Finance

African Banks Favor Govt Debt Over Business Loans (EIB)

African Banks Favor Govt Debt Over Business Loans (EIB)
Monday, 11 November 2024 15:38

Under pressure to meet African governments' funding needs, banks are increasingly turning to public debt. This trend, known as the "crowding-out effect," limits credit access for the private sector and raises concerns about growing risks for the banking system.

African banks have increasingly prioritized government debt over loans to businesses over the past decade, according to the "Finance in Africa" report by the European Investment Bank (EIB), published on November 7. From 2010 to 2023, African banks' holdings in domestic sovereign debt grew significantly, rising from 10.3% to 17.5% of their portfolios. This trend reveals a banking system more exposed to government debt risks and limits funds available for private-sector lending. As a result, private sector loans have dropped, going from 42% of bank lending in 2010 to 38% in 2023, despite rising demand for business funding across Africa.

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Crowding Out Effect Grows in East and West Africa

This "crowding out" effect—where banks favor government debt over private sector loans—has reached record levels in 2023, especially in East, Southern, and West Africa. Banks increasingly channel funds into sovereign debt, which is often seen as lower-risk, putting public and private sectors in direct competition for bank financing. Private investments lose out in this setup, which harms the potential for economic growth and innovation.

In Central Africa, government debt holdings surged from 2.6% of bank assets in 2010 to 24% today. West and Southern Africa saw similar increases of 7% to 9%. Private credit has decreased most sharply in Southern Africa, where it fell by 12.1% of assets, while Central, West, and North Africa recorded declines of 2% to 3%.

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Banks’ preference for government assets stems from financial realities. Government bonds, while low-risk, offer high returns that meet banks’ profit goals. For instance, Ghana raised funds with bonds yielding 19%, while Kenya offered over 12%—compared to the 5% to 8% banks earn on loans to small and medium enterprises (SMEs). This high return on government debt makes it attractive to banks, drawing their focus away from the private sector.

SMEs Face a $194 Billion Funding Shortfall

The private sector is bearing the brunt of this shift. The annual funding gap for SMEs in sub-Saharan Africa is estimated at $194 billion. SMEs, making up 80% of businesses and providing 60% of jobs, are among the most affected by the reduced access to credit. According to the EIB report, 57% of SMEs cite limited funding as their top obstacle to growth, while 45% struggle to access working capital loans.

This funding gap hits agriculture especially hard, as many SMEs in this key sector face reduced access to bank credit.

Banks are also cautious about lending to businesses due to credit risk concerns. In 2022, about 27% of SME loans were classified as non-performing, a rate that, although slightly improved, remains worrisome. This high level of bad loans adds to banks’ reluctance to lend to the private sector.

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