduced the importance of European bank funding for African borrowers. Cross-border lending from European banks accounts for less than 25% of total credit to the African private sector. Outside South Africa the share of foreign, cross border lending reduced from 45% in 2005 to 34% in 2010. Borrowers are increasingly able to borrow from local banks and fund themselves on local markets. European banks also have a limited presence in Africa. Notable exceptions are Portuguese banks in Angola and Mozambique, which mostly fund themselves locally and not via their European parents and are often of strategic importance to the parent banks given their high profitability and growth prospects. Nevertheless, a number of countries and sectors are large borrowers from European banks and the impact of reduced European bank lending will depend on the ability of these sectors to find alternative financing. Regional telecom operators, the commodities sector and South African banks are large recipients of European bank funding. Most of these can be expected to find alternative means of funding. Average lending from foreign banks as a share of GDP is limited in most African countries, but accounts for more than 20% of GDP in Mozambique, Senegal and South Africa and some smaller economies such as Cape Verde and the Seychelles. A decline in global investor confidence has reduced portfolio inflows to some African countries, impacted equity market performance, reduced liquidity in a number of fixed income markets and led a number of African Governments to postpone international bond issues. The performance of local equity markets is closely linked to portfolio flows from foreign investors. More importantly, liquidity in a number of local bond markets has been highly dependent on foreign portfolio investor participation. Recent yield volatility arising from increased inflation and exchange rate depreciation has acted as a drain on local bond market liquidity.
Medium-term prospects remain positive, though, as international investors are still looking to increase investment allocations to Africa.
Namibia and Senegal accessed international markets successfully in 2011 for the first time and the recent track record of African financial market stability has reduced Africa’s risk premia significantly. Market observers emphasize that Africa is affected by contagion through global investor confidence, but that the impact is now in line with that observed in other emerging markets. Investor perceptions of African risk have improved in recent years and an emerging dedicated investor base is reducing price volatility of African securities. A recent global survey of major institutional investors found that Africa will benefit from higher investment allocations over the coming years. The most significant risk for Africa associated with the European debt crisis is that it might trigger domestic, home-made financial sector risks. African credit markets were growing at a fast pace prior to the global crisis and, after a temporary period of slow-down, credit growth has picked up again through 2011. In an environment of weak risk management and limited supervisory capacity fast credit growth is likely to contribute to a build-up of risks in the sector. The example of the 2008/9 global financial crisis should be heeded as a warning. A new round of external shocks emanating from the European debt crisis could again expose or exacerbate prevailing risks in African financial sectors. Strengthening supervisory capacity and risk management capacity needs to remain at the core of the reform agenda. This will be even more important as many of insulating factors that limit the exposure of African financial sectors to global risks will disappear as the Africa region continues to grow and integrate ever more with global markets. Michael Fuchs is Advisor in the Finance and Private Sector Department of the Bank's Africa Region. Michael has worked in the Africa Region since 2003 focusing on financial sector development issues across a broad spectrum of countries and leading financial sector assessments in Mozambique, Kenya, Uganda, Malawi, Zambia, Tanzania and Rwanda.
He has also worked extensively in Nigeria, inter alia in supporting the Nigerian Financial System Strategy 2020 and has led several policy reform and investment operations, including in Kenya and Nigeria. Among topics of special focus are post-crisis monitoring of African financial systems, the impact of revisions in the international financial architecture on LICs, sub-regional financial integration, and facilitating infrastructure finance. Before joining the Africa Region Michael worked for 8 years in the Bank's ECA Region, five of which focusing on Russia in the wake of the financial collapse in 1998. Prior to joining the Bank Michael worked for 11 years with the Danish Central Bank predominantly on monetary policy and advising on the management of foreign exchange reserves.
He has his PhD and MA from the University of Copenhagen and his BA from the University of York (UK).

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