Pimenta is a keen observer of the world of African finance. In charge of a committed portfolio of nearly $18bn at the IFC, this Portuguese and French national, who holds degrees from top Paris universities (École Polytechnique and École Nationale des Ponts et Chaussées), Pimenta has spent nearly 25 years working his way up the IFC’s ranks. He talks here about the state of Africa’s financial industry amid the Covid-19 crisis and the challenges that await the continent.
How are African banks handling the crisis?
The Covid-19 crisis has very severely impacted African economies. For the first time in 20 years, the entire African continent is experiencing a recession. But the financial sector has actually withstood this crisis better than the previous crises. Most financial firms in sub-Saharan Africa are managing to survive the crisis so far, which is a testament to their resilience. There are several reasons for this.
First, they had a more robust capital base and, in all likelihood, higher liquidity levels than before. Second, in a significant number of countries, central banks have provided some form of support to stabilise economies by lending and cutting interest rates. So, you have a situation where banks have thus far better managed the crisis overall compared with the 2007-08 global crisis. And that is relatively good news in this context. Now, we’re going to need to continue to monitor their response because there are still important risks and challenges ahead.
How do you think the situation will evolve for African banks in the medium term?
Bank performance levels are deeply tied to the health of the regional and global economy, and the outlook for these areas of the economy is still quite uncertain. It’s not easy to guess what banks are going to do in 2021 and 2022. Local demand is still relatively flat, interest rates are low and, potentially, there will be less government aid, so all of these factors will create challenges for the sector.
Overall, I don’t think bank revenues will return to pre-crisis levels before 2022 and we may even have to wait until 2024. It all depends on how quickly the range of possible scenarios unfold. In the current climate, what’s likely is that banks will have a higher risk aversion and tighten their purse strings, which is the opposite of what they should do because the economy needs banks that are way more active and ready to take risks.
What can be done to help support African economies?
Financial institutions will play a vital role in the recovery. There will be significant financial needs going forward. Some estimate that they could reach $290bn between now and 2023, and only about half of this amount will be covered by private capital. As a result, we’ll probably see international financial institutions and bilateral donors step up to provide support, which will likely meet a quarter of the total need.
But even with their help, that leaves a gap of tens of billions of dollars. So, domestic banks in Africa are going to have to increase their lending. IFC has a part to play in supporting banks and reducing their risk aversion.
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We provide a combination of financial and advisory support and technical assistance. Such assistance is crucial because it helps banks adjust to the rapid changes that are occurring in the economies in which they operate. I hope that these changes will lead to a different perception of risk/return for banks so that they’ll be more inclined to lend and provide support to economies.
You have many clients in the financial industry and speak to them regularly. What are they asking for and what is at the top of their agenda?
Africa is diverse, so I hear a wide range of views, but overall I get the sense that 2020 was a year of resilience. People also ask me for advice on a certain number of topics and at the top of the list is the shift to a much more digital economy. We have a team in Africa made up of professionals who advise banks on how to shift to mobile banking and manage other digital endeavours.
I can assure you that, since the beginning of the crisis, this team has been the busiest of all. Demand was so high that we had to expand the team so that they could roll out more programmes. Our clients ask us to help them set up platforms and structures that will increase their mobility.
And banks aren’t the only ones that need this support – their clients, the general public and SMEs need it, too. Everyone should be able to access financial services without having to go knock on the door in person of a bank branch.
What about managing costs?
African banks are very concerned about their cost base since it’s higher than in other regions, so they’re thinking about how they can streamline their operations. A lot of their business is focused on supporting SMEs, but needs are high.
How can they support SMEs and, meanwhile, handle non-performing loans (NPLs) and assets amid a crisis in which it’s not far-fetched to think that those numbers will go up? I’ve also been hearing a lot of talk about regional integration and the impact of the African Continental Free Trade Area (AfCFTA). How can banks seize these opportunities and expand their geographic footprint? There are many regional banks in Africa that operate in part of the continent but not all over. They have a footing in four or five countries, are interested in setting up shop in more countries and are looking into how to do that.
Moody’s, in their 2021 outlook report on African banks, expects NPLs to potentially double from 2019 levels (and they were already quite high back then). In the meantime, Africa is lacking in what are known as ‘bad banks’ and related mechanisms. Why is this so and how can we mitigate the risks entailed by this situation?
