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AfricaJuly 22 2021

Rocky road lies ahead for Algerian banking sector

The Banque d’Algérie has managed to keep the country's economy afloat during the pandemic, but concerns are mounting over what will happen when the central bank’s Covid-19 relief measures are withdrawn. 
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Rocky road lies ahead for Algerian banking sector

As Covid-19 cases hit new heights in Algeria, challenges continue to mount for the country’s state-dominated banking sector. A slump in oil and gas revenues from the early days of the pandemic has caused a series of challenges, including low liquidity, under-capitalisation and a rise in bad loans.

While the country’s private lenders have continued to post robust growth figures by focusing on specific niches of the economy, the sector as a whole faces a reckoning when measures put in place by the central bank, Banque d’Algérie (BdA), begin to be unwound. Although the country’s newly-elected government has expressed the need for reform and increased private sector involvement in the banking sector, hope that such reforms will come to pass remain dim.

State driver

In keeping with Algeria’s economy as a whole, the state is the largest player in the banking sector, in the form of six publicly-owned banks: La Banque National d’Algérie, Banque Extérieure d’Algérie, Banque de l’Agriculture et du Développement Rural, Banque de Développement Local, Crédit Populaire d’Algérie, and Caisse Nationale d’Epargne et de Prévoyance-Banque.

Public banks easily hold the largest market share, accounting for 89% of loans and 87% of deposits, according to consulting firm SL Finances. This stands in sharp contrast to neighbouring Morocco, where private banks hold a 66% market share, public banks hold 18% and foreign banks hold 16%.

Profitability data show that bigger does not necessarily mean better: although private banks’ market share is in the low double digits, they accounted for 27% of sector profits in 2018.

Private banks’ operating ratio stood at 38% in the same year, against 29% for public banks. Likewise, return on assets for public banks stood at 86 basis points in 2019, against 2% for private banks, while return on equity for public banks was 8% in 2019, against 15% for private banks.

Another somewhat unusual feature of the Algerian banking sector is the high concentration of state-owned enterprises in banks’ loan portfolios, which has resulted in elevated levels of non-performing loans (NPLs). The sector’s NPL ratio stood at 12.7% in 2018, the most recent year for which statistics are available, according to the World Bank, with SL Finances estimating that NPL ratios are significantly higher at public lenders than private banks.

“Loans to state-owned enterprises represent 51% of total banking sector loans,” says Gabrielle Ventura, an economist with IHS Markit’s banking risk service.

“As a result, government arrears channel through to the banking sector via NPLs, mostly at public banks, which are frequently purchased by the government. For private banks, unclear regulation requiring them to try ‘every possible means of recovery’ before writing off a loan encourages legacy NPLs to linger on balance sheets, resulting in a higher overall NPL ratio.”

There are 13 private banks that are active in the market — all of which are international entities: nine subsidiaries and three international bank branches, as well as one bank with mixed capital, Al Baraka Bank.

Foreign banks with a significant retail presence in Algeria are limited, with BNP Paribas, Société Générale and Gulf Bank Algeria having the largest branch networks. Other foreign banks, such as Citibank Algeria, HSBC, Natixis Algeria and Arab Banking Corporation, are focused mainly on the corporate market.

Sector opacity

The new government of president Abdelmadjid Tebboune, who took office in December 2019 following the ousting of former president Abdelaziz Bouteflika, has made tentative utterances about reforming the banking sector and boosting the role of the private sector. Mr Tebboune said in August 2020 that private banks would be permitted to establish new banks. Then, in April 2021, the Finance Ministry ordered the country’s six state-owned banks to replace their CEOs with their newly-appointed chairs of their board of directors.

The impact of such reforms remains to be seen, with observers noting Mr Tebboune’s close ties to the country’s military, the chiefs of which are likely to resist wholesale changes to the state-dominated economy.

Meanwhile, state-owned banks’ activity remains opaque, and a lack of detailed statistical releases since 2019 has left analysts and observers fumbling in the dark as they attempt to assess the impact of Covid-19 on asset quality and public banks’ balance sheets.

“Basically, what public banks do is apply economic policy from the government,” says Rachid Sekak, a founding partner of SL Finances and former chief executive of HSBC Algeria.

