Managing Risk In Africa

Recognising, identifying and managing risk is core to running a successful company. This becomes even more critical when dealing with foreign investments where other types of risk enter the frame. Richard Seymour writes that Africa’s risk management may have come late, but it is coming on strong.

For a long time, Africa has had to manage crises. But for stable, sustainable growth to be possible, all successful economies must be able to manage risk.

As much as African businesses need to be able to manage risk, they need also to manage perception of risk. In the West, when Africa appears on the news or makes the front pages of newspapers, it is almost invariably to report on civil wars, famine, disease and political instability. There is little they can do about that.

But businesses in countries like China, which are less risk averse, are stealing a march on their European and American counterparts by investing heavily. That they are, and in doing so are helping to reform the business environment in the countries in which they operate, has not gone unnoticed by foreign investors elsewhere.

With so many saturated markets and so much potential having been recognised in Africa, what risk there is, is increasingly being deemed worth it. It would be a mistake, however, to overstate the risk of investing in Africa, to fall for the image presented in the world’s media. It is demonstrably true that the business environment in Africa has improved. Even a country with such an infamous recent history as Rwanda is winning awards and attracting praise all over the world for the strides it has made.

However, as is the case anywhere in the world, wherever someone is thinking of investing, accurate risk assessment is essential.

The collapse of the sub-prime market in the US demonstrated how, in a globalised system, a failure to manage risk in one country can spread its ill effects to other countries who had otherwise done a much better job in that regard, bringing down other sectors with it. It is no longer possible to contain risk to one institution, sector or even to one country. So issues of risk are more important now than ever before.

Not all one size

Entering Africa by setting up a base in South Africa is a well-tried method of dipping one’s toes in the continent. But someone attempting to do this now will have to battle with already well-established competitors and may find themselves outmanoeuvred by those who took a chance and opened for business somewhere else on the continent. In addition, it is foolhardy to imagine that what works in South Africa will also work north of the Limpopo. It is like setting up a base in France in order to exploit opportunities in Russia. In fact, South African companies learnt, to their considerable cost, that the one-shoe-fits-all-sizes approach can be disastrous in Africa. They now look at opportunities in each individual African country, set up base and set out to learn all they can about local business culture, ethics and customs.

This approach separates business risk from country and political risk and allows for a clearer strategy. Risk can then be placed in its proper context. Last year, the Central Bank of Kenya (CBK) reported that 90% of its banks have, by understanding risk better and therefore reducing it, seen an increase in their profits. In 2005, Kenya issued risk management guidelines. Since then, a survey of 43 financial institutions has shown that 95% have created independent risk-management arms, with roles created for chief risk officers seen as essential for effective oversight.

This change has been partly driven by foreign banks entering the African markets, but governments and private institutions have taken it upon themselves to develop their own risk management initiatives.

The insurance industry has an important role to play here. Traditionally, insurers in Africa have offered services to an elite group of large businesses while mostly neglecting the small and medium-sized businesses which form the bedrock of any economy.

Although the situation is changing, that the insurance industry in Africa is still underdeveloped means that the area of risk management is still in its infancy. Working together, governments and insurers can identify risk at all levels, whether political, social or economic, and by means of government legislation the private sector can begin to design affordable policies.

Identifying risk

When it comes to identifying risk, the private sector has a great deal of expertise to lend its governmental partners.

Risk forms a broad spectrum of concerns. The banking crisis of 2008 has led to an emphasis on credit risk. But operational risk, according to surveys, is relatively overlooked. That is, risk arising from an inadequately functioning business or one which suffers an environmental event. The most famous example of what can happen when a business’s functions fail is the collapse of Barings Bank, which continually overlooked the practices of a single individual.

A study by RiskBusiness showed that operational risk is not being taken seriously enough by regulators around the world with Africa scoring particularly badly. Experts in operational risk maintain that it is ignored at one’s considerable peril.

The Institute of Operational Risk (IOR) is an organisation based in the UK that researches methods of identifying risk and mitigating against it and also provides training to clients interested in understanding the management of risk and its application to their businesses.

It says that in recent years, it has received an increasing number of applications from Africa, particularly from Kenya, Nigeria and South Africa. This is partly due to the intention of African banks to bring themselves in line with the Basel Committee of Banking Supervision’s recommendations on banking laws and practices. This means that they need to commit themselves to a greater level of transparency. And it is a recognition on their part of the need for more effective risk management, especially in banking, where a lack of oversight has led to such catastrophic consequences elsewhere.
Individual risk managers, therefore, not only require training but also to be able to produce accreditation of their skills.

Nigeria takes the lead

It appears that Nigeria is taking a lead in developing its risk management industry. The IOR is opening a chapter in Nigeria. It will emphasise the need to collate and share data and hopes to enter into a partnership with the Nigerian Central Bank to achieve this. This announcement came on the back of the country hosting a risk management conference in February last year that was well attended by representatives from across the continent.

That Africa is beginning to take a lead in the development of its own risk management is important because, as is the case wherever you go in the world, the nature of the risks involved are not only unique to the continent but to each individual country within it.

Although there is much knowledge to be gained from parts of the world where the industry is already well established, only Africans can tailor the methods they learn to suit their specific needs. This is why cultural understanding must be factored in when evaluating risk. Some countries in the world have – or had – a more cavalier attitude to personal debt than do others, where a more conservative approach to such things was ingrained in their national psyche. As a result, despite the plaintive cry from leaders of the countries most badly hit by recession that the problem was not of their making but an international crisis, some countries were simply better insulated against the worst.

However, the increasingly globalised nature of financial systems means that one cannot feel smugly insulated from other people’s excesses and mistakes. There is also no question of individuals or institutions being unwilling to share information and ideas. What emerged from the Nigerian conference was the determination that when it comes to risk management, no single institution is an island. When the bell tolls, it tolls for everyone. So cross-border cooperation and the pooling of know-how is being embraced at this early stage, which should help the industry to grow as quickly as it needs to.

Volatile commodities market

Another form of risk that governments have found themselves grappling with recently is the volatile market in commodities. Increasingly, governments are, albeit nervously, offsetting their exposure to commodities. Sovereign involvement in this financial practice has traditionally been rare but that is changing quite dramatically.

Many governments, aware of the negative image hedge funds labour under, have been coy about their involvements, but the government of Ghana has been very open in regard to their own activities. Last year, Ghana’s Finance Ministry announced that it had hedged its share of the revenue from the Jubilee oil field, having already hedged the cost of its fuel imports last year. It is believed that this has helped keep Ghana’s currency stable against the dollar, euro and sterling. And the cost of fuel at the pump has also remained stable.

Senegal has joined the African hedging club and it is thought that discussions to do something similar have taken place in Nigeria.

Understanding the risks a government is exposed to is a complex job, being contingent, as it is, on so many variables; many, especially in developing countries, lack the know-how to take on such a task. Governments are understandably reluctant to take financial positions on liabilities that may come to nothing. And cautionary tales of governments who have had their fingers burnt in such a way have discouraged some from getting involved.

The steady era of growth during the 1990s and the early 2000s has been replaced by uncertainty and volatility. The need for African countries looking to sustain growth over the coming years means that understanding risk and managing it is a necessity. This is true at the level of small businesses right up to large institutions such as banks. And as more and more governments make a success of hedging their positions, so even at the sovereign level, the culture of risk management will have to take hold.