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Central banks drive Africa's recovery

Africa’s underdeveloped economies and financial sectors have proved a barrier for central banks implementing monetary policy and prudential regulation. But recent years have seen significant progress, thanks in no small part to central banks’ growing independence from governments.
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Central banks drive Africa's recovery

Shortly after he became Nigeria’s central bank governor in June 2009, Lamido Sanusi decided to find out more about the health of five banks. The lenders, three of them among the country’s biggest, were showing serious signs of liquidity strains and were borrowing huge amounts from the central bank’s discount window.

The governor was shocked by what he found. Non-performing loans at the banks, which were highly exposed to the crashing stock market because of their rampant margin lending, had soared. Without central bank liquidity, they would have likely collapsed.

Mr Sanusi acted promptly, firing the chief executives of all the banks, as was his legal prerogative. He justified the decision by saying they had to be held accountable for the dire situation their institutions were in.

Yet Nigeria’s financial elites were still stunned. The executives – some of who were later jailed for fraud – were among the most powerful bankers in the country and well connected politically. Until then, they were considered untouchable by the regulators.

Bolder action

These events, and the clean-up of the Nigerian banking sector in the following two years, reflect the growing assertiveness and competence of sub-Saharan Africa’s central banks. Rather than acting as mere piggy banks for kleptocratic rulers, as some have been accused of in the past, they are much more likely today to be taking bold measures to make their banking sectors safer and control inflation.

Much of this progress stems from central banks’ increasing autonomy from governments. The South African Reserve Bank is one of the few on the continent to have its independence constitutionally enshrined. But even in countries where their legal position is more ambiguous, central banks nowadays happily make monetary decisions without consulting politicians. And many go as far as publicly questioning government policies – Mr Sanusi has regularly lamented what he sees as bloated public expenditure in Nigeria, while Uganda’s central bank recently urged the government to cut military spending.

“Ten or 15 years ago, we saw central banks that were a lot less autonomous,” says Razia Khan, head of African research at Standard Chartered. “It has become the norm now that even where formal independence is not granted, central banks have a degree of autonomy. The fact civil society and the private sector expect that to be the case speaks to the strengthening of those institutions over time.”

Evolving roles

Central bankers say that being given more leeway has enabled them to do their jobs better. Caleb Fundanga, governor of the Bank of Zambia from 2002 to 2011, says that on his appointment, the country’s president Levy Mwanawasa told him he would be free to make his own decisions. “There was no possibility that if my position differed from his I would be fired,” says Mr Fundanga. “He said from the beginning: ‘You do what is professionally correct. And if you can prove that’s what you’ve done, don’t expect any backlash from me.’ That was very reassuring. I knew I wouldn’t be punished for doing what was right.”

As Africa’s central banks have become more independent, their roles have evolved. Whereas traditionally they concentrated heavily on development issues, such as boosting employment and cutting poverty, their mandates have become more focused on price and exchange rate stability. The Bank of Ghana became an explicit inflation-targeting central bank when legislation was passed in 2002, giving it independence over monetary policy. Over the past decade or so, several other central banks have also started to target specific levels of inflation, usually establishing monetary policy committees and base interest rates to help them in the process.

Analysts have largely welcomed this change. They say that because of the informal nature of most African economies and their structural weaknesses, it is hard enough for central banks to aim for stable prices, let alone economic growth at the same time.

Many argue that central banks in east Africa – particularly those in Kenya and Uganda – were too slow to put up interest rates in 2011, when food shortages and rising oil prices caused regional inflation to spike, precisely because they were nervous about stunting credit growth, something they viewed as vital for economic growth. “Where central banks are likely to run into trouble is where there is a dual aim,” says Ms Khan. “Part of the reluctance to tighten in the face of a very clear inflation shock in 2011 was central banks taking the view that [low rates] had done a lot for growth. That muddied what many would have considered to be their primary aim of price stability.”

Drawing the line

Mr Fundanga says some form of co-operation between central banks and governments is necessary, with monetary and fiscal policy-makers liaising to make sure they are working towards the same goals. “Central banks don’t work in a vacuum,” says Mr Fundanga. “There should be collaboration between them and their finance ministries.”

An example of this is when central banks try to boost lending to sectors that governments say have been neglected. Nigeria’s central bank provides commercial lenders with low-cost funds specifically for on-lending to agricultural borrowers, which have traditionally struggled to access credit. Andrew Nevin, a partner with PricewaterhouseCoopers (PwC) in Lagos, says such roles can only be carried out by central banks.

