News in Charts: Probability of a banking crisis rising in Africa

Following the COVID-19 pandemic, concerns over the likelihood of financial crises breaking out across emerging markets are returning once more. Fathom’s Financial Vulnerability Indicator (FVI), a comprehensive model assessing the likelihood of banking, currency, and sovereign crises occurring, is currently flashing red in both South Asia and Sub-Saharan Africa. This piece outlines a brief history of African banking crises and outlines the forces driving the current uptick in banking risk.

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Laeven and Valencia (2020)[1] have catalogued the incidence of three types of financial crises (currency, sovereign and banking) for 165 countries dating back to 1970. According to their definitions, there have been 167 African financial crises over that period and the continent has experienced more of each type of crisis than any other region. While South America is more prone to crises on a per-country basis, African countries have, on average, experienced three crises each year, with Mauritius the continent’s only country recorded as remaining crisis-free.

Fortunately, after suffering frequent crises through the 1980s and early 1990s, African economies have fared much better in recent years. Indeed, while there were 5.0 crises annually on average between 1970 and 1994, this frequency fell to 1.9 crises per year subsequently. Africa has also experienced a compositional shift, with all but five of the 37 crises since 1996 manifesting in the form of a currency crisis. Indeed, the continent’s banking system appeared to weather both the Asian Financial Crisis of the late 1990s and the Global Financial Crisis.

However, the odds of a banking crisis next year, as measured by the FVI, are high. Although rising crisis probabilities are not purely an African story, vulnerability does look to be of greater concern in the continent than in most other places. Indeed, the difference between the FVI-implied probability of crisis for the median country in Sub-Saharan Africa and the median country globally is around two percentage points in 2022 Q2.

Higher vulnerability in Africa is primarily driven by two factors. The first of these is having a wider current account deficit which is also a harbinger of vulnerability to a currency crisis. (Exchange rate devaluations typically make banks’ operations more challenging both directly and indirectly through their impact on inflation.) Indeed, it is worth noting that one-in-four banking crises occur within 1 year of a currency crisis.

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The second is a slower economic recovery. While many advanced economies are expected to regain pre-crisis levels of per-capita income before the end of this year, it looks likely that this feat will take far longer in Africa. Weaker economic recoveries in Africa reflect the limited access to COVID vaccines and African governments having less room to deploy fiscal support during the pandemic.

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One consolation, perhaps, is that the economic scarring from banking crises has typically been smaller in Africa when compared to other countries. Indeed, using a simple event study approach Fathom finds that, following a banking crisis, the median hit to output reaches 4% within five years. Repeating a similar exercise for the rest of the world produces a median hit of more than 8%, close to earlier estimates from the IMF.

There are two reasons why this should not be surprising. First, African economies are typically less reliant on their banking systems, which are normally less developed than in other regions. Second, previous Fathom research has demonstrated empirically that more recent banking crises have resulted in greater hits to output, with a large proportion of this attributable to the spillovers to productivity from interest rates being held too low for too long. Since African banking crises have been rare in the 21st century, and since developing economies are rarely able to maintain low rates for any significant duration, these second-round effects have been limited.

IN HOUSE

Access to the regional aggregates from Fathom’s Financial Vulnerability Indicator (FVI) is currently available to Datastream users. The available data can be found via the Navigator under Economics\International Forecasts & Surveys\Fathom Financial Vulnerability Indicator (FVI). For more information on the series, including access to the underlying country-level dataset, please contact enquiries@fathom-consulting.com.

[1] Laeven, L. and Valencia, F. (2020), ‘Systemic Banking Crises Database: A Timely Update in COVID-19 times’, CPER Discussion Paper Series.

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