In a post-pandemic environment, African banks will have to navigate not only an economy in recession, but one where there will be many disruptors to existing business models and a rapid acceleration of existing trends such as digitalisation, cybercrime and the importance of environmental, social and governance (ESG) factors.
Baker McKenzie’s latest report, Finding Balance: The Post-COVID Landscape for Financial Institutions (report), states that at the beginning of the COVID-19 crisis, financial institutions faced two main challenges – prudential and operational. The prudential challenge refers to a sudden drop in the value of financial assets, or loss of liquidity, whether domestically or elsewhere in the world. Much of the initial falls on financial markets have since been somewhat reversed, but asset valuations in the worst affected parts of the economy are significantly down and liquidity remains a major concern. The operational challenge refers to the failure of systems and controls that underpin the financial system in the face of operational risk, reflecting inadequate resilience. By and large, with the reforms enacted since 2008, most global financial institutions have managed the operational issues quite well.
However, the report outlines how a longer and more protracted recession has implications for financial institutions, as it does for other sectors of the economy. At a high-level, while organisations currently remain well capitalised, the position could deteriorate. Banks will face increasing levels of non-performing loans, with corporates drawing down pre-existing credit lines.
The report notes that in recent years, a global investment surge has driven a rising debt burden, which combined with ongoing economic disruption, has created the conditions for rising debt defaults. The lockdowns imposed by many governments to tackle the public health emergency, the consequent disruption to supply chains and the reduction in demand for those corporates whose business models are most impacted by social distancing, will almost certainly trigger defaults and bring their viability into question. A further unknown concerns the path of interest rates in the future, currently at historic lows. All this means that there will likely be significant credit losses for commercial banks that must agree to either restructure debt or write off much of their exposure.
Wildu du Plessis, Partner and Head of Banking & Finance at Baker McKenzie in Johannesburg says that African banks are, on the whole, in good health at this stage, with adequate funds set aside to ease them through difficult times.
“While the big banks have been affected by the pandemic, they still have liquidity and strong capital levels and should not need to raise capital as a result of the impact of COVID-19. However, pandemic relief programmes will soon need to be paid back and it remains to be seen how this debt will be managed in the current economic environment.
Regulation and supervision
The report also outlines the trend towards increasing regulation and supervision of financial institutions. Regulations requiring organisations to act in their clients’ best interests over and above strict contractual obligations – paying close attention to their regulators’ expectations – has received added impetus in light of the flexibility and forbearance shown towards customers in the opening stages of the lockdown.
Du Plessis notes that financial services regulatory frameworks in Africa have improved substantially in recent years, which has aided regulators in their response to the COVID-19 crisis. Over the past decade, African regulators have been improving financial sector stability through the adoption of regulations that, for example, promote competition, improve access to credit information, support tighter lending and more stringent capital ratio requirements, encourage financial innovation and ensure the improved monitoring and governance of financial institutions. Challenges, such as limited enforcement power and the lack of independence of regulators in some countries, still exist.
“There have also been developments in policy reforms around improving financial inclusion in Africa. The United Nations Economic Commission for Africa issued a report in 2019 – Financial Regulation for Inclusive Growth in Africa –which showcased three countries in Africa – Kenya, Morocco, South Africa – as countries with financial institutions and markets that have grown substantially in recent years. The report said all three showed increased financial inclusion and a rapid expansion of bank accounts, especially through mobile banking,” notes Du Plessis.
Less happily, with so many in the financial sector working remotely, the report points to an enhanced risk of cybercrime – especially for banks transferring processes to contingency environments running on outdated security systems. For many financial institutions, a cyber-attack is the highest operational risk they face as they hold so much sensitive (financial) data of great interest to hackers, and securing this information is business critical.
Darryl Bernstein, Partner and Head of Dispute Resolution at Baker McKenzie in Johannesburg, says that post-pandemic, financial services organisations will be focusing on improving their resilience and increasing their digital due diligence as a result of the increased risk of cyber-attacks and data breaches.
“Numerous countries in Africa do not yet have specific legislation around cyber security and in countries where regulations exist, there can be challenges around enforcement. Data privacy laws, which govern, amongst other things, data security and breaches, is present in less than half of African countries. Regionally, the Southern African Development Community and the Economic Community of West African States have data protection policies in place and the continent is also covered by the African Union’s Convention of the African Union on Cybersecurity and Personal Data (2014). However, as of January 2020, only seven countries had ratified the convention. With the rapid growth in the digital economy, it is likely that these increasing cyber security concerns will receive more attention from policymakers.
The report also points to the positive role of technology in transforming the financial services sector, opening it up to competition, introducing new services and disrupting incumbent business models. The immediate impact of COVID-19 is expected to boost existing trends, for example, digitalisation and the remote delivery of financial services.
Janet MacKenzie, Partner and Head of Technology, Media & Telecommunications at Baker McKenzie in Johannesburg, notes that well before COVID-19, banks had turned to technology to reduce costs, improve processes, grow customers and enhance innovation.
“The demand for digital financial offerings grew dramatically during the first six months of the pandemic, and African banks have been implementing a range of digital systems, including artificial intelligence and advanced analytics, to speed up banking services including loan applications, credit scoring and safeguarding against fraud. Further, the African Continental Free Trade Area agreement, which will implement its first deal in 2021, has motivated banks to improve and implement digital trade finance platforms to support a big increase in African trade deals.
“In terms of crypto-based financial solutions, there is already an abundance of local mobile and e-payment platforms easing the transfer of money across the continent. Some governments have taken a positive stance, seeking to understand how best to regulate such solutions, while others have adopted a wait and see approach. Countries in Africa that have seen a rapid growth in cryptocurrency use and are beginning to contemplate or adopt regulations in this regard, include Kenya, South Africa, Nigeria and Ghana,” she notes.
The report also outlines how the crisis has brought home the importance of ESG concerns – not only environmental – but social and governance issues as well. Successful financial institutions will have already embedded sustainability in their prudential frameworks and will have taken advantage of their favourable regulatory treatment to improve their competitiveness. Further, corporates that have stronger, more resilient business models, especially taking into account their ESG footprint, may represent better value partners to financial institutions in the longer term and, therefore, more deserving of equity or loans to survive the economic downturn.
Du Plessis adds that while there will be challenging times ahead for African banks, the sector, on the whole, has been resilient, and is already leveraging the opportunities presented by sustainability and digitisation, to renew operations and gear up for the new normal.