“In Africa, they are essentially the most important economic actors in their countries,” he says. “There are issues around the economy that central banks can control, monetary policy being one of those. There are other issues which they don’t control, but which they need to influence.”

Most central bankers would agree, yet draw the line at suggestions that they, rather than politicians, are mainly responsible for economic growth. “If the idea is being sold that somehow central bank generosity can compensate for fiscal and structural [deficiencies], then that is, in my view, misguided,” Mr Sanusi told The Banker in March. “I don’t think central banks deliver growth. They deliver stability.”

Similarly, Gill Marcus, governor of the South African Reserve Bank, often hints in her speeches that the central bank cannot solve South Africa’s long-term structural issues, be they poor infrastructure or a weak education system. All it can aim for, she says, is macroeconomic and price stability.

By focusing on that stability, central bankers have become more successful at keeping price rises on the continent low. Some countries, such as the mostly French-speaking members of the CFA franc zones in west and central Africa, whose currencies are pegged to the euro at a rate guaranteed by France, have long enjoyed low single-digit inflation.

But even those that have to set their own monetary policy have generally experienced greater price stability. Angola’s inflation fell below 10% for the first time on record in 2011, while Zambia’s fell to single digits at the beginning of 2010 and has since remained well within them. And Kenya and Uganda, partly by putting up interest rates sharply in late 2011, have reversed their inflationary spirals.

There are still several exceptions that demonstrate the limits of African central banks’ monetary powers. Ghana, whose inflation went up from under 9% at the end of last year to almost 12% in July, is one of those. And even central banks that have managed to bring down inflation tend to view anything in single digits as a success. Few are yet ambitious enough to target levels of below 5%.

Weak transmission

A major part of the reason for this is that it remains very difficult for sub-Saharan central banks to influence their economies and manage liquidity via monetary policies (South Africa and Mauritius are perhaps the only exceptions). Because financial and banking systems across the region are underdeveloped, countries lack market-based interest rates or the types of borrowers – such as homeowners with mortgages – that are affected when base rates rise or fall.

“Most countries aren’t financially leveraged,” says Samir Gadio, a strategist at Standard Bank. “If central banks reduce or increase policy rates, the impact might be minimal. In most places, banking penetration is about 10% to 20%. And that’s just people who have accounts. Even fewer have mortgages, car loans or credit cards. As such, the monetary transmission mechanism in Africa is very weak.”

PwC’s Mr Nevin, who helped formulate Mr Sanusi’s response to the Nigerian banking crisis, likens this to driving a car with a steering wheel not properly connected. The result is that to cause their desired effect, central banks usually have to move base rates significantly, rather than incrementally. Kenya’s central bank almost tripled its main rate between August and December 2011 – hiking it from 6.25% to 18% – to combat inflation. “To really influence economic activity, central banks in Africa have to tighten or ease much more aggressively than policy-makers elsewhere,” says Ms Khan.

Some central banks have innovated to get around this problem. In July, the Central Bank of Nigeria, concerned about a build up of liquidity, announced it would increase its cash reserve requirement (CRR) for public sector deposits from 12% to 50%, a decision that took banks and markets by surprise (see Reg Rage). It opted to keep its base rate unchanged in part because it felt the CRR was a blunter instrument with which to move short-term market rates.

For some countries, the most effective anchor for their monetary policies is exchange rate stability. African states typically import the majority of their manufactured goods and any currency depreciation imposes inflationary pressures. “If you are an import-dependent country, it is difficult to keep inflation within a certain range,” says Mr Gadio. “If your exchange rate comes under any pressure, imported inflation will go up.”

Hydrocarbon exporters with current account surpluses, such as oil-rich Angola and Nigeria, have had stable exchange rates in the past two years, partly because their central banks have plentiful foreign reserves they can sell down when they need to prop up their local currencies. Others have tried to generate exchange rate stability by encouraging foreign portfolio investment through easing capital account restrictions. 

Regulating banks

Regulating banks remains a major challenge for central banks in Africa. The consensus among analysts is that their prudential regulation has got a lot better. The number of banking crises in sub-Saharan Africa has fallen markedly since 2000. Nigeria was the only country whose banks suffered badly during the global financial crash of 2008 and 2009. And even there, the central bank’s efforts to save and then revive the financial system were widely lauded.

“Central banks are taking a much stronger line against banks they think might not be well-run,” says Ms Khan. “It goes hand in hand with the more autonomous role of central banks. If they were completely beholden to fiscal authorities, I doubt the same progress would have been made.”

