Can Angola's banks cope with oil windfall?

From this month, (October), new laws in Angola involving payments by oil companies will provide a major windfall for the country's banks, given the size of the oil sector. Questions remain whether the banks will have the capacity to handle such large transactions or if the increased liquidity will have the positive impact on the economy as envisaged by the government. Published in African Banker, October 2012

October will be a critical month for Angola's banking sector, as the first phase of a new foreign exchange law comes into effect. From the start of the month, oil companies working in the country will have to route all of their payments to local suppliers through Angolan banks, offering a multibillion-dollar windfall to financial institutions in Luanda.

A series of other measures will follow over the next year, which should also provide a significant boost to the local currency, the kwanza. But for all the potential benefits to the country's banks and the wider economy there are some risks too, with some observers saying they are concerned the system might not be able to cope and, as a result, some payments will not go through as needed.

Given the vital position that the oil industry plays in the

Angolan economy, it means that regulators, banks and oil companies will all be watching closely as the Lei sobre o Regime Cambial AplicEivel ao Sector PetrolE[degrees]fero, or Law on Foreign Exchange Regulations Applicable to the Oil Sector, is implemented over the coming 12 months.

If any problems do emerge, it will certainly not be because the banking system was taken by surprise. The law was first proposed eight years ago, but it has been delayed until now because of concerns that the country's banks would struggle to cope.

"In 2004 there were meant to be four laws, but just three were passed: on the legal regime, on the tax regime and on the customs regime for the oil sector," explains Eduardo Paiva, a tax director at PricewaterhouseCoopers in Angola. "One law, on the foreign exchange regime for the oil sector,

was paused. One of the main reasons was that there was a sense in the market that the banking sector was not prepared for it. The problem is to manage the volume of operations that the banks will need to deal with."

Since then a number of international banks have come into the market, notably from Portugal and South Africa. They include Millennium Bank Angola, which is majority owned by Banco Comercial PortuguE[logical not]s and which opened its first branches in the country in 2006, and South Africa's

Standard Bank, which received its operating licence from the central bank, Banco Nacional de Angola, in 2009

Partly as a result of the new entrants, the local banking sector is now generally seen as far more mature today than it was in 2004. "The banks in Angola have seen a significant improvement over past few years," adds Paiva. "Several banks have come into the market and banks in the country have improved their operations."

Even so, the new measures are only being introduced in a gradual fashion, which should make the process easier to manage.

Capacity could be a problem The first step, which takes effect on 1st October, is to force oil companies to make all payments to local suppliers from banks accounts in Angola, either in dollars or kwanza. Next year, three further measures will be introduced. From 13th May, oil companies will have to deposit the funds needed to pay their local taxes at Angolan banks, rather than route the payments via banks abroad, as often happens at the moment.

Six weeks after that, from 1st July 2012, all payments by oil companies to local suppliers will have to be made in kwanza rather than dollars. The final measure will come into force on 1st October next year, when payments by oil companies to foreign suppliers and service providers will also have to be made through Angolan bank accounts.

"The timelines are surprisingly slow," says Yvette Babb, Africa strategist at Standard Bank based in Johannesburg. "They have had a lot of time to get ready for this. It has been discussed for a very long period of time and there was a lot of negotiations around the shape this law would take. A lot of preparation has gone into making sure the processes are in place to do this and they have another year to fully gear up for this."

However, despite the long time frames involved, Babb is among those who are not totally convinced that the entire banking system is ready for the new law. "I do have some concerns," she says. "There are a number of banks that may not be well prepared for this, due to institutional capacity as well as liquidity issues. The larger banks will be relatively well prepared. There are a number of local banks that are not as well equipped."

Others that have voiced some concerns include the IMF, which has said on a number of occasions that the central bank's supervisory capacity will need to be strengthened to manage the risks associated with the new law.

Since its annual review of the Angolan economy, which took place in May, the organisation has made its fears clear. Mauro Mecagni, who lead the IMF team that visited Angola for the review, said at the time that the law could increase competition and financial innovation in the country, but added "it may also result in a rapid expansion of banks'balance sheets. In order for the process of financial deepening to be sustainable, a significant strengthening of prudential supervision is advisable prior to the gradual implementation of the law."

In its final report, released in early August, the IMF team noted that Angola's financial system has a number of vulnerabilities "due to capacity constraints in banking supervision, inadequate bank corporate governance, high dollarisation, and liquidity shifts linked to large oil sector transactions".

"There are lots of issues," adds Paiva. "Will the banks be able to manage millions of dollars in several bank accounts and be ready to reply promptly to all the requests that oil companies will make for bank transfers? The risks will be delays for the oil companies in paying local and foreign suppliers. That could be a problem in the beginning."

