Perspectives and Challenges of cross border activities in Africa

1. Perspectives and Challenges of cross border activities in Africa Norman Mataruka Director, Bank Supervision Division Reserve Bank of Zimbabwe

2. OUTLINE • Overview of Cross Border Banks in Africa • Systemically Important Banking Institutions in Africa • Supervision Challenges Posed By Banking Conglomerates • Measures to enhance Supervision of Cross Border Banks • Internal Management of Financial Groups • International Initiatives in Anti-money Laundering, Combating Terrorism Financing and Illicit Financial Flows • International Capital Inflows and Financial Innovation • Conclusion & Way Forward

3. BACKGROUND / INTRODUCTION • Cross-border banking has become an increasingly important feature of African financial landscape and this trend has accelerated in the past decade. • According to Beck et al* there are 104 cross-border banks with at least one branch or subsidiary outside their home country which are active in Africa, one third of which are cross-border banks of non-African origin. • The rapid expansion of cross border banks in recent years, has resulted in the major banks having a systemic presence in around 36 countries across Africa. • The top 10 banks in Africa, which are also systemically important banks with cross border operations are shown in the next slide. (* Beck et al, 2014, Making Cross-Border Banking Work in Africa, 2014)

4. TOP 10 CROSS BORDER BANKS IN AFRICA

5. FACTORS GIVING RISE TO CROSS BORDER BANKS IN AFRICA • The rise in cross border banks, also known as “Pan-African Banks” is attributed to the following reasons: • domestic market saturation - resulting in banks looking beyond borders for potential growth opportunities; • regulatory changes in the country where banks are domiciled which has influenced ambitions to expand beyond borders, e.g. consolidations in Nigeria; • financial liberalisation and deregulation, and • the need to “defend‟ bank-client relationship through following home-country clients into host countries.

6. BENEFITS OF CROSS BORDER BANKING Cross-border banking presents a number of opportunities which include the following:- • promote product innovation, efficiency and competition; • promote financial deepening and financial inclusion & stability; • facilitate transfer of improved skills and technology to domestic banks; • facilitate access to international money and capital markets; and • promote economic growth and development.

7. CHALLENGES OF CROSS BORDER BANKING Nonetheless, cross border banking and the associated financial interconnectedness in Africa has brought about a number of challenges as follows: • challenges with supervision of financial conglomerates; • money laundering issues; • financing of terrorism, and • surge in illicit financial flows.

8. SUPERVISION CHALLENGES POSED BY BANKING CONGLOMERATES

9. CHALLENGES OF CROSS BORDER BANKING • Notwithstanding, the above benefits, the rapid expansion of cross border banks in Africa creates supervisory challenges and burdens. • Challenges arise mainly from differences in financial infrastructure development, lack of supervisory capacity and weak prudential regulation and enforcement. • Further, financial interconnectedness give rise to contagion risks from fragile jurisdictions.

10. Complex and Opaque Structures… • The major cross border banks generally have complex and opaque holding structures which hinder effective supervision. • Complex corporate structures make it difficult for supervisors to have a clear consolidated view of financial groups. • Some of the conglomerates with sophisticated structures include: Bank of Africa Group, Ecobank, Standard Bank Group.

12. Common challenges for supervisors • Capital adequacy requirements in different sectors and jurisdictions: • Banking – largely harmonised. • Securities – lesser degree of harmonisation • Insurance - Foundations under construction • Double gearing through intra-group holding of capital • Regulatory arbitrage.

13. Common Challenges for Supervisors • Identification of a financial conglomerate, parallel owned banks. • Rights of access to prudential information. • Intra-group exposures. • Contagion risk via common branding, distribution & participation in group operations. • Systemic risk due to sheer size.

14. Supervisory Challenges… • Opaque legal and managerial structures. • Corporate governance challenges. • Quality of management. • Risk management challenges, group-wide risk management • Maintaining multinational and inter-agency coordination and information sharing. • Cross-border crisis management and resolution issues.

15. Supervisory Challenges… • Lack of adequate regulatory coordination in Africa - weak coordination and information sharing among supervisors. • No control over unregulated entities - shell banks and booking offices. • Accounting and taxation differences across jurisdictions.

