Macroeconomic uncertainty, criminality and regulation dominate the Africa bank risk environment

The 2008 global financial crisis has forever changed the financial services risk landscape. Nowhere are the changes more apparent than in the banking and insurance sectors, where regulators are developing and implementing tough new solvency tests. Risk managers at Africa’s largest retail banks have their work cut out for them as they plan for the risks posed by the evolving global regulatory environment, slower than expected global economic growth and increasing aversion to emerging markets in addition to the more conventional in-country operational risks. Banking Banana Skins 2015 – a biennial assessment of global bank risks carried out by the Centre for the Study of Financial Innovation in association with PwC – concludes that banks’ boards and executive staff are most concerned with uncertainties in the macroeconomic environment.hideDominic Nixon, global financial services risk leader at PwC Singapore, notes that banks remain vulnerable to high debt levels, future interest rates, weakness in China and other emerging markets, and softening commodity prices among others. But an obsession with the macroeconomy can be counterproductive. South Africa’s First National Bank (FNB) questions the high ranking assigned to the macroeconomic environment. “The challenge for FNB is to continue to deliver excellent service, contain costs and to remain competitive despite the macroeconomic environment,” says Jason Taylor, segment chief risk officer at FNB. The main challenge faced by African banks should therefore be how they manage costs and minimise losses within their preferred trading environments. “The risk management response includes working closely with business partners to protect the bottom line with a simultaneous focus on banking basics, including solid risk management processes and practices,” he says. Regulation features in third place on the Banking Banana Skins bank risk table and the consensus is that bank shareholders could face sub-par returns due to the rising cost of complying with new regulations, especially when coupled with subdued forecast GDP growth rates. Elsewhere, the International Monetary Fund’s World Economic Outlook, published January 2016, pencils in 3.75% GDP growth for the Sub Saharan Africa region through 2016; but warns that the continued adjustment to lower commodity prices and higher borrowing costs is weighing heavily on some of the region’s largest economies, including Angola, Nigeria and South Africa. The latter’s GDP growth for 2016 could fall as low as 0.7%. SA-listed Nedbank Group’s 2015 Annual Report (for the year to 31 December 2015) notes that the extent of regulatory change across the industry and its impact on banking businesses and their clients remains pervasive: “As these requirements become more onerous, they are likely to change the shape of bank balance sheets, increase the costs of regulatory compliance, adversely impact the price of credit extension and cause banks to revise their strategies.” A quick scan of the report reveals the extent of the regulatory tsunami that global banks face. Nedbank, for example, will establish a Regulatory Change Programme Office focused on ensuring efficient delivery against various regulatory programmes, including the following programmes: anti-money laundering, treating clients fairly, protection of personal information, international financial reporting standard nine, risk data aggregation and risk reporting, twin peaks and market conduct programmes. All of which is in addition to maintaining full compliance with the European Basel III phase-in requirements. Mr Nixon observes that banks are not only bearing the direct costs of regulation – new capital and liquidity requirements, restructuring costs, the impact of market conduct requirements, higher costs of compliance and higher costs of customer acquisition – but also the cost of greater management time to re-engineer processes, change culture and increase compliance efficiency. Although banks throughout Africa remain committed to working with regulators to ensure a safer financial services environment, the extent of the change will impact the bottom line due to increased costs of compliance, increased quality and size of capital buffers and increased liquid-asset portfolios. “The increasing volume and complexity of legislation combined with regulatory enforcement action has required FNB to focus on regulatory risk management and adapt to the new reality – management of this risk class has a significant cost impact,” says Mr Taylor. Sheralee Morland, president of the Institute of Risk Management South Africa, says that banks have to consider multiple responses to regulation including the impact on multiple systems, the ‘stretch’ that compliance places on existing staff, appointment of new resources and more. “All banks face a similar predicament whether operating locally, in the rest of Africa or internationally,” she says. First Bank of Nigeria Holdings chief executive officer (CEO), Bello Maccido, confirms that difficult macroeconomic conditions and the tough regulatory environment are impacting results in the financial services sector. In the group’s nine-month trading update to 30 September 2015, he observes that new regulation has had a significant impact on the Nigerian banks’ operations, due to the withdrawal of federal government accounts from commercial banks through the introduction of a treasury single account and the subsequent easing of banks’ regulated cash reserve ratio from 31% to 25%. Communication is a critical component of the bank risk management teams’ response to regulatory risks. The executive needs to be informed of internal regulatory risk management programmes and changes to overarching financial services legislation. It is also important that management, the bank’s governance structures and the regulators are updated frequently by way of an appropriate communication methodology, such as quarterly risk management reports to the board. A casual observer might wonder to what extent new regulation is forcing banks and other multinational financial services firms to reconsider strategy and structure. Barclays Africa (JSE: ASA) and Old Mutual South Africa (JSE: OML) have both cited global regulation as contributing to their respective restructures of financial interests in Africa. The jury is out with respect to the appropriateness of largely western-led regulatory intervention on African banking operations. “For the most part, the regulations we encounter are in-country legislations that must be complied with in order to operate – a careful consideration of the specific circumstances involved is necessary where the ‘head office’ regulator demands a higher regulatory standard,” says Mr Taylor. Cyber risks The biggest climber on the latest Banking Banana