“So, it’s quite difficult to calculate the real performance of the public banks because, with their balance sheets, you [not only] have a commercial operation, but also an operation for the implementation [of] government policy. It’s not always easy to tell the difference.”

There is a certain number of companies that would struggle to pay their debts. That’s not appearing in the balance sheets at this stage

Ramz Hamzaoui, Citi Algeria

The BdA reports that loans to state-owned enterprises, the private sector and households rose by 2.6%, 3.5% and 4.2%, respectively, in 2020. The World Bank, meanwhile, reports that domestic credit to the private sector has risen sharply in recent years, from 13.7% of gross domestic product (GDP) in 2011 to 29.6% in 2020.

Yet lending remains low by international standards. Most consumer loans require heavy collateral requirements and mortgage finance is very low as a result, at just 2% of GDP. Consumer and mortgage lending amount to a combined 8% of GDP, according SL Finances.

Access to credit for small and medium-sized enterprises, and indeed to the private sector as a whole, also remains extremely limited, according to Mr Sekak.

Covid response

While swift, the BdA’s response to the pandemic has differed significantly from neighbours such as Morocco. Rather than providing state-guaranteed loans to support credit growth, the central bank moved to ease most regulatory requirements for the banking sector, starting with a relaxation in liquidity requirements aimed at giving banks more space to operate during the worst of the crisis.

This came against the backdrop of a steady drop in liquidity ahead of the crisis, which then plunged in early 2020. World Bank data shows that banks’ liquid reserves to assets ratio plummeted from 86% in 2010, to just 17.5% in 2019. BdA data from February 2021 highlights the challenges, with banks’ total liquidity falling from AD1.1tn ($8.16bn) at the end of 2019, to just AD461.8bn at the end of September 2020.

“The reduction in liquidity was a result of falling hydrocarbon prices, and the way the authorities managed this was to reduce reserve requirements from a very progressive 12% to 3%,” says Mr Sekak. “They started to reduce the reserve requirement a little bit before the pandemic, and while Covid-19 accelerated the process, it had already been happening.”

The most significant measure the BdA took was a prolonged loan moratorium, rolled out in April 2020. During this period, banks were also allowed to draw down their capital conservation buffers of 2.5% of regulatory capital and liquidity ratios. The BdA also reduced the minimum liquidity threshold for banks from 100% to 60%, and relaxed classification requirements for loans so that they could be more easily refinanced. Refinancing periods were also extended from seven days to one month.

“So far, these measures have successfully maintained positive credit growth, though significantly slower than [before the pandemic],” says Ms Ventura. “Deposit growth has been significantly less supportive, oscillating between positive and negative on an annualised basis since end-2019. However, credit risks have still been building under the surface, resulting from banks’ exposures to state-owned enterprises.”

Indeed, many stakeholders remain concerned about what comes when the support measures are eventually withdrawn. In July 2021, the BdA announced it would keep most of its forbearance measures in place until at least September, further putting off the eventual reckoning.

“I think there is a certain number of companies that would struggle to pay their debts. That’s not appearing in the balance sheets at this stage because the central bank has given forbearance,” says Ramz Hamzaoui, managing director of the north Africa cluster head and chief country officer at Citi Algeria.

“The question is going to be when they lift forbearance — and there’s no question they will — to what extent those companies are going to be able to pay.”

There are already signs that the government is moving towards reinstating some regulations: in February 2021, the BdA ordered Algerian banks to raise capital levels to AD20bn by the end of June. In the same month, the BdA reported that 95% of Algerian banks, including public banks, “have already largely complied with the minimum capital requirement”.

Provisioning problems

Questions also linger as to whether the country’s biggest banks were able to take advantage of relaxed rules, with some observers noting that public banks most likely did not.

IHS Markit reports that provisioning in Algeria is very low, with the last-reported coverage ratio standing at 50.1%, while 43% of banks’ capital is exposed to unprovisioned-for NPLs.

International Monetary Fund stress tests from mid-2020 showed that a prolonged Covid-19 downturn would result in system-wide undercapitalisation, meaning public banks would have an urgent need for near-term financing. According to Mr Sekak, that is exactly what has happened. He argues public banks did not provision for NPLs because credit for public enterprises is guaranteed by the treasury. The BdA refinanced AD2.1tn in 2020, and Mr Sekak expects to see NPL buybacks continue in 2021.

