De-risking is causing widespread problems in Sub-Saharan Africa. But for those who have the appetite and expertise, there are opportunities too.
Many key indicators point to Africa’s long-term growth potential: the rise of an urbanised middle class, driving consumption; multi-party elections that often now meet international standards; and improving agricultural productivity.
In a recent report, EY stated: “Most African economies are in a fundamentally better place today than they were 15 to 20 years ago, and overall growth is likely to remain robust relative to most other regions over the next decade.”
Evolving trade finance in Africa
As the region develops, the provision of African trade finance services is becoming more specialised. There are only a small number of experts able to negotiate the trade corridors between Africa, Asia and Europe and provide connectivity for producers, off-takers and investors, and many of these are African banks.
Trade too is evolving, as Africa develops more onshore processing capabilities. FBN Bank UK’s Tosin Adewuyi explains: “There is new infrastructure being built – privately-owned oil refineries and plantsto process copper, cobalt and cocoa. These new businesses create opportunities for investors, trade partners and lenders. Properly supported, they will become part of a virtuous circle, generating new wealth, creating growth, jobs and increasing trade.”
Many types of business stand to gain from a developing Africa.
These include the growing number of African corporates, mainly mid-tier, whose needs for trade finance, capital funding and access to markets are not yet being met; the European investors who want exposure to Africa; the non-African corporates who want to develop trade links in Africa; and banks seeking to benefit from new lending opportunities in the African markets.
De-risking: A serious challenge
Set against this positive outlook are challenges that deter many financial institutions from seeking exposure to the African markets.
Following the global financial crisis, regulators introduced new rules to strengthen financial stability and combat money laundering, which require more complex systems, the need for specialist staff, training, and the obligation to deepen due diligence.
Faced with rising regulatory requirements and costs, banks have reduced business activity in emerging markets – so called ‘de-risking’. A recent survey by IFC describes the negative effect of de-risking on trade flows as “subtle, complex and pervasive”. According to the survey, 25% of emerging market banks have lost correspondent banking relationships and in Sub-Saharan Africa, that number rises to 33%.
Where correspondent banking services are not withdrawn completely, they are often cut back. Limits may be reduced, and some geographical territories may be deemed too risky and expensive. Banking services may be limited to letters of credit and nothing more. The survey goes on to say that 80% of banks in Sub-Saharan Africa have been affected.
The effect of de-risking
De-risking has left its mark on the business, financial and social landscape in Sub-Saharan Africa. At a financial level, local banks are finding it increasingly difficult to serve their customers as correspondent banking relationships are curtailed. The smaller, local banks find themselves most heavily impacted: sometimes they and their clients are completely excluded from cross-border business.
At a commercial level, a reduction in correspondent banking services affects European SMEs trying to export their goods and services and African importers trying to source goods and services. And at a social level, some of the vitally important remittances sent back to families in Africa by people working overseas are also impacted.
Ironically, de-risking may be introducing more risks into the banking system. A 2016 study on Correspondent Banking by the Committee on Payments and Market Infrastructure (CPMI) at the Bank for International Settlements (BIS) reveals a reduction in the number of active correspondents and in the value of transactions, but an increase in the volume of transactions, meaning that correspondent banking activity is being concentrated in the hands of fewer and fewer banks.
Furthermore, more traditional trade will now have to be done in the informal or shadow banking world, further reducing the transparency needed to combat money-laundering and terrorist financing.
What can be done?
The industry is looking at a range of different measures to tackle the problem:
Standardisation and harmonization: The IFC in its report on correspondent banking recognises the importance of “standardising due diligence processes to assess risk for a particular customer or by actors along the payment process, including the trade finance supply chain, remittance flows and others”. There is also a need to establish common standards for enforcement of the regulations. These measures would make the risks simpler for correspondent banks to assess, and therefore make it easier for them to offer full correspondent banking relationships where the standard is met.
A central KYC utility: The BIS/CPMI report is one of many papers that raises the possibility of establishing a centralised KYC utility where banks could provide and consult KYC information. The report recognises that the scale and cost of customer due diligence is enormous. According to SWIFT, the 7,000 banks that use the SWIFT network for correspondent banking have more than 1 million individual relationships. A centralised utility would reduce the KYC cost significantly for correspondent banks.
New technologies: Several banks see potential in distributed ledger technologies such as blockchain to help reduce the incidence of fraudulent transactions, and although these are at an early stage, they will have a role to play in providing a transparent and immutable audit trail of payment transactions.
FBN UK: Taking action
Paul Cardoen, FBN UK CEO, believes it is time for urgent action. He claims: “The industry is fundamentally resourced for yesterday’s KYC challenge, not for tomorrow’s. We need to move away from pre-established ‘tick the box’ screening criteria to a fundamental improvement in systems, software and processes using the latest tools, including artificial intelligence and alternative data sources.”
In order to cope with the new regulatory requirements, FBN UK itself is introducing several measures to help clients and other stakeholders regain trust and risk appetite in cross-border trade finance and overcome the challenges posed by de-risking.
Along with local stakeholders (regulator, banks, law firms, consultants), FBN UK is in the process of establishing a compliance academy, creating a virtual network promoting best practice in compliance management. Under this programme, FBN UK will bring together, in regular weekly sessions, compliance officers from African banks, sharing experience, knowledge and plans to build out risk governance and compliance expertise.
FBN UK is considered by the regulator to be a smaller player or level 3 bank, which means that it is not subject to the full regulatory scope of a globally systemic important or level 1 bank. Nevertheless, its board has taken the voluntary approach to meet most of the requirements of a level 1 bank. Cardoen explains: “We have radically revised our governance structures, bringing three non-executive directors onto our board. At the same time, we have undertaken a comprehensive review of our incentive and reward policies, and beyond our own enterprise, we are requiring all our partners, suppliers and clients – the extended enterprise – to adopt the same high standards on compliance, conduct and ethical standards that we ourselves have adopted.”
Implementing a dual accountability scheme
FBN UK is renewing policies and processes that relate to data protection for GDPR (General Data Protection Regulation), establishing procedures to ensure compliance with the Criminal Finances Act which has just come into force in the UK. It is also incorporating human rights protection – as provided by the Modern Slavery Act – into lending processes to stop human rights violations, and investing in new ways to improve compliance monitoring and testing.
On this last point, the bank can point to an early success in a recent transaction – financing a mine in Africa which had a history of child labour. FBN UK made it a condition of the loan that there should be no child labour associated with the operation, and worked with the owners to ensure that was the case. They carried out a rigorous due-diligence before granting the loan, and now it has been granted monitoring will take place on a regular basis throughout the life of the loan.
It is clear that Cardoen sees these regulations not as a problem, but as an opportunity.
“Banks that have better detection and screening mechanisms can grow faster,” he says. “We’re not just trying to comply with the regulator – if we are better equipped, we can and will take on the business that others leave behind.”