African banks' profitability under pressure amid weakened economic growth
The banking sector in Africa faces increased pressure on asset quality and weak operating conditions as COVID-19 pandemic disrupts key sectors
The socio-economic impacts of COVID-19 have led to contraction of the economy in Africa. The real gross domestic product (GDP) of Africa is projected to fall to -2.6% in 2020. Africa is predicted to endure GDP losses amounting to between $145.5 billion and $189.7 billion by the end of 2020. The region is projected to witness a slight recovery to reach 3.7% in 2021. Before the onset of the pandemic, GDP growth was estimated to reach $2.76 trillion. However, the region may still endure losses of up to $47 billion. The economic recession has affected many countries in the region especially those that have poor healthcare systems in place, as well as economies relying on tourism, international trade and exports, in addition to countries with increasing debt and dependence on international financial flows.
In East Africa, the economy is driven by wider diversification and lower dependence on primary goods. Compared to other regions, economic growth is expected to remain steady with strong growth of 5.2% in 2019 and drop to 1.2% amid the pandemic
In 2020. In comparison, the Southern Africa region’s economy endured a deeper recession with a projected drop of -4.9%. This slump is impacted by the drop in commodity prices. West Africa is expected to drop to -2% in 2020, with Nigeria’s GDP reaching -4.4% affected by the drop in oil prices.
For non-resource intensive African countries such as Kenya, Ethiopia, and Senegal, economic growth remains resilient with a projected increase of 0.6% in 2020. It is driven by the countries’ diversified economic structure and strong public investment. As for Africa’s largest economies including South Africa, Nigeria, Morocco, Egypt, and Algeria, they are expected to witness an overall contraction except Egypt which is expected to remain positive but decreased from 5.6% in 2019 to 3.5% in 2020.
In terms of inflation, the region has seen an increase by more than 9% in the first half of the year. This increase is driven by the disruptions in the supply of food and energy. It was also a result of the fall in demand caused by the lockdown in some countries. Furthermore, exchange rates witnessed large fluctuations in 2020. South Africa recorded sharp exchange rate depreciations as its economy is more integrated with the global financial system. Other tourist-dependent countries also witnessed intense depreciations. These depreciations are in some cases reflected by increasing fiscal and current account deficits. On the other hand, Africa’s average current account deficit is estimated to increase to 6.8% of GDP in 2020 compared to 4.3% in 2019.
African economies are projected to recover across the board in 2021. The World Bank forecasted an overall growth in Eastern and Southern Africa regions with an average of 2.7%. The Western and Central Africa regions are expected to experience an average growth of 1.4%. In contrast, South Africa and Nigeria are expected to experience a weak recovery. African countries are increasingly moving forward with necessary reforms and investments which will support developments in the long term
Given the uncertain economic landscape in Africa, the banking sector is faced with challenges such as the drop in oil prices and tourism, and contractions in key sectors that have been impacted by the pandemic. Central banks have taken proactive actions by cutting interest rates and providing liquidly support. Egypt’s central bank lowered interest rates by 300 basis points. The South African Reserve Bank (SARB) cut its main lending rate by 50 basis points to 3.75%. Central banks and governments have been coordinating their actions to lessen the economic distress by providing fiscal support measures while preserving their inflation targets. In Morocco and South Africa, the government introduced measures including corporate tax suspension, guaranteed loan schemes, contributions for small and medium sized. enterprises (SMEs) and payment loan holidays to help overcoming cash flow shortfalls as a result of the economic contractions.
Asset quality deteriorated from high levels of non-performing loans
Moody’s Investors Service expects that asset risk in Africa’s banking sector will remain high as a result of rising government arrears, high loan concentrations, lack of borrower-friendly legal frameworks, and still evolving risk management and supervision capabilities. Banks will maintain high exposures to their respective sovereigns which link and cap their credit profiles to those of their governments.
The asset quality of the sector in Africa will undergo adversity in countries such as Morocco which witnessed an increase in non-performing loan (NPL) ratio to more than 8%. In South Africa, the weak asset quality is related to unsecured retail lending and SMEs. On the other hand, the banking sector in Nigeria is exposed to risks in oil sector and currency depreciation. Banks focus on retail lending including SMEs with exposures in local currency. In Kenya, tourism and manufacturing sectors’ contractions will likely have negative impact on consumer lending and SMEs. Therefore, credit losses are expected to rise by 2.5% in 2020 due to their vulnerability to cyclical sectors and households during the pandemic.
Overall profitability weakened
According to Moody’s Investors Service, most rated African banks maintain high capital levels and that funding and liquidity in local currency will remain solid in most countries. Banks in South Africa, Nigeria, Tunisia, and Angola will face the greatest challenges while Egyptian, Moroccan, Mauritian, and Kenyan banks will be more resilient. Moody’s has downgraded its outlook for banking systems in South Africa, Nigeria, and Morocco from stable to negative as the coronavirus caused banks’ asset quality to deteriorate, put pressure on profitability, and hit economic growth in each country.
Fitch Ratings the banking sector will stabilise in 2021 as operating conditions and activity recover gradually, translating to slightly higher business volumes and a rebuilding of lost revenues. However, it also forecasted that a return to pre-pandemic performance levels is unlikely for at least another two years. Banks are expected to remain profitable despite a sharp rise in credit losses. Adequate capital, funding, and liquidity will continue to underpin credit fundamentals and regulators will remain supportive.
Keywords: Gdp, Asset Quality, Economic Growth, Npl, Profitability, Covid-19
Institution: The South African Reserve Bank, Moody's, Fitch