Significant constraints on banks' capacity and willingness to absorb potential increases in government financing needs in the event of a shock are intensifying government liquidity risks in Middle Eastern and African markets, according to a leading rating agency.
In a recent report assessing regional governments' capacity to fund their borrowing needs from domestic banks, Moody’s said Angola (rated B3 stable), Bahrain (B2 stable), Ghana (B3 stable), Kenya (B2 stable) and Lebanon (Caa1 stable) are particularly vulnerable to shocks.
"When governments' access to external markets is constrained and more costly, their capacity to finance borrowing needs from domestic banks is a key driver of their liquidity risk," said Lucie Villa, Senior Credit Officer at Moody’s and author of the report.
"In Angola, Bahrain, Ghana, Kenya and Lebanon, governments combine at least two of the following constraints: government borrowing needs are large relative to the size of their banking systems, banks' exposures to government debt are already high, deposit inflows are low relative to fiscal deficits."
The capacity of a banking system to absorb governments' borrowing needs is driven by the system's size, the scale of the government's gross borrowing requirement and the size and consistency of banks' own funding that can be invested in government securities.
Banks' willingness to provide finance is influenced by a range of qualitative factors. These can include policy credibility, or the risk-reward trade-off in lending to the private sector versus the government.
In Egypt, Nigeria and the Democratic Republic of the Congo, Moody's has identified pockets of vulnerabilities but expects governments to rely on domestic banks to cover their financing needs.
“Some constraints are apparent either because the banking system is very small or already largely invested in government securities, but these factors are mitigated by limited government financing needs or the system's high deposit growth,” the report noted.
There is scope for increased domestic bank financing of governments' needs in Mauritius and South Africa. Both countries have more developed financial sectors than the other countries covered by this report. Aside from substantial banking systems, non-bank financial institutions including insurance and pension funds provide stable and long-term funding to the government.
