Financial Stability - A Regional

Perspective

By

Dr. Iyabo Masha

IMF Resident Representative

Presented at the International Conference on

Financial Stability in Sierra Leone – The Road Map

Organized by

Bank of Sierra Leone and IMF Money and Capital Markets Department

FREETOWN, SIERRA LEONE

July 3, 2017

OUTLINE OF PRESENTATION

I. Financial Stability – Background Issues

i. Concept and Definition

ii. Linkages to the macroeconomy

II. Recent Economic Developments and Financial Spillovers

i. Global Developments – evidence from 2017 GFSR

ii. Regional Developments – evidence from 2017 Africa Regional Economic Outlook

III. West Africa Financial Stability- Regional Financial Stability FrameworkIII. West Africa Financial Stability- Regional Financial Stability Framework

i. State of Play

ii. Financial Stability Indicators – Banking Sector

iii. Financial Stability Indicators – Non-bank Financial Institutions(evidence from WAMZ Financial Stability Report

IV. Financial Stability Challenges in the Region: Policy Focus Going Forward

V. Conclusion

2

PART I

FINANCIAL STABILITY – BACKGROUND ISSUES

Concept and definitioni. Concept and definition

ii. Linkages to the macroeconomy

3

FINANCIAL STABILITY: CONCEPT AND DEFINITION

“A financial system is in a range of stability whenever it iscapable of facilitating (rather than impeding) theperformance of an economy, and of dissipating financialimbalances that arise endogenously or as a result ofsignificant adverse and unanticipated events” (Schinasi,2004)

“Financial stability is a condition, in which an economy’s“Financial stability is a condition, in which an economy’smechanisms for pricing, allocating, and managing financialrisks are functioning well enough to contribute to theperformance of the economy.” (Schinasi, 2005)

4

FINANCIAL STABILITY CONCEPT AND DEFINITION

The first definition implies that a financial system is stable when there is

confidence in the ability of the system to manage and absorb potential

macroeconomic shocks with minimal disruption of economic and financial

activity. The second definition states out the key roles of the financial system:

• Efficient and smooth allocation of economic resources: A stable financial system facilitates efficient and smooth allocation of resources inter-

temporally and spatially between savers and investors.

• Identification and management of potential risks: In a stable financial system, potential risks are continuously identified, reasonably priced and effectively

managed.

• Absorption and containment of financial and economic shocks: A stable financial system is able to absorb and contain shocks to the financial and

real sectors with minimal disruption to financial and economic activity.

5

FINANCIAL STABILITY AND MACROECONOMIC LINKAGES

� In the absence of financial stability, the capacity of financialmarkets to facilitate trade, production, capital accumulationeconomic growth and social welfare is hampered.

� The consequences of financial instability are manifested in:

� Decline in national output and incomes – real GDP growth

� Increased fiscal expenditures – fiscal deficit

� Balance of payments deficits – external balances and reserves accumulation

� Exchange rate instability – prices and competitiveness

� A stable financial system is necessary for sustainable GDP

growth and low inflation. Similarly, sustainable growth in the

economy with stable prices will also make the economy less

prone to financial instability. 6

GLOBAL LINKAGES

In an interdependent world, global financial stability maters

� The global financial crisis of 2007-2009 showed that financial stability can be jeopardized even in an environment of price stability and macroeconomic stability.

� Any disruption in the financial system anywhere in the world has the potential of affecting the real economy not only in that country but also elsewhere. The extent of transmission of disruptions through different channels, namely finance, trade and confidence channels was strong.

� Domestic financial stability cannot be a sufficient goal in the absence of a conducive global environment.

7

PART II

RECENT ECONOMIC DEVELOPMENTS AND

FINANCIAL SPILLOVERS

i. Global Developments – evidence from 2017 Global Financial Stability Report

ii. Regional Developments – evidence from 2017 Africa Regional Economic Outlook

8

GLOBAL FINANCIAL STABILITY - EVIDENCE

FROM 2017 GFSR

The financial crisis of 2007-09 and its aftermath emphasized the need for a global approach when assessing financial stability risks. In this context, IMF’s biannual Global Financial Stability report, GFSR assesses global financial stability, identifying potential sources of risks and vulnerabilities.

According to the 2017 edition:

� Global financial conditions are broadly stable: Financial stability continued to improve since October 2016.since October 2016.

� Economic activities and interest rates are increasing: Economic activity has gained momentum and longer-term interest rates have risen, helping to boost the earnings of banks and insurance companies.