Skins bank risks ladder is criminality, up from ninth position to second. Concerns in this risk space include cyber attack, internal fraud, money laundering and tax evasion. PwC ascribes the rapid increase in concerns over criminality to the prevalence of cybercrime – most notably data theft – in an increasingly borderless global market. Cyber risks go hand in hand with technology risk (fourth place), which is in turn closely associated with underinvestment in and obsolescence of bank systems, and increased competition from tech-savvy financial sector start-ups. Although singled out as a risk, technology is also the primary weapon that risk managers have to fight criminality. “We continue to develop a range of risk management tools to protect the bank from fraud risks including the use of advanced data analytics, enhanced training of staff (to improve accountability and encourage risk-aware behaviour) and advanced systems to manage high transaction volumes,” says Mr Taylor. Outlook for Africa Although emerging market risk comes in at a lowly 15th in the report it remains relevant to Africa-based banking operations. A major slowdown in Chinese growth, coupled with the continued slump in commodity prices, has impacted many African economies. “The slowing of the commodity supercycle has led to the growing need for banks across the continent to form in-country franchises,” says Mike Vacy-Lyle, CEO at FNB Business. “With dollar-based revenue slowing, the need to generate local currency balance sheets is becoming increasingly important, so there is potential for a lot more on-the-ground deposit-raising in franchise-holding activities, in order to remain competitive.” In its February 2016 economic outlook, Mauritius Commercial Banks (MCB) observes that financial market risks continue to surround emerging markets. “Concerns about deteriorating macroeconomic prospects, coupled with China’s unexpected yuan devaluations and stock market corrections within the past year, as well as waves of significant competitive currency depreciations in key commodity-exporting emerging market and developing economies, contributed to greater financial market turbulence,” it says. Country GDP growth rates may have slowed, but Africa remains a desirable business destination thanks largely to demographic factors. “Financial sector leaders and policymakers from across Africa – along with global market participants that are active on the continent – remain optimistic about Africa’s economic growth,” says Mr Taylor. “Our representation in Africa is gaining momentum and FNB will continue to support its African operations as an important part of our overall strategy.” Ironically, banks are responsible for one of the major challenges facing firms that are keen to expand their operations into Africa, namely financing. A Rand Merchant Bank (RMB) report – Where to invest in Africa 2015 – reveals that despite the proliferation of banks across the continent, most countries are characterised by shallow financial markets. The ratio of liquid liabilities to GDP in Africa’s frontier and financially developed markets is reportedly half that of emerging markets. Other financing-related difficulties encountered by firms as they expand into Africa include low intermediation levels, uncompetitive banking landscapes, large interest rate margins and difficulties in assessing creditworthiness. These challenges aside, the soundness of the banking system throughout Africa is improving. “Most African countries are implementing a minimum 8% risk-weighted capital adequacy ratio, with some banks in Sub Saharan Africa having already exceeded that figure,” says Mr Vacy-Lyle. Audit firm KPMG singles out three key trends behind financial sector development in Africa. These include advancing ICT, extending the reach of pan-African banks and regional integration. “Pan-African banks are creating significant cross-border networks and have started to play a more important role in debt syndications and infrastructure projects – in some cases they have even become more dominant than the US and European-headquartered banks operating on the continent,” says the firm. But RMB observes that pan-African banks struggle, even when sticking to defined areas such as the East African Community (EAC). Each of the EAC’s affiliates operates different monetary and exchange rate policy frameworks and they are characterised by varying levels of liquidity and capitalisation. On the ICT front, the popular m-pesa mobile money model – developed in Kenya – has been copied in Uganda, Tanzania, Côte d’Ivoire, Zimbabwe, Botswana, Rwanda and South Africa. RMB notes that this model allows for decent money account penetration rates and has even had success in less developed financial markets like the DRC. FNB notes that infrastructure constraints across the continent have delayed the development of traditional bricks and mortar banks on the continent. “This constraint is overcome by ‘smart thinking’, as evidenced by the rise of non-traditional entrants such as mobile banking,” he says. “As a result, there has been significant innovation in this space, with mobile operators challenging banks that want to enter the SME and consumer spaces.” Risk and responses to risks are more interconnected today than ever before and steps taken to insulate banks from one set of risks can introduce others. PwC notes that traditional bank earnings models are starting to be threatened as tech-enabled competitors chip away at margins. Banks have responded by experimenting with new industry models that leverage technology and focus more on customer-centricity and less on products; but this exposes them to even higher risks in the areas of cybercrime and financial terrorism. Looking ahead So what does the future hold? Over the short term, it would appear that risk managers can expect more of the same, with most of the aforementioned bank risks remaining prominent. MCB observes: “The risks to the global outlook remain tilted to the downside and include lower than estimated commodity prices, a deeper than envisioned economic deceleration by China and a more generalised slowdown in the expansion of emerging economies.” The group adds that financial markets will undoubtedly be impacted by the asynchronous monetary policies in place across advanced economies. Risk management will be a key differentiator for Africa’s banks during the next three to five years. “In order to meet our short-term risk management challenges we must contain costs, provide service excellence and compete in the market place,” concludes Mr Taylor. “There has never been a time in the banking industry when it was more important to get risk management right in order to face the challenges of today.”

Macroeconomic uncertainty, criminality and regulation dominate the Africa bank risk environment

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