Like Moody’s, Fitch recently changed its outlook for African banks from stable to negative. Why have you done so?
We revised our sector outlook for sub-Saharan African banks to negative for 2020 (from stable in 2019) due to the build-up of operating environment risks, particularly in the two largest economies, South Africa and Nigeria.
This captures weak GDP growth, policy uncertainty, emerging stress in key industry sectors, a generally weak corporate sector and rising regulatory risks in Nigeria and to a lesser extent in Angola and previously in Kenya. The negative outlook does not imply a severe systemic stress in any of the markets, but that risks are skewed to the downside.
How do the sub-regions compare in your assessment? And what is special about Kenyan banks?
We are broadly seeing the same trends across most regions, with banks entering a new decade with more downside risks than in the two previous years, navigating through which will prove more difficult.
Financial metrics will be moderately affected in 2020, but a severe stress in any of the SSA banking sectors is highly unlikely.
The Kenyan banks received a huge boost in November when the lending rate cap was repealed by the government. We believe it will increase earnings and profitability on the back of loan repricing and stronger loan growth, with credit flowing back to key sectors like micro, small and medium-sized enterprises and consumers.
The large Kenyan banks also benefit from expansion in East Africa, which offers significant growth opportunities. One of the key strengths of the Kenyan banks is their early adoption of digital banking, which has contributed to financial inclusion in Kenya being among the highest in Africa.
How much of a difference (on profitability, asset quality, liquidity, loan growth, etc.) will the recent repeal of the interest rate cap law in Kenya make?
Margins and earnings are unlikely to return to pre-cap levels. This is partly because banks have indicated that they might limit any increase in the cost of credit to customers and partly because the policy rate is 1.5% lower than pre-cap.
The full positive impact on profitability will be felt only over time. In addition, since it was introduced, banks have successfully grown non-interest revenues to compensate for lower margins. We believe private sector loan growth will rise by around 10% in 2020.
The repeal will help asset quality to some extent as new loans will flow into sectors which were previously starved of credit. The industry non-performing loan ratio is high (around 13% in September) and a key constraint for Kenyan bank ratings.
For many African banks, asset risk remains high. How strong are their defences?
The banks have tightened underwriting standards over the last 4–5 years but asset risks are high because they operate in challenging and volatile conditions. They remain exposed to high industry and borrower concentrations, which is unavoidable when operating in narrow economies.
Based on what you can see at the moment, what is the probability of an upgrade in your outlook for African banks to stable this year?
The health of banks is intertwined with that of sovereigns. Given that several of the larger sovereigns in SSA are on a negative outlook, it is unlikely that our outlook for the banking sector will be revised back to stable in the near term.
For Nigerian banks, Fitch believes the “main threat to asset quality comes from likely rapid lending growth to comply with the LDR, especially during periods of economic fragility.” Shouldn’t the forecasts for potential bad loans be much higher then? What were the considerations behind the relatively mild deterioration projection?
Nigerian banks are facing increasing regulatory risks amid unorthodox monetary policy. The central bank recently introduced a minimum loan-to-deposit ratio (LDR) of 65%. This effectively forces banks to lend at a time when operating conditions are not conducive to growth. As a consequence, we are expecting a further, albeit modest, increase in impaired loans over the next two years as these new loans season.
Furthermore, risks in the oil, gas and the power sectors persist, giving rise to continuing asset quality concerns despite sector impaired loans reducing since 2018. We are not expecting a faster deterioration in asset quality as banks have (over the last two/three years) written off, restructured or recovered large amounts of legacy bad loans.
In any case, what is your assessment of the impact thus far of the lending boost policies of the Central Bank of Nigeria?
While we don’t agree with the LDR, it is clear that the CBN’s measures to stimulate bank lending are working. Banks have reluctantly resumed lending, initially increasing exposure to their existing prime customers but given the need to meet the higher LDR hurdle (in a relatively short-time frame), they have started to increase lending in new segments, particularly in retail banking (which most banks avoided in the past). The banks’ retail expansion strategies rely heavily on digital banking – which is relatively new in Nigeria.