“The treasury will not pay in cash, it will pay in coupons. After that, the public bank will go to the central bank on the basis of the portfolio of T-bonds, and they will refinance at the central bank,” he says.

“So, basically, it will be indirect money creation by buying back NPLs on the back of public enterprises. It looks like an open market operation, but it’s clearly not the case.”

Profitable niches

By contrast, foreign banks have been able to record stronger performance over the past 18 months, with clear provisioning mandates from group level and a focus on core competencies.

“In 2020, our revenue grew. We maintained a healthy loan portfolio so we were not impacted in any significant way by a rise in NPLs, or anything like that,” says Mr Hamzaoui.

“Although obviously the economy was impacted by Covid-19, and certainly our customers were impacted, we managed to produce growth — not double-digit growth, but we were able to grow our business and maintain a solid balance sheet.”

Credit risks have still been building under the surface, resulting from banks’ exposures to state-owned enterprises

Gabrielle Ventura, IHS Markit

Citibank Algeria thrived in 2020 by focusing on a tightly defined target market and a selective group of corporate clients that were in good shape before the pandemic began and who have remained resilient throughout. A strong focus on electronic banking (e-banking) platforms was also a major bonus, particularly during the first wave of the pandemic.

“The e-banking platform is a powerful tool that facilitates client acquisition,” says Mr Hamzaoui. It also help customers grow accustomed with digital channels, such as online or mobile banking platforms.

Digital doldrums

Accelerating digitisation to improve financial inclusion is a key challenge facing the Algerian banking sector. A report by US software company Acuant estimates that just 42.8% of adults in Algeria had a bank account as of October 2020, while slightly more than half use the internet and social media.

Yet the scope for innovation by the banks or by new players, such as fintech or digital disruptors, is limited in Algeria, as the regulatory regime required to facilitate such innovation is not in place.

“You’ve got countries in Africa where you’ve seen telecom operators come onto banks’ turfs. All those kinds of development are not really present in Algeria in this stage,” says Mr Hamzaoui. “Even electronic payments – credit card and debit card penetration is low and the authorities want to correct it. It’s not happening today, but I think that has to happen and it will happen.”

Signs of hope

Although low digital penetration and a wave of bad loans will remain a major problem for the sector in the near and medium term, there are nonetheless signs of hope on the horizon.

The recent relaxation of foreign exchange rules means that exporters are now able to keep 100% of export proceeds in a foreign currency, which could help support future credit growth. Perhaps more significantly, oil prices have risen sharply in recent months, providing relief for exporters such as Algeria after a torrid 2020.

“Credit growth will be driven by the domestic macro picture, which is likely to improve for a number of reasons,” says Mr Hamzaoui. “First of all, we’ll be coming out of Covid-19. The lockdown measures were not as stringent in Algeria as they were elsewhere and they have been relaxed, so activities in services and things like that will support growth and credit demand.”

While a recent surge in cases caused by the Delta variant of the coronavirus has prompted authorities to extend lockdowns in 14 of the country’s 48 provinces until early August, liquidity and credit growth are both expected to perform well this year as oil prices bounce back.

“My feeling is that liquidity in 2021 has improved for at least two reasons — firstly, it improved a little bit because you have an increase in the pay deposit coming from the sector; secondly we have noticed a huge decrease in reserve returns, which would have improved the liquidity situation,” says Mr Sekak.

And while rising global oil prices might offer the perfect opportunity to avoid enacting long-awaited reforms in the sector, including the privatisation of state-owned banks and improvements to public bank governance, Mr Hamzaoui argues that a doom-and-gloom approach is not entirely appropriate, given the gradual improvements the sector has already witnessed over the previous decade.

“What I can say is over the past 10 years Algerian banks have significantly consolidated their equity funds and capital, and improved provisioning, solvency, governance and systems,” he says. “I wouldn’t say they went into this crisis particularly weak, so depending on how quickly the economy recovers, this could be manageable.”

Continue reading: Cracks appear in Algeria's economy

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Read more about:  Africa , Algeria