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Can the ECO Increase Systemic Risk in WAEMU?

Feb 10, 2020
Dhafer Saidane , PhD in Economics, Professor SKEMA Business School

The sub-prime crisis of summer 2007 led to an economic downturn that shook the financial sector worldwide. The global financial system’s fragility was, in part, attributed to Lehman Brothers’ collapse in September 2008. This major bank’s failure called into question the concept of "too big to fail". Some of the reasons for the Banking system’s vulnerability are the failure of large banks triggering a financial crisis due to inter-connectivity, the impact of a debt crisis, sudden changes in interest rates and deregulation are. Following the crisis, African banks have begun to fill the void left by banks in rich countries by expanding their operations abroad.

President Emmanuel Macron has just announced the launch of the ECO, the West Africa's new currency which will replace the CFA Franc. The ECO can stimulate banking inter-connectivity and the existence of systemic risk in West African Economic and Monetary Union (WAEMU) countries if regulatory measures are not adopted.

New trends were already emerging long before the introduction of the ECO. These trends have led to an increase in banking relations among developing countries and to a South-South regionalisation of international banking operations. As a result, African banking models are in a search of their new critical size. They are better defined in terms of business lines but are expanding in all directions. For example, between 2009 and 2010, the net profits, balance sheet total and the number of accounts at Coris Bank - a pan-African bank - grew by 112%, 64% and 122% respectively. Between 2016 and 2017, the same indicators increased by 20%, 28% and 14% respectively, exceptional growth rates that are targeting a critical size that may become systemic.

It should be noted that the African banking market is the second largest in the world in terms of growth and profitability. McKinsey Global Banking Pools (2018) data project an annual banking revenue growth on the continent of about 8.5% between 2017 and 2022, which will generate revenues of about USD 129 billion, with USD 53 billion coming from retail banking [1].

Faced with this situation marked by exceptional growth in banking activity, it would be appropriate to consider the level of systemic risk to which African financial centres could be exposed, as well as reforms to be adopted to promote a stable banking model that will contribute to development finance.

WAEMU's case is relatively interesting for this analysis given that it is a monetary union in which banks are subject to the supervision of a community regulator: The Central Bank of West African States (BCEAO) and the Banking Commission. Banks are therefore subject to the same regulations. This region's banking sector has, since independence, been dominated by foreign banks such as French banks. In recent years, there has been a penetration of regional banks, mainly from Nigeria, Morocco and Libya. The proportion of pan-African banks, which was less than 30% in 2000, is estimated at just over 60% in 2017. This expansion of regional banks can be explained by the search for profit, as the zone has recorded a more than 5% economic growth since 2012. Also, the banks operating in this zone are entitled to a single license which gives a banking institution the right to have an active presence in another member state of the union, without having to immediately build up capital. Moreover, the regional regulator's prudential rules on minimum capital provide an incentive for banks to expand in order to optimise their capital. Therefore, banks that are members of monetary unions are more motivated to expand.

Together with my colleagues, Babacar Sene and Désiré Kanga, we conducted a study of 82 credit institutions comprising pan-African banking groups and medium-sized banks over the 2000-2017 period. The probability default estimation combined with CIMDO (Consistent Information Multivariate Density Optimizing) method and the use of the cluster method, based on the notion of geographical footprint measured by the number of countries in which the bank operates, constitute a novelty in the field analyzed. It shows that the current banking system does not face systemic risk. However, if the financial strength of major pan-African groups deteriorates, there could be contagion effects that could weaken the union. Indeed, due to its very rapid evolution, especially in terms of size, a deterioration in the financial strength of large pan-African groups could lead to contagion effects detrimental to the zone's financial stability.

Therefore, cooperation on cross-border supervision is necessary. It has already begun, but enhanced and sustained collaboration is essential. The rapid expansion of pan-African banks poses challenges, including the following five challenges:

–          Oversight issues which, if left unaddressed, may increase systemic risks. Oversight capacity is already limited and under-resourced.

–          Transparency and disclosure, good governance, sound prudential supervision and a legal and regulatory framework which supports comprehensive supervision and crisis management, including in host countries. The ability and suitability of owners and shareholders, especially bank holding companies, are not always fully assessed and, in some cases, ownership structures are opaque.

–           The absence of a single accounting standard across the continent makes it difficult to assess the overall challenging situation facing the banks. And in many countries, the supervision of the way business is conducted is just beginning to take shape.

–           Lack of regulatory oversight of bank holding companies and their supervision on a consolidated basis in some home jurisdictions needs to be addressed.

–           Memoranda of Understanding guaranteeing full information sharing are required between all banking institutions and host countries.

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[1] MC Kinsey (2018) Roaring to life: Growth and innovation in African retail banking


About the author

Dhafer Saidane, PhD in Economics, is a Professor at SKEMA Business School and at the University of Côte d'Azur. He heads the SKc Corporate Financial Management MSc on the Lille campus, the International Observatory for Sustainable Finance and the SAB Trophy for Sustainable Finance. He is an advisor to the “Club of Directors of Banks and Credit Institutions in Africa” and consultant on financial issues in Africa to the United Nations. He is a scientific advisor for the journal "Techniques Financières et Développement" (Paris) and hosts a regular column in the journal African Banker.

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