� Political and policy uncertainties have heightened: Threats to financial stability are emerging from elevated political and policy uncertainty around the globe. Policy developments in advanced economies that cause unanticipated changes in growth and debt could result in rising risk premiums and volatility in financial markets.

� Shifts towards protectionism: A shift toward protectionism in advanced economies could reduce global growth and trade, impede capital flows, and dampen market sentiment. 9

GFSR 2017 (CONTD)

The macro environment has important effects on the financial stability:

� Low growth / low interest rate environment: A prolonged low-growth, low-interest rate environment can fundamentally change the nature of financial intermediation. In such an environment, yield curves would likely flatten.

� Bank earnings: Combined with low credit demand, this would lower bank earnings, particularly for smaller, deposit-funded, and less diversified earnings, particularly for smaller, deposit-funded, and less diversified institutions.

� Impact on non bank financial institutions: Prolonged low interest rate also presents long-lasting challenges for life insurers and defined-benefit pension funds.

� Achieving domestic policy objectives: Though global shocks have significant impact on domestic financial conditions, countries retain influence to achieve domestic objectives—specifically, through monetary policy. 10

GFSR (2017) RECOMMENDATIONS

� US policy mix: In the United States, policymakers

should provide incentives for economic risk taking

while guarding against excessive financial risk taking.

� Emerging market economies should address domestic

imbalances to enhance their resilience to external

shocks.shocks.

� Developing economies should continue to

strengthen supervisory frameworks.

� There should be no rollback of the post-crisis reforms

that have strengthened oversight of the financial

system in other regions.

11

REGIONAL MACRO DEVELOPMENTS -EVIDENCE FROM AREO (2017)

GAB

ERI

BWA

5

6

7

8

Fre

qu

en

cy

Resource-intensive countries

Nonresource-intensive countries

Weighted

average = 5.0Median = 5.1

Prior to 2015, African countries experienced high rates of economic growth,

improvements in macroeconomic fundamentals, resulting in significant

transformation and growth of their financial systems.

Real GDP Growth, Average 2010–15

SSD GNQ CPV GIN ZAF GMB SWZ MUS SEN MWI UGA NGA ZMB TZA ZWE GHA ETH

CAF MDG GNB MLI STP COG TGO NAM NER RWA COD

COM BDI LSO CMR SLE KEN TCD MOZ

BEN AGO SYC CIV

LBR BFA

GAB

0

1

2

3

4

5

≤ –2 –2.0 –1.5 –1.0 –0.5 0.0 0.5 1.0 1.5 2.0 2.5 3.0 3.5 4.0 4.5 5.0 5.5 6.0 6.5 7.0 7.5 8 >8

Fre

qu

en

cy

Percent

12

REGIONAL MACRO DEVELOPMENTS -EVIDENCE FROM 2017 AREO

COM CMR BFA

CPV

BEN

4

5

6

7

8

Fre

qu

en

cy

Resource-intensive countries

Nonresource-intensive countries

Weighted

average = 1.4

Median = 3.7

Since 2016, SSA economic growth slowed sharply, averaging 1.4 percent, the

lowest in two decades.

Real GDP Growth, 2016

SSD NGA LBR SWZ ZAF ZWE MWI ZMB MOZ MUS SYC UGA TGORWA KEN TZA ETH

GNQ BDI AGO NAM GMB LSO ERI STP SLE MLI SEN CIV

COG GAB BWA MDG NER GNB

TCD COD GHA CAF GIN

0

1

2

3

4

≤ –2 –2.0 –1.5 –1.0 –0.5 0.0 0.5 1.0 1.5 2.0 2.5 3.0 3.5 4.0 4.5 5.0 5.5 6.0 6.5 7.0 7.5 8 >8

Fre

qu

en

cy

Percent

13

REGIONAL MACRO DEVELOPMENTS -EVIDENCE FROM 2017 AREO

Drivers of the slowdown

� Exogenous : global commodity price decline, compounded by problems with security and food shortage in several countries.

� Policy drivers: lack of flexibility in exchange rate policy and recourse to excessive domestic financing as external financing dried up.

� Inadequate policy response which magnified the adverse outcomes in many countries.

14

700

800

900

1,000

Basis

poi

nts

Emerging markets

Sub-Saharan Africa frontier markets

The impact of the slow down is pronounced. Borrowing cost has risen

sharply, making external market financing less attractive.

EVIDENCE FROM 2017 AREO CONTD.

Frontier and Emerging Market Spreads, 2014-17

200

300

400

500

600

Jan-14 Jul-14 Jan-15 Jul-15 Jan-16 Jul-16 Jan-17

Basis

poi

nts

15

AGOBDI

CIV

GAB GHA

GNB

KENSYC

SLE

UGA20

25

30

35

Dec.

