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Profitability: The case (curse?) of African banks


The interim reporting season for banks is upon us and they have been duly lining up to show the market what they achieved over the first six months of the year.

In the run-up to this period the usual sense of anticipation may have perhaps been diminished and replaced by a sense of anticlimax given the signals that emanated from the sector as it sought to deal with the litany of challenges that confronted it during the review period.

Interestingly, now that we have seen the numbers, the performance of banks so far paints an optimistic picture, though in a guarded manner.

This, against an operating environment which although considerably more stable, has been anything but friendly and if anyone must really find excuses for sub-optimal performance, they don’t have to look very far because almost every aspect of the operating environment matrix is an eligible candidate.

The operating environment has been a real punisher, not only for the financial services sector, as the case of one listed manufacturing entity proves.

An inquiry into the causes of poor performance of one of its divisions revealed that results had been significantly overstated through the inclusion of fictitious sales during the first half of the year.

Further investigations concluded that this overstatement of divisional sales in turn caused an overstatement of profits by US$767 000.

Disciplinary action had to be instituted and management had to find new excuses for poor performance. We don’t know if they were asked to vote with their feet or given another chance to correct their errant ways.

Although every single set of financial results acknowledges the stability ushered in by the multi-currency regime, the overwhelming concern is that economic performance, coming from a very low base as it is, has stagnated at a rather lowly plateau and something significant needs to happen in order for the trajectory to be lifted again. (Most people think that it will be proceeds of diamond sales.

Let’s wait and see). Consequently none of the chairmen’s statements misses the opportunity to say something about the myriad operating challenges threatening the stability.

Even for banks otherwise declaring a good set of results, the allusion to fragility is unmistakable. Some of the key challenges mentioned include high staff costs, poor liquidity conditions attributed to lack of credit lines and negligible savings, negative perceptions impacting on country risk profile, unsustainably high utility bills, a low deposit base impacting on the ability to generate interest income, lack of a lender of last resort hence little interbank activity and the uncertainty regarding implementation of the Indigenisation and Economic Empowerment Act.

Against that depressing backdrop, the results achieved by some of the banks in Profit after Tax (PAT) terms as at June 30 2010 (against the comparative period in 2009), show profitability trending upwards as illustrated in the table below:

It is against this background of constrained operating environments typical of most of Africa’s financial services sectors that I recently came across something that I initially found to be incredible but which, upon further reflection, proved to be a fairly accurate reflection of the situation on the ground.

According to Mark Napier, editor of Real Money, New Frontiers, Africa’s financial sector is one of the most profitable in the world, with bank returns doubling or trebling what other emerging markets deliver.

This paradox was aptly summed up by WT Manase, the chairman of Metropolitan Bank, when announcing the bank’s results: “Although the sector remains bedevilled by liquidity constraints compounded by unavailability of favourable credit lines which slowed the economic growth prospects, the banking sector continues to defy the odds by registering notable growth as the economy continues to shift back into the normal way of doing business.”

Given the litany of problems typically faced by African banks, some of which we have already discussed above, I was intrigued by Napier’s observation and was keen to find out why this is the case and if it applies to the Zimbabwean situation.

Firstly, Napier argues that financial depth, measured by deposits mobilised or credit extended, has been on a rising trend since the mid-1990s, especially in deposit mobilisation.

I couldn’t agree with him more as deposits have been rising in Zimbabwe at about US$100 million a month since early 2009 and this will no doubt have positively impacted on the profitability of local banks.

The loan-to-deposit ratio has also being rising steadily.

Secondly, African banking systems are highly liquid, partly because their success in mobilising deposits is not matched by success in lending to the private sector.

Wasn’t it only last year that the Reserve Bank had to apply moral suasion on the sector since some banks were allegedly sitting on funds (liquidity hoarding) and refusing to lend?

In the end the regulator had to direct the banking sector to structure their lending portfolios in a prescribed manner.

Thirdly, banks generate huge margins from deposit-taking business, charging fees to depositors, paying little by way of interest but profiting from huge spreads.

Again, the monetary authorities have had to intervene in order to urge local banks to pay higher interest on deposits and to reduce their transaction charges.

When profitability is deemed to be excessive and at the expense of the banking public, it can become a curse of sorts, inciting regulators to institute measures they deem necessary to ensure a fairer distribution of wealth. Remember the days of the Financial Institutions Levy?

According to Napier, the combination of inefficiency in many banking systems in sub-Saharan Africa, in which high operating costs are not adequately compensated by productivity, with year-on-year profitability, leads to the inevitable conclusion that lack of competition is a fundamental reason why banks in Africa are so profitable.

Where economies are very small, there is a limit to how much profit in absolute terms can be extracted from them and so new entrants stay away and markets remain uncontested.

This may not be entirely true for Zimbabwe at the moment because the level of competition is probably at its peak given the number of players in the market in relation to the level of business.

Napier concludes by veering into financial inclusion territory and by saying that that banks in Africa occupy fairly narrow niches but have benefited from an environment of profitable inertia.

Outside the narrow niches is a much more complex world of unsalaried or informally employed people, small businesses with no collateral and farming communities where the prospects of a return are often uncertain.

This definitely holds true for Zimbabwe, otherwise how would one explain the large swath of unbanked and underbanked people?

While the situation currently obtaining in Zimbabwe is still in a state of flux as the economy is in recovery mode and can hardly be described as typical of most of Africa, one can see that most of Napier’s arguments broadly hold true for the country’s banking sector.

Omen N. Muza is a banker and Managing Director of TFC Capital (Zimbabwe) (Pvt) Ltd. He writes in his personal capacity. Feedback: omen.muza@gmail.com

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