One of the reasons for this situation is that we all refer to NPLs as ‘bad loans’. There is a stigma surrounding NPLs. They have such a bad reputation that we prefer not to explore them or deal with them. No matter how vibrant an economy is, you’ll always have companies that take risks and succeed, and others that’ll run into problems and fail.
In the most well-functioning economies, when companies fall on hard times, there are mechanisms in place so that they can overcome the challenges they’re facing and either recover and thrive again or, in some cases, close down, but in an orderly way so that there’s not much of an impact.
The worst-case scenario – and this is what happens in the most rigid economies – is that as soon as a company runs into a sizeable problem, it collapses and ends up impacting their suppliers, employees, clients and so on, and, in that case, there are huge negative impacts. So, the idea is first to have someone who sits down and says, “Let’s figure out a solution and see how you can restructure your loans”.
That way the company can get enough room to breathe and move forward. This system greatly benefits small companies that get into these situations, but it also helps banks that have large amounts of NPLs on their books. These loans impact their bottom line, their balance sheet and their ability to lend more. In more developed economies, there are operating mechanisms for NPLs that allow banks to offload NPLs to a third party – one that specialises in managing such loans – once the amount reaches a certain threshold.
So it’s beneficial to have well-functioning secondary markets for NPLs. In Africa, even before the Covid-19 crisis, this was an issue IFC was taking a look at and it’s even more relevant today because NPL volumes are on the rise. But to put these markets in place, you need the right kind of infrastructure and regulatory environment.
This approach is well aligned with IFC’s strategy called “working upstream”, which means that before we initiate a project, we see if we can create a market. This is exactly what we are doing in 10 African countries (Angola, Côte d’Ivoire, Egypt, Kenya, Morocco, Mozambique, Nigeria, Senegal, Tunisia and Uganda). We have teamed up with key stakeholders in the industry to create an environment that’ll allow players to come in and develop these markets.
You already managed to do this in Southern Africa.
Yes, that’s right. In some countries, like South Africa, the market is more advanced and that enables us to jump ahead to the next phase, i.e., help the system actually operate. We recently invested in one of these platforms, run by a debt management company called Nimble. This investment involved creating a special purpose vehicle (SPV) that buys NPLs from financial institutions.
In just one year of operation, the SPV bought out 1.5 million of these loans. This platform has about $100m in capital. Compared to the size of the economy, this may not sound like much, but it means that these are small loans. In addition to South Africa, this SPV is active in Botswana, Eswatini, Lesotho and Namibia. What’s more, we expect them to expand to Kenya in 2021, where Nimble has established servicing capacity.
What comes next?
We have a project pipeline of $300m to finance the sector. Is that enough for the total volume of NPLs in Africa? More investment will be needed but our primary goal is to set an example. If our strategy works in one market, then you’ll find other players that’ll replicate it elsewhere. And then it’ll have an even bigger impact. This is something we’ve already successfully done in Asia.
African banks aren’t very active in trade finance, even though this sector is much needed now that the AfCFTA has come into force. Why is this the case and how can trade finance be promoted?
Trade is the lifeblood of the economy. It’s so important. In January, one of our clients – a pan-African company operating in more than 10 countries – told me that when he makes transactions between two of his companies located in separate African countries, he’s forced to transfer funds through New York.
So, we need to facilitate trade, especially now that it’s under pressure because of the crisis. IFC has been very active on this question, as we’ve increased our trade operations in Africa. Over time, we’ve performed more than $1.4bn worth of guarantees in trade operations.
I also think it’s important to point out that all of them were successful. We never had a default. This shows how healthy this sector can be in Africa. We have several different lines of credit tailored to a variety of needs: the Global Trade Finance Program (GTFP), structured trade finance, commodity finance, etc. What’s important is to focus on intra-African trade. A few things can be done and much of it involves the regulatory environment.
One solution that would be easy to implement is to reduce collateral requirements for trade finance. A second could be to ease regulatory frameworks, as they’re quite complicated in a number of markets. Companies should also increase their financial literacy so that they can improve their bankability and be better equipped when it comes time to persuade banks to do business with them.
And, of course, there are more prescriptive measures, like requiring lenders to devote a certain share of their loan portfolios to trade, although we prefer to use measures that encourage people to do business, rather than force them to do a certain thing. Showing that trade is a good business for banks and companies is probably the best way to get things moving.
Sergio Pimenta will be participating in the Africa Financial Industry Summit, a two-day digital conference, alongside influential decision-makers in African finance, the 10 and 11 March 2021.
Click here for the programme, speakers and registration
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