2016

or la

test a

vaila

ble, p

erce

nt of

com

mer

cial b

ank a

ssets

Increasing Exposure

EVIDENCE FROM 2017 AREO CONTD.

As a result, domestic financing is being accumulated at a high pace.

Exposure of Commercial Banks to the Government

BEN

BWA

BFA

CPV

CMRCAFTCD

COMCOD

COG

CIV

GNQ

GIN

GNB

LSO

LBR

MDG

MWI

MLI

MUS

MOZ

NAMNER

NGA

STP

SEN

ZAF

SSD

SWZ

TZA

TGO

ZMB

0

5

10

15

0 5 10 15 20 25 30 35Dec.

2016

or la

test a

vaila

ble, p

erce

nt of

com

mer

cial b

ank a

ssets

Average December 2010–13, percent of commercial bank assets

Decreasing Exposure

16

15

20

25

30

Per

cent

2013

Latest available

EVIDENCE FROM 2017 AREO CONTD.

Financial sector asset quality is declining.

Nonperforming Loans to Total Loans

0

5

10

CA

F

SLE

GN

Q

NE

R

LBR

GH

A

CM

R

TCD

AG

O

GIN

TZA

ZAF

BW

A

NG

A

GA

B

NA

M

CO

G

SE

N

MD

G

BD

I

SY

C

SW

Z

RW

A

UG

A

KE

N

MU

S

LES

MO

Z

Resource-intensive countries Nonresource-intesnive

17

-10

0

10

20

Perc

enta

ge p

oint

s

EVIDENCE FROM 2017 AREO CONTD.

As governments ramp up domestic borrowing amid declining economic

activities, credit to the private sector is declining.

Change in Credit Growth to the Private Sector, Average 2011–13 vs. 2016

-50

-40

-30

-20

TCD

GAB

COG

AGO

GNQ

CMR

NGA

ZWE

CAF

GIN

ZMB

BFA

LBA

GHA

BWA

TZA

NAM

NER

ZAF

SLE

COD

MLI

GNB

GM

BLS

ORW

AKE

NM

USUG

ATG

OSW

ZSE

NBD

IBE

NCP

VST

PET

HCO

MM

WI

MDG ER

ICI

VSY

CM

OZ

Oil Exporters Other resource-intensive countries Nonresource-intensive countries

Perc

enta

ge p

oint

s

18

PART III

WEST AFRICA FINANCIAL STABILITY

Regional Financial Stability Frameworki. Regional Financial Stability Framework

ii. Financial Stability Indicators – Banking Sector

iii. Financial Stability Indicators – Non-bank Financial

Institutions - evidence from WAMZ Financial Stability Report

19

REGIONAL FINANCIAL STABILITY FRAMEWORKRegional financial stability framework is based on international best practice and in the recent past, considerable efforts have been made to strengthen the legal and regulatory frameworks of the financial sector in the region.

� Technical Assistance: IMF and other international organizations provide technical assistance to improve the legal and regulatory framework and enforcement capabilities of the national authorities.

� Training: Supervisory staff from SSA countries have participated in training seminars offered by the IMF Institute in Washington as well as regional training centers.

� FSAPS: Joint IMF-World Bank Financial Sector Assessment Program, FSAPs have helped to identify weaknesses and proposed corrective measures, many of which have been implemented by the countries concerned.

� WAMZ: The West African Monetary Zone has a College of Supervisors that provides a platform for supervisory cooperation and strengthening of regional financial stability.

� Non bank FSI: Developing and compiling FSIs for non-banks, life and non-life insurance companies, credit unions and pension funds is however limited.

20

Bank Supervision and

Regulation

Other Multi Topic

Crisis Management

Bank Supervision and Regulation

Other Financial Stability

Monetary and Foreign Exchange

Operations

IMF Technical Assistance Field Delivery by Topic

Financial stability related TA represent the highest proportion of IMF MCM TA missions in FY2016.

Other Financial Stability

Monetary and Foreign

Exchange Operations

Monetary and Foreign

Exchange Policy

Asset / Liability

Management OperationsMonetary and Foreign Exchange

PolicyAsset / Liability Management

Other Multi Topic

Crisis Management

Source: IMF / MCM databases.