Some of the concerns expressed by the IMF and others have been acknowledged by leading bank executives in the country, although they also insist that they are ready.

Alvaro Sobrinho, chief executive officer of Banco EspE[degrees]rito Santo Angola (BESO), a subsidiary of Portugal's Banco EspE[degrees]rito Santo, estimates that an additional $2bn a month will flow through the Angolan banking system as a result of the new law. He told a meeting at the London think-tank Chatham House in mid July that his firm and others were fully prepared for the influx of cash.

"We have [had] some conversations with the largest oil companies," he said. "The oil companies say there is no capacity in the local banks to manage our money. I think the four or five largest banks are prepared right now to receive the money."

Whether or not all t he countr y 's banks are ready, in practice most o f t h e f unds are in any case likely to pass through the largest banks. And beyond the r isk of s o m e m i s s e d o r delayed payments, the administrative burden that the new law imposes should not affect the oil companies too greatly, although they remain cautious for now.

A spokesman for the UK oil major BP, which has interests in nine offshore oil blocks as well as the country's first liquefied natural gas (LNG) project, says, "We currently believe this new legislation is unlikely to delay current projects or have a direct impact on future investment decisions."

Will the economy benefit? The more significant impact of the law could be on the wider economy. The hope among supporters of the new measures is that the additional liquidity in the banking sector will encourage the country's banks to lend more to local businesses and individuals.

The official press agency Angop reported comments from Jose Severino, chairman of the Angolan Industrial Association, in January that the new measures should give a major boost to the availability of finance in local currency from commercial banks and would also help to diversify the economy.

This too will have to be carefully managed. The IMF, for example, has warned that the situation could get out of hand, saying in its August report that the transfer of funds to local banks could create an environment of "excessive risk taking and a credit boom".

The government is certainly keen to boost lending, particularly to small and medium-sized firms. A number of initiatives have been launched in recent months to do this, including the Angola Invests programme, which 19 banks signed up to in July this year. In the same month the government launched another initiative, the Angolan Risk Capital Fund (FACRA), to boost lending to local firms, managed by the Kwanza Management Society of Entrepreneurial Projects.

However, the short-term nature of the deposits that will come about as a result of the new l aw means t hat new lending may not happen, or at least not on the scale that some are hoping for. Although several billion dollars will be coming in to the banks, much of it will be quickly leaving top ay suppliers or to settle the oil companies' tax bills

"What the banks do with the extra liquidity is something that has still to be discovered," says Pieter van Welzen, a partner at international law firm Clifford Chance. "It is shortterm liquidity, so you can't use it to make long-term loans or investments or you will have the same sort of financial crisis that there was in Europe."

An added difficulty is that information on customers is not always readily available in Angola, which makes it hard for banks to adhere to international 'know your customer' standards before they lend, and so restricts lending as a whole.

At the meeting in London in July, Sobrinho acknowledged that compliance systems are different in Angola from those in other markets such as his parent's company's home territory of Portugal.

"The standards are the same, the practices are different," he said. "To implement the rules is very difficult. The first difficulty is the identification of people. Around 50% of Angolan people in 2007 had no form of identification. It is impossible to implement the 'know your customer' rules. And the main deposits in Angola are in cash."

Such difficulties help to explain Angola's low position in the World Bank's annual Ease of Doing Business report. In the latest edition, published in October last year, the country is ranked 126 out of 183 countries when it comes to the ease of getting credit. That placed it behind other African countries with far smaller banking systems, such as Tanzania, Cameroon and Equatorial Guinea.

A more likely consequence of the new law should be a strengthening of the kwanza. With more payments having to be made in the local currency, demand for it will rise. It should also make the government and the wider economy less dependent on dollars - something that will be welcome given the country's difficulties in paying its bills when oil prices crashed on international markets just a few years ago.

"The 2008/09 crisis made the government aware that action would need to be taken to make the economy less dependent on oil money, but also to make the domestic economy less dependent on dollars," says van Welzen.

One final consequence may be that some new banks will be tempted to enter the market if the new law's implementation goes well. While South African and Portuguese banks have made the running in recent years, the country has also attracted some interest from elsewhere.

In 2010 the UK's Standard Chartered opened a representative office in Luanda and it was joined in February this year by Germany's Commerzbank, which also opened a representative office in the Angolan capital.

Eight other banks have licences for representative offices, including Bank of China, Banco do Brasil and the State Bank of India.

"It would be a good idea to have at least some fresh blood in the market, not necessarily from the traditional countries but from the more sophisticated markets," says Van Welzen.

International banks may prefer to wait on the sidelines to see how smoothly the new law is implemented. But whether the short-term risks do become a reality, the longer term consequences for Angola should be positive, leading to a more mature and sophisticated banking sector.