17. Different levels of financial sector regulation and supervision standards… • African countries are at different development levels with regards to their financial sector regulation and supervision standards and operate at varying stages of implementation of international standards. • Notably, while a number of countries have implemented Basel III standards, only a few have fully implemented Basel II while some countries are still on Basel 1 as shown on the next slide…

19. Internal Management of Financial Groups

20. Organisation of Financial Groups With Cross Border Operations • Banking groups vary widely in terms of structure, range of activities and complexity. • The complexity in structure and size of many conglomerates make them difficult to supervise.

21. Organisation of Financial Groups With Cross Border Operations • There are two key issues of concern to supervisors in relation to financial group structures: • the organisation of business activities along business lines versus along the corporate legal structure; • the organisation of corporate control functions on a global or centralised basis versus on a local basis.

22. Organisation of Financial Groups With Cross Border Operations • There is need for supervisors to understand the complexities of transactions and arrangements that are extensively used to transfer risk and income intra-group between affiliates in the "global" structure. • Information exchange among all supervisors is useful in order for an overall view to be taken, because an individual supervisor may often see only part of the management matrix.

23. Control of Operations of Financial Groups Business Activities aligned with Legal Entities & Global Control functions… • business activities are aligned with the legal entities but corporate control functions are organised at the head office or in a separate dedicated legal entity. • Management and boards of legal entities retain a substantial role, in some cases related directly to some business operations or specialised activities that are prevalent in a particular entity. • Alternatively, the legal entities may be broadly responsible for their own business strategies and certain corporate control functions, but may be subjected to very close monitoring and oversight from their parent companies.

24. Organisation of Financial Groups Supervisory Concerns… • The various supervisors need to assess the effectiveness of controls which may be located in a different country. • The primary/lead supervisor needs to assess the adequacy of controls within the subsidiaries. • All supervisors need to understand the division of management responsibilities centrally and in subsidiaries and subsequently divide responsibilities amongst supervisors. • Lead supervisor needs to understand how the local business strategies consolidate into a meaningful business strategy for the group as a whole.

25. Organisation of Financial Groups Business Activities aligned with Legal Entities & Local Control Functions • Local management operates rather autonomously from the parent entity. • The corporate control functions are aligned with the local legal entity structure, with few functions exercised globally. .

26. Organisation of Financial Groups Supervisory concerns… • All supervisors need to understand the influence of the dominant or parent entity and the effectiveness of firewalls, particularly when there is an unsupervised holding company. • The primary supervisor needs to have the ability to assess the effectiveness of local controls and the reliability of risk management information. • Communication between supervisors will be important to assess the extent of de facto local and central controls. For all supervisors there is an enhanced need to understand group-wide risk exposures

27. Organisation of Financial Groups Global Business Lines & Local Control Functions • The group is organised along business lines which cut across the legal entities but its corporate control functions are organised locally, within legal entities. • This is an anomalous situation as the corporate controls located in legal entities are less integrated than the business line and therefore cannot fully monitor and control the risks in those business activities. • This type of a group may carry inordinate risk that the controls that are intended to ensure the proper conduct of business would fail.

28. Organisation of Financial Groups Supervisory concerns… • Such groups may not be easy to supervise and can involve a high degree of subjective judgement by supervisors. • All supervisors should be alert to and inform the primary supervisor if concerns within supervised legal entities arise and assist in any ensuing analysis of the group. • There is need for all supervisors to exchange information regularly in order to facilitate the assessment of the control environment.

29. Organisation of Financial Groups • For all group structures, information sharing between supervisors is essential in enhancing supervisors’ understanding of the operations of the conglomerate and in assisting supervisors in determining the characteristics of the conglomerate. • A pre-requisite for assessing information sharing needs amongst supervisors is a good understanding of the organisational structures and business activities of the financial conglomerate.

30. Organisation of Financial Groups • Supervisors need to be alert to highly autonomous local managers, weak global controls or any other evidence that theoretical and actual management structures are divergent. Other warning indicators might include separate audit arrangements and different accounting year ends among the conglomerate’s legal entities. • The key to ensuring that overall group management practice conforms to the understandings of individual supervisors is effective communication among supervisors and an understanding of each other’s supervisory techniques.