21

FINANCIAL STABILITY INDICATORS: STATE OF

PLAY - BANKING SECTOR

Banking risks Metric

SSA

Average1

West Africa

Average2

Credit risk NPL/TL 10.8 13.5

Sub Saharan Africa Banking Risk Analysis, 2016

Profitability risk ROA 2.2 2.4

Capital adequacy risk Rcap/RWA 18.8 11.9

Source: IMF Global Financial Soundness Indicators; http://data.imf.org/?sk=51B096FA-2CD2-40C2-8D09-0699CC1764DA

1. 21 countries reporting.

2. Chad, Ghana, Guinea, Nigeria reporting.

NPL, TL, ROA RCAP and RWA refer to Nonperforming loan, total loan, return on asset,

bank regulatory capital and risk weighted asset respectively.

22

FINANCIAL STABILITY INDICATORS: STATE OF

PLAY - BANKING SECTOR

6.00

8.00

10.00

12.00

14.00

16.00

Credit risk, 2010-16

0.00

2.00

4.00

6.00

8.00

10.00

12.00

14.00

16.00

18.00

20.00

SS

A A

vera

ge (

NP

L/T

L)

WA

Avera

ge (N

PL/T

L)

SS

A a

vera

ge (R

OA

)

WA

ave

rage (R

OA

)

SS

A a

ver

age (R

cap/R

WA

)

WA

ave

rage (R

cap/R

WA

)

Financial soundness, 2010-16 (average)

0.00

2.00

4.00

6.00

2010 2011 2012 2013 2014 2015 2016

SSA Average (NPL/TL)

WA Average (NPL/TL)

SS

A A

vera

ge (

NP

L/T

L)

WA

Avera

ge (N

PL/T

L)

SS

A a

vera

ge (R

OA

)

WA

ave

rage (R

OA

)

SS

A a

ver

age (R

cap/R

WA

)

WA

ave

rage (R

cap/R

WA

)

Credit risk SSAAverage (NPL/TL)

Profitability Capital Adequacyrisk

Data source: IMF Financial Soundness Indicators database

23

2.00

2.50

3.00

3.50

4.00

Profitability, 2010-16

15.00

20.00

25.00

Capital adequacy risk, 2010-16

FINANCIAL STABILITY INDICATORS: STATE

OF PLAY - BANKING SECTOR

0.00

0.50

1.00

1.50

2.00

2010 2011 2012 2013 2014 2015 2016

SSA average (ROA)

WA average (ROA)

0.00

5.00

10.00

2010 2011 2012 2013 2014 2015 2016

SSA average (Rcap/RWA)

WA average (Rcap/RWA)

Data source: IMF Financial Soundness Indicators database

24

FINANCIAL STABILITY INDICATORS: NON

BANK FINANCIAL INSTITUTIONS (NBFI)

� NBFIs in the region comprise insurance companies,

pension administration; primary mortgage companies,

rural and community banks and finance companies.

� They play important role in promoting financial

inclusion and risk sharing in the region. However, theirinclusion and risk sharing in the region. However, their

size is very small.

� They remain largely unregulated, though some

countries notably Nigeria and Ghana are now

improving regulatory oversight.

25

PART IV

FINANCIAL STABILITY CHALLENGES IN THE

REGION: POLICY FOCUSREGION: POLICY FOCUS

26

KEY FINANCIAL STABILITY MATTERS FOR

POLICY FOCUS

� Development and enforcement of micro prudential

regulations

� Establishment of robust crisis management framework

� Improvement of cross border supervisory oversight

� Improvement of efforts to build FSIs for non-banks,Improvement of efforts to build FSIs for non-banks,

insurance, credit unions and securities firms that operate

in the regional economy.

� Adoption of IFRS methodology in financial reporting

� Undertake risked based supervision

� Mitigate macroeconomic risks from fiscal dominance.

27

THANK YOU!!!THANK YOU!!!

28

REFERENCES

� Africa Regional Economic Outlook (2017) Washington, D.C. : International Monetary Fund http://www.imf.org/en/Publications/REO/SSA/Issues/2017/05/03/sreo0517

� Global Financial Stability Report (2017) Washington, D.C. : International Monetary Fund

� http://www.imf.org/en/Publications/GFSR/Issues/2017/03/30/global-financial-stability-report-april-2017

� Schinasi, G., (2004), “Defining Financial Stability”, IMF Working Paper No. WP/04/187, October http://www.imf.org/en/Publications/WP/Issues/2016/12/31/Defining-Financial-Stability-17740

------------- (2005) Safeguarding Financial Stability Theory and Practice Washington, D.C. : � ------------- (2005) Safeguarding Financial Stability Theory and Practice Washington, D.C. : International Monetary Fund https://www.imf.org/External/Pubs/NFT/2005/SFS/eng/sfs.pdf

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