2017 was the year of lazy banking in SSA as banks bought USD8.7bn worth of Governments-issued debt securities and lent nothing to the real economy

It appears 2017 was the year of lazy banking across Sub-Saharan Africa (SSA). But before I start raising your hairs, let me provide a bit of background on this. Modern day banking is founded on Fractional Reserve Banking (FRB)-where commercial banks take deposits from the public, keep a fraction with central banks (in the form of mandatory reserve requirements) and lend the rest.

Conceptually, commercial banks borrow from depositors at low rates and lend at higher rates. This is the intermediation role that banks play in any economy. Effectively, they play the vital role of reallocating capital from surplus capital owners (or depositors) to those seeking capital deficit financing (borrowers). However, in this capital reallocation game, commercial banks aren’t ordinarily expected to lend to central Governments as part of its business strategy-except as part of liquidity management (both for regulatory and internal requirements).

Because customer loans are illiquid, partly because SSA still lacks an active secondary market for loans, banks always need to maintain certain portion of their asset books in near-cash (or liquid) form, ostensibly to take care of depositors who may want their money back. The lazy banking designation stems from the fact that a bank dumps this intermediation role by preferring to invest depositors’ money in Government bonds at relatively low returns and negligible default risk(s). This is exactly what transpired in 2017.

During the year, commercial banks’ asset-book growth momentum seemingly stagnated. Indeed, across a sample of 21 markets across the SSA region (excluding South Africa), total banking sector assets declined by 100 basis points year-on-year in USD terms. While there is a minor element of exchange rates in that decline, much of the decline was driven by the fact that on-balance sheet risk-weighted assets, which account for about 60 percent of total assets, equally declined. Instead, growth was driven by banks’ purchase of Government-issued debt securities (bills and bonds).

Across the 21 markets, the share of Government securities rose sharply by a staggering 300 basis points year-on-year to stand at 21 percent as at end-2017. At the same time, growth in loans remained flat year-on-year. Nominally, commercial banks invested a staggering USD8.7 billion in Treasury bills and bonds and literally no liquidity went into lending to the real economy. In a way, you could say banks were justified. First, there was a sustained elevation in credit risks across SSA. Indeed, across the region, commercial banks’ loan non-performance, as measured by the ratio of gross non-performing loans (gross NPL) to gross loans, weakened by 110 basis points year-on-year to 7.5 percent as at end-2017, in USD terms.

Behaviorally, banks have tended to tighten risk admissibility criteria in times of stress. Consequently, commercial banks across the region, in a synchronized pattern, generally slowed down the pace at which they lent. Data from the April 2018 edition of SSA regional economic outlook by the International Monetary Fund (IMF), which shows that annual private sector credit growth in SSA plunged to 3.3 percent in 2017, from 12.5 percent in 2016, corroborates this. Second, Governments’ aggressive fiscal deficit financing actions from domestic debt markets played a much greater role. By deepening domestic borrowing, a number of Governments in the region effectively crowded out the private sector.

For instance, in Zimbabwe, the Government’s penchant for borrowings saw commercial banks’ holding of Government securities rise from just 7 percent of total assets as at end-2014 to a staggering 30 percent as at end-2017. The fact that Zimbabwe’s economy remained dollarized offered additional incentives for banks. Nigeria and Ghana classically demonstrated the crowding-out effect. In Nigeria, the Central Bank of Nigeria (CBN) mopped up excess local currency liquidity by selling to banks shorter-dated securities (technically known as CBN bills) whose price tags averaged at about 20 percent and attracted zero tax.

In Ghana, the interest rate on a 12-month local currency Treasury instruments averaged at 16.5 percent; and while it compared unfavorably to the 2016 average of 23 percent, it still represented a significant premium for banks to avoid taking real risks. Consequently, banks’ holding of Government securities rose from 23 percent of total assets as at end-2015 to 30 percent of total assets as at end-2017. Lending to central governments, by way of purchasing Treasury-issued debt instruments, often presents three core advantages: (i) little or no operational costs attached to it; (ii) zero risk-weighting; and (iii) in some jurisdictions, like Nigeria and Ghana, zero tax implications. However, the story for Kenya’s banks was a little different as the key driver of elevated purchases of Government-issued local currency debt was the interest rate cap, which basically established a roof on commercial banks’ ability to price credit risks, both perceived and real.

As the 2018 clock continues to run down, the two lazy banking incentives aren’t submerged yet; (i) the de-elevation of credit risks seems to be unfolding at a snail pace (at least in the first half of 2018); and (ii) Governments’ fiscal trajectories still remains weak, at least when you look at key countries like Kenya, Nigeria, Zimbabwe and Ghana. However, there exists a classic dochotomic situation. So, while the incentives aren’t submerged, yield curves across the region are troughing in, presenting price risks. This effectively means commercial banks will have to reposition their balance sheets to reflect the dichotomy. This will be a tough call.