Re-imagine banking in Africa in a post-Covid world
Author: Timothy Wambu, CFA, Head of Equity Research, Absa Kenya; and Khayelihle Mthembu, Equity Analyst, South Africa Banks Research, Absa Corporate and Investment Banking
In September, we hosted our inaugural Africa Banking conference, on the theme: “Reimagining banking in Africa in a post-COVID world“We were delighted to have the opening address given by the Governor of the Central Bank of Kenya, strong panel discussions moderated by eminent and distinguished speakers and finally, a strong representation of businesses and institutional investors.
COVID-19 has significantly disrupted the operational and financial performance of banks. Under strict lockdown restrictions, banks have had to close branches and send employees to work from home. Profits fell dramatically as banks increased the provision for forward-looking impairment under IFRS 9 and regulators advised banks to suspend dividend payments to conserve capital in the face of uncertainty.
However, the message from banks, regulators and experts who presented at the conference is that banks across the continent have remained profitable and capital ratios have remained well above minimum regulatory requirements. In addition, the financial performance of banks in the first six months of 2021 points to a recovery with economies reopening and vaccination rates resuming.
Two factors are essential for recovery:
- Loan arrangements and other borrower relief measures implemented by regulators and governments.
- Increased levels of digitization: With the introduction of movement restrictions and social distancing measures, alternative channels for accessing banking services have become even more important, including mobile and internet banking.
Unwinding of provisions spurs upturn in profits for Kenyan banks
The pandemic hit Kenyan banks in 2020, with a notable increase in non-performing loans (NPLs) and the cost of risk. The NPL ratio peaked at 14.5% in December 2020 and would have been much higher had it not been for the flexibility offered by the Central Bank of Kenya in classifying loans affected by the pandemic. The Kenyan banking sector had restructured 57% of gross loans by December 2020 and banks have cautiously increased their provisioning for loan losses. We estimate the average cost of risk increased 2.5 ppts year-on-year to around 3% to 4%. This resulted in lower profits at all Kenyan banks in 2020.
2021 is a year of recovery, with Kenyan banks reporting significant profit growth so far (1H21A), mainly through the release of credit loss reserves. Restructured loans affected by the pandemic had increased to 16% by July 2021, with 92% of restructured loans operating under the terms of the restructuring. The industry’s NPL ratio also improved to 13.8% in July 2021.
Nigeria depreciations surprise on the upside
Drawing a parallel with the 2016-2017 oil crisis, we expected Nigerian banks to experience a similar deterioration in asset quality in FY20A, if not worse, given the additional impact of the COVID-19 pandemic. However, asset quality improved in 2020 despite concerns, with the industry’s NPL ratio improving slightly by 9 basis points to 6.01%. Regulatory forbearance appears to be the main factor behind stable asset quality, as several press releases from Nigeria’s MPC acknowledge.
The percentage of restructured loans to total loans was last reported at 43%, at around 7.7 billion naira in September 2020. Deposit banks, however, argue that the figure is lower when you exclude microfinance institutions.
Nigerian banks’ cost of risk (CoR) increased slightly in 2020 compared to other jurisdictions. This supported the profit growth recorded in 2020 at all Nigerian banks, in contrast to sharp declines in profits in other markets due to a large increase in the CoR. We expect asset quality to remain stable and cost of risk to remain limited in 2021, in line with management guidance. We contend, however, that we may see an upside risk for both measures when the regulatory forbearance period ends.
The year 2020 has been a difficult operating environment for Nigerian banks. The Naira has been devalued twice, depreciating about 25% against the US dollar. In addition, interest rates plunged to record lows, with the 364-day T-bill hitting a low of 1.15% in November 2020. Banks, however, took advantage of the volatility to report strong trading gains on fixed income securities and foreign currency revaluations on their currencies. denominated assets. With the Naira relatively stable and an interest rate rebound expected in 2021, we expect a reversal and should see the trading losses materialize.
Nigerian banks are also grappling with a difficult regulatory environment. The loan-to-fund ratio (LFR) directive remains in place, requiring banks to maintain their loans at 65% of their total funding. This was particularly difficult to achieve in a risk-free environment. Banks were therefore penalized by ceding customer deposits to the Central Bank of Nigeria (CBN), resulting in cash reserve ratios (CRRs) well above the required minimum of 27.5%. In addition, the sharp reductions in regulatory fees on transactions and bank fees adopted in December 2019 hurt banking revenues in 2020. We are seeing a rebound in transaction fees in 2021, but largely due to an effect basic.
The digital banking revolution is gaining ground
For several years, banks have had to reinvent themselves to adapt to the changing competitive landscape and customer behavior. For example, between 2000 and 2010, banks had an internal bias, investing heavily in system changes to support product-driven innovation. Over the past decade, we’ve seen banks shift to an external bias, focusing on the customer experience and making huge investments in large-scale transformation in support of digitization.
The digital banking revolution has attracted non-traditional players such as telecoms, fintech and big tech. This means that for banks to remain relevant and compete effectively, they must become platform organizations and embrace strategic partnerships with these non-traditional players.
Digital banking trends have accelerated dramatically during the COVID-19 pandemic. For example, the CBK reported that 94% of transactions were made outside bank branches in Kenya, an improvement from 90% before the pandemic. Around 61% of Nedbank’s main banking customers are now digital customers, and the bank’s digital sales represent 54% of total sales. Mpesa recorded a 50% increase in the value of transactions and a 35% increase in the number of transactions. Meanwhile, Absa Bank Kenya recorded a 40% reduction in branch transactions.
These trends allow banks to rationalize their physical infrastructure and optimize the cost of service.
Regulators across the continent are responding with measures to level the playing field, while promoting innovation. Laws are being amended to improve the security and resilience of these digital systems, as well as to ensure that lenders (including non-traditional lenders) have the required liquidity. Digital banking has the capacity to accelerate financial inclusion across the continent and it was encouraging to hear our speakers mention the solutions being implemented against infrastructure constraints.
As Africa’s premier pan-African bank, we look forward to learning from this conference and continuing to innovate for the benefit of our clients.