One consequence of the new law is that some new banks will be tempted to enter the market if its implementation goes well

Angola: Forex windfall test for banks

Oil companies will soon have to process all their supplier payments through the local financial system but will the system be able to cope? Published in Africa Confidential, 7 September 2012

Eight years after it was first proposed, the government is bringing in a law that will force oil companies to pay their suppliers through banks inside Angola. The Law on Foreign Exchange Regulations Applicable to the Oil Sector will provide a huge boost to liquidity levels in the local banking sector but it remains unclear if there will be many practical benefits for the local economy and how well local banks will cope with the influx of funds (AC Vol 52 No 24).

The law takes effect on 1 October and payments by oil companies may be made in dollars or kwanza. Over the next year, the measures will be gradually tightened.

From 13 May, payments necessary to settle local tax bills must also be deposited with Angolan banks: until now, some oil companies have paid their tax bills via banks abroad, including in London. Then, from 1 July 2013, all payments to local suppliers must be made in kwanza. Finally, from 1 October 2013, any oil company payment to foreign suppliers or service providers will also have to be made from Angolan bank accounts.

The potential impact on the local banking sector is huge. Speaking at a meeting at the Royal Institute of International Affairs (Chatham House) in London in July, the Chief Executive Officer of the Banco Espírito Santo Angola, Álvaro Sobrinho, said that he expected US$2 billion a month in extra funds to flow through the banking sector. The scale of the changes is a key reason why the law is only now being implemented, despite being first mooted in 2004. Oil companies and others have been concerned that banks would not be able to handle the scale of transaction involved. The government is betting that the banks will indeed cope.

The gradual process increases the chances that the law will go smoothly but not everyone is convinced it will be problem-free. While the banking sector is generally perceived as far stronger than in 2004, some smaller banks could still struggle. At least one small bank is thought to have serious liquidity problems, says a banking source, and others may lack the institutional capacity to deal comfortably with the higher volume of transactions. ‘I’d say the banking sector is better prepared than in 2004 but probably not totally prepared,’ a senior accountant in Luanda says. ‘Only when we see it put into practice will we know. It is a great question mark.’

The International Monetary Fund has also raised concerns about the new law while noting potential benefits. In a statement after an Article IV consultation and monitoring mission in May, the head of the IMF’s country team, Mauro Mecagni, said that the shift in transactions from offshore to domestic banks was ‘expected to increase the scope for domestic financial intermediation and serve as a channel to promote increased competition and financial innovation’. He cautioned, however, that ‘it may also result in a rapid expansion of banks’ balance sheets. In order for the process of financial deepening to be sustainable, a significant strengthening of prudential supervision is advisable prior to the gradual implementation of the law.’

For now, oil companies are unlikely to alter their investment decisions because of the foreign exchange regulations. They are likely to favour Angola’s larger banks with their funds. Among the main institutions expected to win out are the Banco Angolano de Investimentos and Banco Privado Atlântico, both part-owned by the state oil giant, Sonangol. Other banks well placed to capture a significant share of the funds include South Africa’s Standard Bank (AC Vol 51 No 21), which is expanding its presence in the country, Banco Caixa Geral Totta de Angola and Banco de Fomento Angola.

Sobrinho says that the entire economy could feel the benefits. ‘I think this is very important for the Angola economy,’ he told Chatham House. ‘In terms of business, it is very important to finance the economy, entrepreneurs and the largest companies. We need to invest in some sectors. The banks need to have funds because there are no capital markets in Angola...the funds will be very important, first to the banks and second to companies, because the banks will have the necessary money to give credit for the Angola economy.’

Banks have already been making noises about boosting lending to the private sector. In May, 19 signed up to a new initiative led by the ministries of Economy and Finance called the ‘Angola Invests’ programme, to boost finance for micro-, small- and medium-sized companies at low interest rates. Yet the funds that they will receive from oil companies as a result of the new law will largely be in the form of short-term deposits. They are not well suited to acting as the basis for longer term loans or investments.

One practical difference which the new measures will make is a need to revise some existing long-term contracts between oil companies and their suppliers, particularly after 1 July 2013, when oil companies will have to pay local bills in kwanza. ‘To date, most payments for the oil sector have been done offshore or, if onshore, they have been done in dollars rather than the local currency,’ says one international lawyer with clients in Luanda. ‘All these contracts will have to be made in the local currency. Receiving the money in local currency may not be a bad thing but you must be able to export the currency and get dollars for it if you need to repatriate it. So, if you have longer term contracts you probably want to ensure that your contracts provide for a dollar reference rate and then receive the relevant amount in kwanza.’

In the long term, the new measures are likely to boost the kwanza and help to reduce Angola’s current reliance on dollars. That could affect not just the oil and banking sectors but the entire economy.