31. International Initiatives in Anti-money Laundering, Combating Terrorism Financing and Illicit Financial Flows

32. Money Laundering, Terrorism Financing & Illicit Financial Flows • Over the last few decades, financial markets have increasingly become globally integratedand interwoven. • As part of regional or global integration, barriers are eliminated for citizens and corporations to operate or offer cross-border services. • Global integration has brought new challenges relating to Money Laundering, Financing of Terrorism and Illicit Financial Flows. • Proceeds of these economic malpractices are largely channelled via cross border banks.

33. ILLICIT FINANCIAL FLOWS Illicit financial flows are a world wide phenomenon and in Africa, illicit financial flows involve the following practices: • money laundering, • tax evasion, • trade mispricing. • transnational corruption/bribery, and • bulk cash movements which results in massive losses in government revenue.

34. ILLICIT FINANCIAL FLOWS • According to the December 2015 report from Global Financial Integrity entitled “Illicit Financial Flows from Developing Countries: 2004-2013,” developing and emerging economies collectively lost an estimated US$7.8 trillion in illicit financial flows from 2004 through 2013. • The illicit outflows have increased at an average rate of 6.5 percent per year—nearly twice as fast as global GDP.

35. ROOTS OF ILLICIT FINANCIAL FLOWS Generally, Illicit financial flows are rooted in four (4) central issues that many African Governments face, namely: • poor resource governance models; • weak tax administration coupled with multinational tax-avoidance schemes; • tax havens, which are beyond the influence of African governments; and • the lack of resources for addressing financial crimes and money laundering.

36. The following phenomenon has been observed in many jurisdictions across Africa: • Cash couriering where physical cash is moved across borders for banking in foreign jurisdictions and tax havens e.g. British Virgin Islands, Panama, Isle of Man. • Smuggling of goods, particularly precious stones and fuel, across borders, for sale and repatriation of proceedsvia financial systems. • Over-invoicing of goods imported, as a means to channel funds to other jurisdictions.

37. Under-declaration of imported goods to Customs Authorities in order to avoid import tax. • Under-invoicing of exports for the purpose of externalizing export revenue. • Misrepresentation of business proceeds as personal income or free funds for the purpose of avoiding company tax and subsequent remittance of the relative proceeds to other jurisdictions.

38. FACTORS DRIVING ILLICIT FINANCIAL FLOWS Across African countries, illicit financial flows have been driven by the following factors: • corruption; • dysfunctional regulation; • weak enforcement of rules; • tax evasion and avoidance; • smuggling; • lack of transparency and accountability in the collection and management of natural resource revenues; and • rent seeking behaviour.

39. IMPACT OF ILLICIT FINANCIAL FLOWS • Illicit financial flows constrain economic growth and development through reduction in domestic expenditure and investment, both public and private. • Illicit financial flows which involve financial crimes like money laundering, corruption and tax evasion which are detrimental to economic growth. • Proceeds of corruption or criminal activities will generally be spent on consumption of items such as luxury vehicles, or invested in real estate, art, or precious metals (World Bank, 2006). • Further, proceeds are also spent on financing acts of terrorism. • Illicit financial flows threaten financial stability.

40. FIGHTING ILLICIT FINANCIAL FLOWS • Addressing financial crime is challenging, particularly when it involves multiple jurisdictions spread across different continents • In view of the surge in illicit flows, there is need for a collaborated approach among African countries to fight money laundering, terrorism financing and illicit financial flows. • Governments ought to initiate reforms that promote ethics in banking, business and trade. Reforms should focus on good corporate governance and enhanced supervisory scope to include business models, behaviour and culture. • All countries are urged to adhere to the guidelines under the Financial Action Task Force (FAFT).

