Macro Analysis / Global

Banks face headwinds from shaky emerging market government finances

  • Covid-19 lockdowns have put pressure on EM sovereign finances; banks could be asked to take some of the strain
  • GCC banks appear susceptible to higher taxes (Saudi Arabia recently hiked VAT); Bangladesh banks already heavily taxed
  • Banks in Oman and Sri Lanka appear to have capacity to hold more sovereign debt; Nigeria and Pakistan banks less so
Banks face headwinds from shaky emerging market government finances

Recent budget announcements (Kenya and Mauritius in Africa, Bangladesh and Pakistan in Asia) highlight the strain caused by Covid-19 lockdowns on emerging market finances. While government spending is increasing to lessen the economic hardship, income is falling as economic activity declines. In this context, we think bank shareholders could once again find themselves in the firing line.

Banks are already exposed to the economic downturn through lower revenues, higher risk costs and tighter liquidity. In addition, regulators have adjusted loan contract terms in most markets so that borrowers may enjoy payment holidays or even lower interest rates.

Banks could face higher taxes and/or be asked to hold more sovereign debt

Tighter sovereign finances could result in two additional claims to which bank shareholders would be exposed. The first is that governments may raise taxes on the banking sector in order to plug fiscal gaps. While governments so far seem content with raising taxes on consumer staples such as telcos, tobacco and alcohol, past experience (such as the super taxes in Pakistan, or the debt repayment levy in Sri Lanka) suggest banks could also find themselves in the firing line.

Which banks could be most exposed to higher tax rates?

Comparing 2020f projected fiscal deficits with last year’s effective tax rates for our banking coverage highlights GCC markets along with Egypt as being potentially most at risk (ie names in the lower left quadrant of Figure 1 below).

Saudi Arabia recently hiked its VAT rate to 15% (from 5%), which could bring in additional revenues equivalent to 4% of GDP. Looking outside the GCC region, we note that Nigeria has already put in place measures to increase the tax burden on its banks via higher VAT (5% from 0% for online transactions, and 7.5% from 5% for other service fee income) and revocation of the tax-exempt status of government securities from 2022. Kenya in 2018 increased the excise duty charged on bank fees from 10% to 20%, which brought in KES8.3bn in receipts that year, equivalent to around 5% of the banking industry’s pre-tax profits. Another example is Egypt, which has introduced a less favourable tax regime for banks’ T-bill holdings. The chart below suggests that other tax-raising measures in these markets cannot be fully discounted.

Which banks will be asked to fund sovereign deficits?

A longer-term impact comes from increased reliance of bank funding by EM sovereigns. As well as crowding out private sector lending, banks carrying more government debt on their balance sheets make their risk profiles more closely intertwined. Even if such instruments carry zero risk-weights, particularly for the most indebted sovereigns, they are anything but, as the recent example of Lebanon spectacularly highlights.

We think banks in Oman and Sri Lanka could be increasingly called upon to carry more sovereign debt assets, particularly given that the likely increase in global sovereign issuance could lead international investors to become more discerning. We note that Sri Lanka banks are currently barred from holding USD sovereign debt, but they continue to invest in LKR-denominated government bonds.


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This report is independent investment research as contemplated by COBS 12.2 of the FCA Handbook and is a research recommendation under COBS 12.4 of the FCA Handbook. Where it is not technically a res...

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