A cautionary tale of banking in Tanzania and the dangers of inadequate KYC
It’s never good news when a central bank is forced to issue a fine on a major bank in a country. But when the fine is on not one, but five major commercial banks, all for the same compliance issue, that hints at deeper flaws across the entire banking sector.
This particular story played out in September 2019 in Tanzania, the Texas-sized nation in East Africa. The Bank of Tanzania (BOT), the country’s main monetary authority, issued fines of over $800,000 on these five banks – I&M Bank ($284,000), Equity Bank ($252,000), UBL Bank $141,000), Habib African Bank ($76,000), and the African Banking Corporation ($63,000).
All five were penalized for “for failure to conduct proper customer due diligence” and for further non-compliance related to reporting suspicious transactions to the government’s Financial Intelligence Unit.
Unfortunately, the Tanzanian banking system is no stranger to such stories of banking rule violations and punitive actions by the BOT. Immediately before these sanctions, the BOT had fined two major lenders – The Diamond Trust Bank and National Bank of Commerce – for breaching data rules.
In the last 3-4 years, BOT has been forced to take stern action on multiple occasions against financial institutions in the country. The reasons for the current troubles of the Tanzanian banking sector can be easily gleaned from a quick look at its recent history.
Banking in Tanzania – a snapshot
Up until 1991, the Tanzanian banking industry was firmly in the control of a handful of nationalized banks. But the advent of globalization and liberal reforms in the country’s financial sector in the 1990s, the landscape undertook a radical transformation.
There are now 41 commercial banks in the country’s banking ecosystem, with total assets worth $14 billion. Many foreign banks like Barclays and Standard Chartered also have a foothold in the country. But despite the large and diverse ecosystem, banking in Tanzania works in practice like an oligopoly – the top five banks together hold more than 50% of the assets.
Two of these, CRDB and NMB – both former state-owned banks, together account for 40% of all deposits in the country and 35% of the total assets. The other major banks include Standard Chartered, Stanbic, Exim, Barclays, Diamond Trust Bank, and NBC – the latter duo was fined in 2019 as mentioned above.
The Tanzanian financial services market shares many of the features found across other developing nations in Africa. The banking penetration rate is quite low at 39% (19% if you exclude mobile banking), leaving massive scope for expansion. And in the past decade, this unbridled expansion has resulted in severe faultlines.
The wider context of banking in Africa
Across the world, the banking industry has been in the doldrums since the 2008-09 financial crisis. Only a few regional markets have bucked this trend in the past decade, and Africa is one of the biggest and brightest spots for bankers.
According to McKinsey, it is the second-fastest-growing banking market in the world (both retail and wholesale combined). While the global growth rate of the industry is somewhere around 3% (2016) with return on equity stagnant between 8-10%, African banks are growing fast at double-digit rates (11% in 2017), with profits twice the global average.
But there are challenges aplenty across the continent for its banks, with low-income levels, over-reliance on cash, and most importantly, high lending risk due to poor credit reporting coverage. The experience in Tanzania over the last 8-9 years highlights how rapid growth can lead to instability further down the road when these fundamental issues are left unaddressed.
Crisis in the Tanzanian banking system?
In December 2018, an IMF report on the state of banking in Tanzania raised significant red flags. According to the international organization, more than half the banks in the Tanzanian market were highly vulnerable to market shocks and carried a high risk of future insolvency.
Undercapitalization was the major threat highlighted by the IMF, with 22 Tanzanian banks carrying 32% of total industry assets at risk of it in the event of adverse market conditions. This was not news to the BOT, which had been forced to revoke the licenses of 5 banks in January 2018 due to critical undercapitalization.
The roots of this malaise lay in the early years of this decade when the Tanzanian economy, and the domestic real estate market, in particular, enjoyed a bull run. Profitability was high, attracting banks to provide a huge number of loans to developers and other businesses in this segment.
When the national economy went into a slump after 2015, the entire banking sector received a systemic shock due to overexposure to the real estate market. Aggressive lending without adequate KYC checks of bad actors in the market played a key part in this slump. Virtually all banks were affected, including the big two – CRDB and NMB.
Across the industry, the Non-Performing Loan ratio (NLP) climbed into double digits, peaking at 11.5% in 2017. The worst-hit banks had an NLP ratio of over 55% that year. Many, like Barclays and StanBic, had to resort to aggressive measures like write-offs to bring down the NLP ratio, suffering fall in profits along the way.
The aftermath – cost cutting & increased regulations
The direct result of the crisis was a tightening of regulations by the central bank. The BOT started taking an aggressive approach, introducing stricter measures – raising total capital ratios, including additional capital conservation buffers, to name a few.
Licenses of the worst offenders were revoked – the number of banks forced to close since 2017 is currently at 9. Other underperforming banks were forced to merge, or their management was taken over by the BOT in some instances.
While things have improved in the last two years, with many banks posting healthy profits in 2018, significant concerns remain. Cost-cutting, lay-offs, and other measures can improve the balance sheets, but as long as customer due diligence remains static, the vulnerabilities will continue to haunt the system.
According to the credit rating agency Moody’s, asset quality continues to be a major concern for Tanzanian banks, though things have improved since the horror days of 2016-17. But as the recent fines on major banks by the BOT in 2019 indicates, the problem of KYC due diligence persists in the system.
The future – compliance & digital innovation?
Tanzania still has a tremendous scope for growth. With the advent of mobile technologies, the percentage of the population with access to some form of banking/financial services has jumped from 9% in 2009 to 65% in 2017. But they still need access to core banking services and other credit facilities.
Given the poor track record (and penetration) of credit rating and reporting services in the country, the drastic overhaul may be necessary for the short to medium term. Digital platforms and innovative KYC measures that leverage big data could have a massive role to play.
Nearly 23 million Tanzanians have regular access to the internet, indicating an overall internet penetration of 45%. With an annual growth rate of 16%, this number will surely rise in the coming years, providing new opportunities for the introduction of cloud-based technologies, and data-driven compliance measures.
But at the moment, it is all about stabilization and better compliance. As the BOT continues to increase its regulatory oversight, banks will have to toe the line. Given the still-fragile state of the banking industry in the country, this is a welcome state of affairs for now.