41. INTERNATIONAL CAPITAL INFLOWS AND FINANCIAL INNOVATION: WHAT STEPS CAN CENTRAL BANKS TAKE?

42. International Capital flows & Financial Innovation • International capital flows have increased dramatically over time, despite a temporary contraction during the global crisis. • Gross cross-border capital flows rose from about 5% of world GDP in the mid-1990s to about 20% in 2007, or about three times faster than world trade flows • In the last decade, Africa has seen large-scale capital inflows through a surge in short-term portfolio and cross-border bank flows. • The scale of international capital flows is immense as total private non-resident capital flows to emerging markets in 2014 have been estimated at USD1.1 trillion.

43. International Capital Flows & Financial Innovation • The increase in cross-border international capital inflows in Africa is directly linked to capital account openness and this has brought a number of benefits to economies including: • reduces cost of capital as capital account liberalisation promotes a more efficient global allocation of capital; • facilitates more efficient savings mobilization for productive investment; • enables African countries to cushion fluctuations in national incomes and smooth out consumption level; • facilitates the transfer of technological and managerial know-how while encouraging competition and financial innovation; and • increases liquidity in the recipient country.

44. International Capital Flows & Financial Innovation • While capital inflows can stimulate higher growth, they also bring macroeconomic challenges such as: • high inflation; • real exchange rate appreciation; • risk of sudden stops or abrupt reversals of capital flows which may lead to growth collapse and major exchange rate volatility or even crises; • facilitates the emergence of credit and asset price boom-and bust cycles; • large capital inflows may challenge the absorptive capacity of host countries in the short run by making them vulnerable to external shocks; and • heightens the risks of economic overheating.

45. WHAT CENTRAL BANKS CAN DO ABOUT INTERNATIONAL CAPITAL FLOWS

46. Economic and prudential policies • Given the opportunistic and volatile nature of international capital flows, regulatory authorities should formulate timely and appropriate economic and prudential policies including: • strengthening prudential and regulatory framework in line with international best practices, whereby the key focus should be enhancing risk management systems as well as promoting stronger governance within financial institutions; • identifying and assessing the risk of contagion for the domestic financial systems arising from regional and global financial markets; • identifying and measuring contagion risk between various economic sectors and the financial sector with a view to facilitating the assessment of the impact of stresses from the economy on the financial sector and vice versa;

47. Economic and prudential policies… • enhance supervisory capacity for effective supervision of new products and services (e.g. derivatives); • strengthen financial and product market regulation; strengthen anti-money laundering systems; • put in place macroeconomic policy adjustments including assessing foreign exchange reserve adequacy and need to realign the exchange rate with fundamentals such as the country’s position in the business cycle and the risks to local banks and corporates’ balance sheets; • put in place capital flow management measures to manage changes in capital flows; and • implement structural policy reforms to reduce the associated vulnerabilities mainly through a better composition of inflows, with more foreign direct investment and less debt.

48. RECOMMENDATIONS FOR EFFECTIVE SUPERVISION OF CROSS BORDER BANKS • There is need for greater commitment and adherence to common rules of the game, as embodied internationally accepted standards and practices. • Harmonise regulatory and supervisory norms as well as accounting standards through convergence to internationally accepted standards and practices including Basel Core Principles for Effective Bank Supervision, and International Financial Reporting Standards (IFRS); consolidated supervision, risk-based supervision, Basel Capital Standards, sound risk management and good corporate governance practises.

49. RECOMMENDATIONS FOR EFFECTIVE SUPERVISION OF CROSS BORDER BANKS • To facilitate effective information sharing and building trust among supervisors in home and host authorities, the following needs to be enforced:- • expand MoUs to include crisis management and bank resolution issues; • extend cooperation to cover resolution of cross border banks, establish crisis management groups for systemically important banks and require them to develop recovery and resolution plans.

50. RECOMMENDATIONS FOR EFFECTIVE SUPERVISION OF CROSS BORDER BANKS • broaden range of joint examinations to include all major cross border banks; • conduct effective supervisory colleges for all cross border banks; • conduct macro and micro stress tests techniques to ensure that national financial systems are sound to reduce cross-border contagion; • share national financial stability findings; • ensure adequate legal framework, featuring special resolution regimes, are in place to resolve failing banks and bank holdings; and • Build and retain capacity in all areas of bank supervision.