African banks are exposing themselves to potential losses with heavy investments in government securities while starving the private sector the much- needed credit.
The European Investment Bank (EIB) says in its latest annual finance in Africa report that the lenders’ appetite for government securities is a risk to them, even as it has also contributed to limited and expensive credit to private sector players.
The Report, 'Unlocking investments in an era of digital transformation and climate transition (2024)', on November 7 says the severity of crowding out the private sector from credit was particularly high in 2023 in over half of the African countries.
Regionally the highest levels of crowding out were seen in East, Southern and West Africa, where also governments have amassed public debt that is threatening repayment capabilities.
“African bank holdings of domestic sovereign debt increased sharply to 17.5 percent in 2023 from 10.3 per cent in 2010, raising the potential for bank losses in the event of a debt default or restructuring.
"At the same time, there is a decreasing trend in banks’ private sector lending to 38 percent in 2023 from 42 per cent in 2010, posing concerns about the severity of crowding out,” the report says
Increasing financing needs
The report notes that crowding out significantly tightened to record levels in 2023 before easing in 2024 driven by higher public debt issuance and a rebound in private credit demand which created intense competition for banks’ funding “African governments faced increasing financing needs as international investor appetite declined, strengthening the connection between governments and banks and increasing crowding-out effects (when banks channel their financial resources to sovereign instruments at the cost of limiting lending to the private sector),” the report says.
“Over the past four turbulent years, bank holdings of domestic sovereign debt have increased sharply across Africa.” African banks absorbed a sizeable share of government papers, raising the domestic sovereign debt but they also helped governments finance the widening fiscal deficits in the wake of multiple shocks – the Covid-19 pandemic, the cost-of-living crisis stemming from Russia’s invasion of Ukraine, and the global economic slowdown.
Two of the largest banks in Ghana suffered their first loss following the country’s decision to restructure its local currency and overseas debt at the end of 2022.
Domestic sovereign debt exposure
Ghana Commercial Bank – the largest bank in terms of assets – posted a net loss of $50.5 million in 2022 for the first time since 1993, and Ghana’s Standard Bank – the largest bank by market value – registered a loss of $25.4 million.
In Nigeria, banks also reported suffering a loss of about $1.4 billion following Ghana’s public debt restructuring.
The report notes that the continued exposure of banks to government borrowings poses concerns about the severity of crowding out with domestic sovereign debt exposure of banks increasing in Africa to 17.5 per cent in 2023 from 10.3 per cent in 2010.
Inflation increased to 13 per cent in 2022 and 19.3 per cent in 2023 from nine per cent in 2019, with the most pronounced increase in West Africa to 17.1 per cent in 2022 and 20.4 per cent in 2023 from 8.2 per cent in 2019. According to the report, higher interest rates triggered considerable portfolio outflows from emerging markets.
“As advanced economies raised interest rates, international investors shied away from the riskier assets of emerging markets, favouring the safer and higher quality assets offered by advanced economies,” states the report.
Monetary policy tightening
With 90 per cent of central banks raising interest rates by the end of 2022, emerging market assets experienced portfolio outflows totaling $49 billion in 2022, which was higher than the $36 billion outflows seen during the first year of the Covid-19 pandemic in 2020.
This year (2024,) the US Federal Reserve maintained its monetary policy tightening bias to support the US dollar, dragging inflows to emerging markets and in response to monetary policy tightening, returns on African stocks declined more compared with those of emerging markets and developing economies.
Higher interest drove lower stock prices globally, but the decline was more pronounced in Africa relative to emerging markets and developing economies
According to the report, Africa’s indebtedness has increased significantly in the last decade and the mix of ample liquidity available after the 2008 global financial crisis and governments’ resorting to bilateral and market-based lending fueled indebtedness in the continent.
Governments issuing US dollar bonds in 2023 faced greater yields than those seen before the Covid-19 pandemic and yields on US dollar sovereign debt in Africa increased to an even greater extent, leading to wider spreads relative to the bonds of emerging markets and developing economies.
“This rising cost of debt has contributed to fiscal problems. In nominal terms, interest payments on long-term external debt stock by emerging markets and developing economies have doubled since 2010 to an all-time high of $210 billion in 2022,” states the report.
In sub-Saharan Africa interest payments multiplied to $20 billion in 2022 from $4 billion in 2010.
By African region, the increase in yields was most pronounced in North Africa and West Africa, followed by that in East Africa and Central Africa then Southern Africa
Gross issuances of government bonds in Africa stagnated in 2023, following a sharp decline in 2022 as Sub-Saharan African governments were effectively locked out of international capital markets for almost two years, following a Eurobond issuance in April 2022.
The only countries that issued government US dollar-denominated Eurobonds in 2023 were in North Africa (Egypt and Morocco).
However, Côte d’Ivoire, which is the world’s largest cocoa producer, succeeded in tapping international capital markets in January 2024 for a $2.6 billion bond, selling $1.1 billion via a sustainable bond maturing in 2033 and $1.5 billion in conventional bonds due in 2037.
Benin followed in February 2024, selling $750 million of 14-year bonds at an 8.4 percent yield, matching Côte d’Ivoire’s rate for its 2037 notes.
Demand for Benin’s issuance exceeded the offering by over six times, signaling strong investor interest in emerging market assets.
In February 2024, Kenya sold a new $1.5 billion Eurobond maturing in 2031, which it will use to buy back a large portion of a $2 billion international bond due in June 2024 via a tender offer.
“Thus, market access is being restored but at elevated interest rates,” the report says.
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