The sudden and severe crisis brought on by the COVID-19 pandemic has dealt a cruel blow to African countries, threatening the lives and livelihoods of millions and causing a rapid economic contraction. This has had knock-on effects for industries across the continent, including banking. Now, as companies and leaders start to look toward recovery, new analysis from McKinsey provides some optimism.
Government data and financials released by banks in four major economies on the continent (Kenya, Morocco, Nigeria, and South Africa) show that, despite a resurgence of the virus, the pandemic’s impact on African banks in 2020 was less severe than initially expected. And given the important role that banks play in the broader economy and society in Africa, this in turn could signal a faster recovery for the continent.
Unlike many past economic shocks, the COVID-19 crisis is not limited to banking; it is a humanitarian crisis and a crisis of the real economy, with banks being affected by cascading credit losses and uncertain demand. In developed markets, we estimate that the average return on equity (ROE) for banks could dip below 1.5 percent in 2021 before recovering to precrisis levels of around 9 percent by 2024—this equates to five years of returns effectively lost for the banking sector. The impact on African banks is likely to be less severe. While the average ROE for African banks fell by 50 percent—to 7 percent in 2020, from 14 percent in 2019—we expect this to rebound to near precrisis levels within the next three years if economic recovery on the continent follows the scenario that a majority of global executives believe will most likely unfold.
Drawing on McKinsey’s global research, as well as from real-world examples from across Africa’s banking sector, this article builds on our analysis in June 2020 to provide insights and analysis to help shape and accelerate this recovery. We believe that a focus on three imperatives—centered around productivity, risk management, and scaling up technology—could help banks build core strength and resilience in the new reality.
A rapid recovery has helped cushion the blow to banking
A year into the COVID-19 crisis, we now have a better picture of the pandemic’s economic impact on the continent. McKinsey has developed nine global macroeconomic scenarios, which reflect a range of virus-containment, public-health, and economic-policy responses. The early consensus of global executives had been that the two scenarios most likely to prevail would be A1 (a recurrence of the virus and muted world recovery) and A3 (a contained virus and global growth returning in 2021).1 It is now evident that the actual impact of the pandemic in 2020 for most major African economies was somewhere in between these two trajectories.2 South Africa was an exception; existing weaknesses in that economy, coupled with a strict nationwide lockdown, led to a fall in GDP in line with our A1 scenario. This relative clarity has allowed us to refine our analysis and outlook for African banking in several key respects.
Real GDP across the four major markets we assessed declined by 6 percent in 2020—roughly halfway between estimates of 8 percent (A1) and 3 percent (A3).3 While the virus was resurgent, its impact on banking revenues after risk costs was less severe than expected. Postrisk revenues declined by 18 percent in 2020, compared with 21 percent estimated in the A1 scenario on the back of a combination of factors, including government fiscal interventions and the easing of lockdowns.4 In Kenya and Morocco, for example, the relaxation of lockdowns and curfews in mid-2020 slowed the expected economic decline, despite challenges in the agricultural sector, including locust swarms in Kenya and drought in Morocco. In Nigeria, the partial recovery of oil prices and the lifting of restrictions also led to a gentler decline in GDP of –3.1 percent, between the A1 and A3 estimates of –5.9 and –1.8 percent, respectively.
Government support programs—including moratoriums on repayments and credit infusions such as loan-guarantee schemes—combined with low interest rates and a decline in nondiscretionary spending played a key role here, helping to increase affordability and to support loan and deposit volume growth.5 The sharp fall in interest rates together with lower transaction volumes and fee waivers led to a decline in client-driven interest and fee revenues.6 Overall, lower economic activity and higher unemployment have increased banks’ risk on loans, leading to higher loan-loss provisioning.
African banks could return to precrisis levels of postrisk revenues by 2022
Despite seeing stronger revenues after risk costs, African banks are facing a challenging path to recovery. Increasing risk, lower-for-longer interest rates owing to all-time-high government debt levels, and subdued demand are likely to be the major headwinds facing banks as they start to look beyond the crisis.
The speed of recovery will vary depending on the scenario that unfolds. Under the A3 scenario, which assumes a partially effective government policy response and an optimized healthcare response that effectively controls the virus’s health impact, revenues after risk costs could rebound to precrisis levels by as early as 2022. However, a slower recovery—as posited by the A1 scenario, which assumes partially effective economic interventions and an effective public-health response with localized recurrences of the virus similar to what we have already seen across the continent—may not see revenues recovering until 2023.
In plotting their path to recovery, banks in each country will face their own set of challenges. Future growth in revenues after risk costs are likely to differ significantly by country and will depend largely on volume growth and on the normalization of provisioning levels. Depending on which scenario prevails, growth in revenue after risk costs could vary between 9 and 21 percent compound annual growth rate over the next four years, off a low base in 2020. Under the A1 trajectory, a gradual normalization of risk costs and volume growth could help drive recovery in South Africa and Kenya in 2021, while in Nigeria and Morocco a further increase in risk provisioning could continue to drive down postrisk revenues.
McKinsey’s analysis suggests that, for most banks, the level of provisioning undertaken in 2020 is likely to influence the shape and pace of recovery of revenues after risk costs in each country. Historically, falling GDP can be correlated with a rise in nonperforming loans (NPLs), and we therefore expect NPLs to increase in all countries in 2021—yet not all banks are equally prepared. Third-quarter 2020 results for Nigeria, Kenya, and Morocco and half-year results for South Africa show that the level of provisioning varies significantly by bank and country.7 In South Africa and Kenya, banks have already increased loan-loss provisions by more than 200 percent since 2019 to cover for potential bad debts. As a result, they may see improved results in 2021 (that is, return to normal provisioning levels). However, if the historical correlation between declining GDP and rising NPLs holds, then it is likely that banks in Morocco and Nigeria may need to further increase provisioning levels in 2021, as the current loan-loss provisions in those countries may not adequately cover the expected increase in bad debts, especially in the A1 scenario.
The gap in expected NPL increase is much wider between the two scenarios in Nigeria than in any of the other three countries. The A3 scenario assumes that the 2016–17 crisis, precipitated by falling oil prices, led to a major cleanup of banks’ books and strengthened risk-management processes, thereby sufficiently preparing banks for future crises. However, under an A1 scenario, NPLs in Nigeria could rise steeply if forbearance measures are rolled back and stress in the oil and gas sector ramps up.
Three imperatives to power the recovery and growth of African banks
Given the still uncertain trajectory of the pandemic, African banks cannot afford to leave their recovery to chance. If risks are not mitigated, our estimates suggest that the African banking market could lose more than $48 billion in cumulative postrisk revenue by 2024, leading to multiple years of returns below the cost of capital.8
While many African banks have already acted boldly to manage the economic fallout of the pandemic and to protect the lives and livelihoods of their staff and customers, now is the time to turn their focus toward growth and resilience postpandemic. Lessons from the 2008 economic crisis suggest that, in times of crisis, speed is everything. Banks that reacted quickly and decisively during that crisis fared much better in the long term.9
In our previous article, we provided detailed ideas and analysis for banks’ response strategies.10 We revisit these here, outlining three imperatives and drawing particular attention to the opportunity for banks to structurally review their cost base and operating models. These adjustments remain fully within their control.
Source: McKinsey