African banks tend to be well capitalised and conservative. Many of the biggest have capital adequacy ratios above 10% and loan to deposit ratios far below 100%. Very few fund themselves with short-term capital market instruments, instead preferring deposits.

But central banks can hardly afford to rest on their laurels. In many African countries, a crash in the banking sector would pose a huge risk to their economies, not least because of the sheer pace at which they are growing amid rapid economic expansion. “Central banks in Africa are all faced with banking sectors that are growing quickly,” says Mr Nevin. “In Nigeria, if you’re not growing your assets at 20% annually, you’re probably falling behind the market.”

Implementing Basel III and other recent international regulations will go a long way to bolstering the strength of African banks. South Africa’s lenders, which were among the quickest in the world to meet the requirements of Basel II, are already fairly advanced when it comes to conforming with the latest framework, as are banks from Namibia, Lesotho and Swaziland, which form a common monetary area with South Africa. Those from Botswana, Kenya, Mauritius and Nigeria are expected to be able to comply too. “The rest of the continent is probably lagging when it comes to Basel III,” says Charles Okeahalam, an economist and founder of AGH Capital, a Johannesburg-based investment group. “But these countries’ banks are going to have to comply if they are going to have the relationships they need to carry out international trade and transactions.”

Cross-border headaches

One factor that is new for African central banks is the increasing internationalisation of the lenders they regulate. The continent’s big banks have expanded across borders quickly in the past 10 years. Togo-based Ecobank operates in 34 sub-Saharan countries, while Nigeria’s United Bank for Africa has licences in 19. Five other Nigerian lenders and most of Kenya and South Africa’s biggest institutions have also grown their international arms.

Few central banks on the continent have reacted explicitly to this, even though many are nervous at the prospect of their banks coming unstuck because of problems in other jurisdictions. Nigeria’s central bank is one that has. In 2012 it stopped its banks from recapitalising their foreign subsidiaries. This was in response to regulators in Zambia – where two Nigerian lenders operate – suddenly putting up capital requirements for foreign banks from $2m to $100m.

The Zambian case was unique because of how drastic the increase was and how it discriminated against foreign banks (local ones only had to raise their capital to $20m). But it highlighted the fact that central banks in Africa would have to formulate policies for the foreign subsidiaries of their banks sooner or later. “Multinational banks present a new and much bigger challenge for African regulators,” says Mr Okeahalam.

To consolidate or not?

Another issue is whether to encourage consolidation. Nigeria and South Africa both have fairly consolidated banking sectors, with 24 and 16 commercial banks, respectively. But Africa’s smaller economies tend to have far larger numbers of lenders. Kenya has more than 40 and Tanzania has almost 35. Perhaps the starkest example is the west African CFA franc zone, which despite having just $32bn of banking assets, has 106 commercial banks (by comparison, Nigeria’s 24 lenders have $115bn of assets).

Analysts say that too many banks in Africa lack the size and capital needed to develop economies of scale. Central banks could help by raising capital requirements. “In many countries the banking sector is too fragmented and needs some consolidation,” says Mr Nevin. “The quality of banks is often not high enough. They don’t have the resources to invest in technology. A lot are essentially family banks with a few branches. That’s not good enough in the modern world and if countries want to have sophisticated financial systems. The central banks have to be the ones that say why consolidation needs to happen and to determine its direction.”

Yet few seem willing to do that. The central bank in Ghana, which has 27 commercial lenders, says it has no plans to increase capital requirements for existing banks from the equivalent of $27m (although in August it did raise requirements for new entrants to double that amount). “We are leaving it to the banks themselves to determine whether or not they should merge,” says Millison Narh, first deputy governor of the Bank of Ghana.

Among other priorities, central banks are encouraging greater volumes of electronic transactions, be they over the internet or through mobile phones. Reducing the use of cash would bring more money into the formal financial system and allow them to monitor economic flows more closely, thus aiding their monetary policies.

African central banks have made plenty of progress in the past decade. The autonomy they have gained from governments has enabled them to concentrate more on their core mandates of stabilising inflation and keeping their banking sectors safe.

The next few years will throw up plenty of new challenges, however, as Africa’s banks and economies continue to grow rapidly and become more complex. As such, central banks will have to keep bolstering their prudential regulation and finding ways to make sure their monetary policies are as effective as possible. Should they succeed, they will go a long way towards ensuring there is no repeat of Nigeria’s financial meltdown four years ago.

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