The WAEMU banking sector is affected by the coronavirus pandemic

The impact of the COVID-19 pandemic, which is now reaching Sub-Saharan Africa and particularly the WAEMU countries, is of the same nature as in the countries already affected. The resulting contraction of economic activity is brutal and on a large scale, affecting both the public and private sectors and, by ricochet, the banking sector.

Like all the central banks of the countries concerned, the BCEAO has taken a number of monetary measures to encourage banks to support the private sector. These measures, however necessary they may be, do not include the solvency dimension of bank financing and must, therefore, be extended.

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A banking sector in difficulty

The economic crisis resulting from the health crisis, which is impacting the private sector, is also leading to an increase in unforeseen public spending combined with a fall in tax revenues, aggravating pre-existing public deficits, increasing outstanding debt and requiring massive recourse to issues of public securities acquired in part by the banking sector.

Banks therefore face an increased risk on their assets as a result of increased counterparty risks. In addition, the collapse of activity:

• Reduces the volume of their customer transactions in terms of loans, deposits, and transfers, resulting in a fall in Net Banking Income ;

• Increases operating expenses induced by preventive measures (social distancing measures, barrier gestures, etc.);
• Increases the cost of risk (credit risk, operational risks, etc.) and consequently a lower than expected level of results.

Moreover, in the immediate future, banks are facing new operational risks. As a result of this health pandemic, they must take specific measures to maintain their activity. Remote working is therefore a solution, but requires a high-performance IT system, fluid and high-speed internet connections to ensure data quality and security. However, this increases the vulnerability of banks to cyber attacks.

According to one bank executive, the immediate impact of COVID-19 on his bank would be: ”Decrease in customer activity and therefore inflows to the bank, unpaid debts, rescheduling or restructuring of debts, impact ratios, risk of provisions, reorganization of HR in teleworking, holidays, minimum banking service provided, suspension of investments, unbudgeted expenses to deal with the pandemic […]”

For another, the solidity of banks risks being undermined by the impact of the crisis on the cost of risk: “The crisis could lead to a contraction in the productivity of the bank or banking activities, a fall in NBI, an increase in the net cost of risk leading to a fall in the bank’s net income.”

Monetary policy measures that support bank liquidity but insufficient to encourage banks to support the private sector

The BCEAO has decided to lower the interest rate applicable to tender auctions from March 27th 2020 to its minimum rate of 2.50% with sufficient liquidity. This is the lowest level ever reached by this key rate. It also decided to widen the range of instruments eligible for BCEAO refinancing (admission of B-rated private claims).

By facilitating banks’ access to central bank money and lowering the cost of obtaining it, the BCEAO is strengthening bank liquidity and increasing their ability to grant credit to the private sector at a lower interest rate. As a result, the BCEAO is allowing banks to classify the maturity deferrals due to this crisis as healthy loans rather than as past-due loans, as recommended in the current bank chart of accounts.

These monetary and accounting measures are relevant only if it is anticipated that economic activity, which has been suspended for a while, will resume in the same way at the end of this pandemic. However, nothing is less certain, because no one can know whether this crisis will not lead to changes in consumption behaviour and thus impact production in the future.

Moreover, given the regulatory standards for risk division (limit of commitments on a single signature), the limits on banks’ internal sectoral concentrations, the volumes of existing commitments but above all the importance of additional financing, the financing required to ensure the survival of certain key economic sectors, such as air transport for example, may exceed the banking sector’s capacity to cope with it.

The urgent need to take additional measures to encourage the system to provide more financing

In times of crisis, the quality of bank portfolios deteriorates, leading to a decline in banks’ profitability and a deterioration in their capital. In this context of uncertainty, increasing the volume of private sector financing could expose the banking sector to serious solvency problems in the future. Taking counterparty or credit risk into account in the financing decision is as important as liquidity risk.

Therefore, monetary authorities should not only focus on easing banks’ refinancing mechanisms, but also consider measures to contain counterparty risk. Monetary authorities could act on three levels. In support of measures already taken, they could defer the provisioning of claims whose downgrading is linked to the impact of COVID-19 or, failing that, exceptionally[2] redefine the eligibility of claims arising from the impact of COVID-19 as overdue. According to an exploratory survey of bank managers in the sub-region, more than 3 out of 4 (76.9%) bank managers want this moratorium and believe that without such measures, the downgrading of debts to doubtful and disputed debts (CDL) would be followed by their depreciation and would undermine the soundness of the banking system. Many of the companies concerned would have no hesitation in putting themselves into preventive settlement to absorb the impact of the health crisis and to reorganise in order to get back on their feet.

They could also set up a joint fund, financed equitably by BCEAO and commercial banks, to buy back all or part of the bank claims of companies impacted by COVID-19. The companies concerned would have no hesitation in taking preventive measures to absorb the impact of the health crisis and reorganize themselves to recover. This should enable the banking sector to better finance the recovery of the private sector. Indeed, when outstanding receivables are provisioned, banks’ equity decreases and their capacity to finance productive activities is negatively affected. In the event of non provisioning, distressed claims deteriorate the capitalization of banks since they are deducted from core capital. As a result, effective capital will decline, negatively affecting banks’ solvency. And when insolvency becomes chronic and widespread, the risk of systemic crisis increases. In both cases, bad loans have a crowding out effect on the financing of companies that borrow. The risk of a vicious circle is thus created between the banking crisis and the economic crisis.

In addition, a further reduction in the interest rate applicable to tender auctions and regulated interest rates (savings accounts, time deposits, etc.) would make it possible to reduce the impact on banks’ balance sheets of maturity extensions without interest charges, fees or penalties for late payment.

At the same time, the public authorities should ease the constraints on the private sector, particularly with regard to public procurement, in order to allow the latter to have financial margins and thus meet their financial obligations. This could include, for example, cancelling the application of penalties for delays and interest on arrears in the execution of public contracts; and/or speeding up payments to the private sector to reduce pressure on cash flow. Debt relief measures could allow governments to take such action.

Furthermore, in the current context, it is necessary, in the specific case of VSEs and SMEs, to set up a WAEMU SME COVID FUNDS Community guarantee fund to guarantee the additional credit needs of this target whose cash flow has deteriorated due to the decline in their activity. It could cover up to 75% of the credit amount.

The banking reforms implemented in 2018, particularly the transposition of Basel II/III prudential standards into WAEMU and new accounting rules, have strengthened the soundness and resilience of the Union’s banking sector. However, given the increased risk to their assets as a result of the increased counterparty risks generated by this pandemic, it is necessary to extend the transitional provisions relating to minimum capital requirements initially set in 2022 by one year and to take measures to temporarily ease their capital requirements to enable them to devote themselves fully to their business. This will enable them to maintain the financing of economic activity in the Union and mitigate the economic impact of the COVID-19 pandemic.

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(Featured image by mbotela via Pixabay)

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First published in Financial Afrik, a third-party contributor translated and adapted the article from the original. In case of discrepancy, the original will prevail.

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