Credit growth in Africa

Jul 23, 2010
Prior to the recent global crisis, Africa’s economic upswing – which went beyond the usual commodities boom – was noted for a number of factors: narrower fiscal deficits, lower inflation and lower debt-servicing costs, which were often driven by yield-curve extension and the deepening of domestic debt markets. Unsurprisingly, rising levels of household consumption and, in many countries, an increase in private-sector credit extension also featured heavily.

Although credit growth was most dramatic in Nigeria, following a ten-fold increase in the minimum capital requirement, almost every African frontier market experienced rising rates of private sector credit, banking sector consolidation and a rush to grow assets as banks scrambled to maintain return on shareholder equity.

While easy money typified the growth upswing the world over, in Africa the growth rate of private-sector credit – off an admittedly weak base - exceeded that seen in many other developing regions.

Fast-forward to the global crisis.

In theory, Africa, with its limited dependence on cross-border lending, should have been more immune to the credit crunch than it proved to be. Among financial intermediaries in Sub Saharan Africa, dependence on domestic depositor bases for funding is greater than reliance on wholesale inter-bank markets. Only one major African economy – Nigeria - experienced its own home-grown banking crisis, with the rapid growth of credit during the upswing helping to mask (for the most part) an unsustainable asset market bubble, poor risk management practices, and – in some instances – outright fraud.
The authorities intervened in a timely way to prevent any of the undercapitalised banks from failing. However, Nigeria is not alone in exhibiting weak credit growth. Measured in y/y terms, credit growth in many other African economies is even weaker. ###MORE###

In South Africa, where financial sector regulation is often considered among the best globally, y/y rates of private-sector credit extension (PSCE) were contracting until May 2010.
Even now, PSCE is still only weakly positive.
What would explain this?

The longer lag which characterises African economic cycles has certainly played a role in the weakness of credit growth.
Consumption baskets in Africa are dominated by food, and Africa was hit hard by the joint food and fuel price shock of 2008.
Inflation soared above the single-digit levels that had briefly typified Africa’s macro economic stabilisation. While the rest of the world was able to move quickly to provide a monetary stimulus, with many major central banks introducing quantitative easing, continuing high inflation forced many African central banks to proceed more cautiously. It is only recently, with a clearer disinflation trend finally manifesting itself across Africa, that African central banks have been able to be more aggressive in providing liquidity. The bias towards monetary easing persists in most markets, and this should eventually feed through into healthier levels of credit growth, albeit with a lag.

South Africa’s pre-crisis credit binge

Nonetheless, for a variety of country-specific reasons, concerns abound over the transmission mechanism of monetary policy. The pre-crisis years saw South Africa experiencing a credit binge of its own, with a new and growing middle-class proving to be receptive borrowers. Household debt as a percentage of disposable income soared from 52% in 2002 to over 80% at the peak of the cycle. Even after a recession in South Africa, debt levels remain high, inhibiting new demand for credit. Unemployment is over 25%, consumer confidence is generally weak, and even 550bps of easing by the South African Reserve Bank in this cycle has done little to lift credit growth.

Although anecdotally there has been some loosening of tight lending standards by the banks in recent months, this has not yet gone far enough. Credit is not available on the same easy terms as it was pre-crisis. Both the supply and demand for credit are constrained, and further interest-rate easing – more than might take place in a more ‘normal’ cycle – may well be required.

Paltry credit growth in Ghana

In Ghana, despite significant interest-rate easing (500bps so far in this cycle) and the introduction of new minimum capital requirements for foreign banks, which – other things being equal – should have lifted loan growth, commercial bank credit to both the private and public sectors over the twelve months to May 2010 was a paltry 3.2% y/y. The sector has certainly seen some improvement in financial soundness indicators – the capital adequacy ratio, for example, has increased to 19.2% from 14.5% a year ago, following the new minimum capital requirements. But even this has proven insufficient to compensate for the hit suffered by the sector as a result of Ghana’s 2008 twin-deficits crisis, which continues to impact the country’s macro economy.
The build-up of arrears in the energy sector has unsurprisingly translated (with some lag) into higher non-performing loans (NPLs) in the financial sector.
Although NPLs at 18.7% in May 2010 have declined from the 20% recorded earlier this year, the total is still higher than the 11% ratio registered only a year ago.

Moreover, new entrants into Ghana’s banking sector and increasingly fierce competition for liabilities have driven up deposit rates.
Faced with a structural increase in their cost of funds, with high rates of deposit interest paid on time deposits in particular, official easing by the Bank of Ghana has had little impact.
In time, this should change:
The maturing of time deposits will see lower rates offered on new deposits, and with a lower cost of funds in place, loan rates should eventually decline. But all of this will take some time, suggesting that the transmission of monetary policy changes has slowed appreciably.
In addition, with arrears in the region of 6% of GDP still to be resolved, and NPLs likely to remain high in the meantime, it will be a while before credit growth reacts meaningfully to interest-rate easing by the Bank of Ghana, even as the country moves to oil producer status.

Nigeria: disappointing credit growth

Perhaps nowhere in Africa has the breakdown in the traditional transmission mechanism of monetary policy received more attention than in Nigeria.
Although the costs of the banking crisis have been somewhat limited – to date, no bank has failed, and even the fiscal impact of the bank rescue looks likely to be minimal – credit growth is nonetheless disappointing. Given that the quantum of losses announced by the Central Bank of Nigeria (CBN)-rescued banks was sufficient to erode two-thirds of the Nigerian banking sector’s capital, disappointing credit growth ahead of the formal establishment of a recapitalisation vehicle (such as the proposed Asset Management Company) is not a surprise.
In the meantime, various measures have been put in place by the CBN to stimulate lending.

Interest rates have been cut, with deposit rates reduced to just 1% in order to encourage banks to lend rather than keeping money on deposit with the CBN.
The authorities have made long-term funds available for on-lending at concessional rates to certain industries.
The same facility can also be used for refinancing existing obligations in the manufacturing, airline and other industries. A credit guarantee scheme for SMEs has also been established, through which the CBN will repay 80% of the principal to banks in the event of a default. Finally, the 1% general loan-loss provisioning regime previously in place has been temporarily suspended, on the grounds that it could prove too pro-cyclical.

Will it work?

While there is plenty of evidence that Nigerian banks are awash with liquidity (borrowing from the CBN’s discount window remains minimal), this excess liquidity has not yet found its way in to the real economy. Perhaps it will take more time.
Perhaps it will take more confidence. Perhaps there is little prospect of a meaningful rise in credit until the NPLs that are constraining new credit growth have been removed from banks’ balance sheets. (Given the imminent establishment of an Asset Management Company to do precisely this, Nigeria may not have to wait too much longer to see record liquidity transformed into private sector credit.)

In the meantime, a telling trend can be observed, both in Nigeria and elsewhere in Africa. Given aggressive monetary easing, lows in interest rates, and banks’ excessive liquidity positions, even in an environment characterised by considerable risk aversion, the competition to lend to the best credit risks is growing. Spread compression has begun, and eventually, banks will seek higher returns by lending to riskier market segments. For now, however, the negative effect of the crisis may still have to run its course.
Monetary easing alone is unlikely to be sufficient. Greater confidence in real economy outcomes will be needed to see a more meaningful improvement in credit growth. Razia Khan is Head of Macroeconomics and Regional Head of Research for Africa at Standard Chartered Bank.

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