De-risking for Sub-Saharan African Banks in 2020
De-risking is the decision to terminate a business relationship when the customer risk is considered more sensitive. This term is frequently used to refer to the withdrawal of international banks from the African continent regarding so-called correspondent banking activities i.e. cash management and trade finance. This has been the focus of most financial institutions in sub-Saharan Africa in recent years. The level of transactions in the world depending on financing solutions is regularly estimated at 80 to 90% . The International Chamber of Commerce has also developed the concept of trade finance gap which corresponds to the financing gap faced by the continent's economic stakeholders. Africa is particularly affected by this phenomenon with a financing gap currently estimated at about a hundred billion USD.
Before the crisis, correspondent banking activities were generally considered a business line like any other. The risk/return ratio added to the potential of side-business (money market, foreign exchange lines, risk sharing, etc.) governed the relationship between banks. Regulatory constraints were much less present and had little impact on the correspondent banking services offered to banks. The context changed significantly in 2010 and its effects will continue to be felt in 2020 and probably in the years to come.
There are significant differences between access to services related to cash management (clearing services) and those related to the sound conduct of their trade finance transactions. In 2020, the former is significantly more difficult to access than the latter. We will develop this aspect further ahead in the conclusions of our study.
The 2008 Crisis Triggered Profound Changes in the International Banking Sector
These developments in the banking and financial sector have changed the approach of banks to correspondent banking issues. This can be explained by three factors:
- The exit of major players such as Barclays, BPCE or BNPP from the continent through the sale of all or part of their domestic subsidiaries. These divestments have led to a loss of local knowledge by these institutions and have reduced their appetite to continue providing correspondent banking services to local banks, especially when the market now considers them to be high-risk. The positive effect of these withdrawals was that they gave way to new, active banking operators, some of them African, and redefined the market.
- The 2009 crisis had a significant impact on the regulatory requirements (KYC & Capital) imposed on financial institutions and reduced - sometimes drastically - the scope for financing capital-intensive activities such as project financing, aircraft, shipping or trade commodity finance. African import and export trade finance has also suffered from these changes. Rising human and financial costs (implementation and monitoring of transactions) and capital cost are the direct consequences. Capital costs are especially high when the sovereign ratings of some countries in the sub-region have been downgraded by the markets and/or by the banks themselves;
- A business model change within certain banks has had impacted correspondent banking activities: reduction or even elimination of these services deemed non-strategic, the advent of the Originate to Distribute logic, and the development of advisory vs. financing activities. For example, one bank in our network, historically considered as a leader in trade finance on the continent, has totally stopped its correspondent banking activities. At the same time, it has developed and promoted its advisory activities for African banks (IT, risk management). Others have chosen to refocus their activities and efforts on their traditional banking clientele, thus abandoning smaller clients who are considered less commercially attractive than before.
Parameters for a De-risking Approach
Our study sample covers 90 banking and financial institutions that are active on the continent (83 commercial banks and 7 development banks): 51 institutions from Europe, with the majority represented, 19 from Asia and the Middle East, and 5 from Africa. All these players offer trade finance lines, but only 30% of them offer cash-clearing services in USD - which is the main source of tension in the sub-region today. Since 2012, it is estimated that at least a dozen major institutions, which have historically had a strong presence on the continent, have withdrawn these services from their clients. However, some have maintained the processing of EUR-denominated transactions in a context where more than half of the world's trade is conducted with the US dollar. There are two reasons for this withdrawal: (i) a (voluntary) refocusing of activities as described above; and (ii) a forced withdrawal. In the second case, the correspondent bank(s) of these institutions forced their client to stop doing business in certain countries or with certain institutions, sometimes both at the same time. This decision is mainly motivated by the institution's desire to exercise greater control over all transactions passing through its books, thereby reducing the risks associated with the processing of transactions that expose it to the regulator and to reputational risk.
In addition, an IFC study conducted in 2017 with a sample of 300 banks in 92 countries highlighted the main reasons that led an institution to terminate a business relationship. There are seven main reasons for business termination presented by descending order of importance: (i) the low profitability of the relationship; (ii) low risk appetite; (iii) shortcomings in the bank's provision of information; (iv) weak governance in the host country; (v) ALM and FT risks; (vi) the bank's customers deemed too risky; and ( vii) country risks deemed too high. Although KYC and compliance constraints have increased over the last 10 years, it is interesting to note that credit, compliance and sovereign risks are at the bottom of the list. On the contrary, it is increasingly collateral damage caused by the crisis that explains the persistence of de-risking over the long term.
Therefore, the relationship's low profitability tops the list of reasons provided. A Tier 2 or Tier 3 bank, which is unable to provide its correspondent bank with sources of income other than cash flow, will experience an increase in the relationship risk being called into question. For example, most Fitracor partners do not consider a new relationship if the estimated overall profitability is less than several tens of thousands of US dollars per year. This could reach six figures in the case of larger institutions with higher structural costs. In addition to the decline in the willingness of banks to work with a clientele deemed risky, the main reason put forward is the lack of quality and regular information provided by the bank to its correspondent bank. Against a backdrop of increased control by regulators, the day-to-day conduct of operations is gradually deteriorating and lacks fluidity and transparency to the extent of ultimately threatening the relationship. These two major explanations form the basis of our approach to seeking correspondent banks for our clients.
What Strategy Can Sub-Saharan African Banks Adopt in this Context?
The banks concerned by stress on these issues have no choice but to deal with these constraints, regardless of the ranking or size of their correspondent banks. The advent of the digitalisation of transactions through the Fintech and Blockchain offer will still require time to apply to correspondent banking. Alternative fund-raising and transaction monitoring solutions via SWIFT are also areas that the banks concerned should undoubtedly consider in order to secure the long-term future of their relationships. The fact remains that in 2020, these alternatives are still theoretical. The digital adaptation to an often-complex business with a significant number of participants and controls, remains essentially in the hands of men and enriched by a strong and regular relationship between two parties.
In this context, one of the cornerstones of the approach that we are defending, over and above the essential initiatives taken by governments and central banks, is to return to the essence of what correspondent banking is all about: communication between two institutions, between two groups of people. It is a key element, not only to establish a relationship, but also to maintain it and make it sustainable over the long term. Maximising the chances of obtaining and keeping reliable partners starts with robust governance, solid risk management and satisfactory liquidity. These strengths are enhanced by dynamic and proactive communication. As the relationship manager of a leading European bank recently pointed out, a correspondent bank will never have the same quality of information as the local bank. It is the banks in sub-Saharan Africa that have the information and they are responsible for sharing it, regardless of the micro- or macro-economic context. Coupled with a global approach that includes cash, trade finance and related products such as foreign exchange and treasury products, the leveraging of information is one of the keys to the success of a correspondent banking relationship, be it in the 1950s - when the use of letters of credit began - or in 2020.
About the author
Mathieu Saadati is the founder of Fitracor, an independent financial services advisory and arrangement firm based in Paris and specialized in Trade Finance in sub-Saharan Africa. Before Fitracor's creation in 2019, Mathieu was Head of East Africa and the Middle East / North Africa at Société Générale, Paris within the Raw Materials - Financial Institutions department. He has fifteen years of experience in commercial and flow banking, in Trade Finance and in emerging countries, mainly on the African continent. He graduated from Paris-X University in Banking, Finance and Insurance.