## 1. Systemic Vulnerability Heatmap, 2010–22 (sipea2024014)

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### Overview and system structure
- Total banking system assets: CFAF 64 trillion—or 58 percent of regional GDP—at end-2022.
- Banking sector share of financial system assets: around 72 percent; other financial institutions: around 28 percent.
- Number of credit institutions at end-2022: 155 (of which 132 were banks).
- Geographic concentration of banking assets: Côte d’Ivoire 34 percent; Senegal 19 percent.
- Regional banking groups: 34 groups hold nearly 85 percent of banking sector assets.
- Public majority-owned banks: 13 banks hold 10 percent of banking assets and 13 percent of banking capital.
- Bank asset composition (end-2022): 58 percent short- to medium-term loans to non-financial corporations; 35 percent securities (mostly WAEMU sovereigns held to maturity); 7 percent other assets.
- Main funding sources: mostly short-term deposits and refinancing from the regional central bank (BCEAO).
- System segmentation: banks with excess liquidity versus banks with structural liquidity deficits and significant reliance on BCEAO refinancing.
- Heatmap finding: systemic vulnerability indicators are generally low, but pockets of weakness persist (credit, concentration, liquidity, and sovereign risks), with a rising sovereign–bank nexus.

### Regulatory framework and reforms
- Transition to Basel II/III completed in 2023, except for introducing liquidity requirements and Pillar II capital and liquidity surcharges.
- BCEAO decision: doubling the minimum share capital of banks to CFAF 20 billion.
- 2023 regional banking law features:
  - Extended supervisory scope (payment institutions, electronic money institutions, bank holding companies, financial companies).
  - Designates the macroprudential authority, incorporates Islamic finance and macroprudential supervision, strengthens consolidated supervision of banking groups.
  - Outlines arrangements for early intervention, resolution, and liquidation measures.
- Recent reforms align with 2022 FSAP recommendations; effective implementation expected to address persistent vulnerabilities.
- Key policy emphasis: build on recent reforms; enhance macroprudential policy effectiveness and banking supervision frameworks.

### Credit risks
- Private sector bank credit growth: 14.2 percent in 2022 and 10.3 percent in 2023.
- Credit-to-GDP gap for the union: stabilized at around a modest 1 percent in 2022 (BIS credit-to-GDP gap estimates using a Hodrick-Prescott one-sided filter with λ=400,000).
- Country heterogeneity: credit gap negative in Benin, Niger, and Togo (not particularly large).
- Methodological cautions: limitations of BIS credit-to-GDP gap methodology noted; BCEAO also uses Castro, Estrada and Martinez (2016) methodology.

### Asset quality and capital adequacy
- Gross NPL ratio: 8.4 percent in 2022; increased to 8.7 percent by June 2023.
- Country extremes in NPLs: Niger 16.1 percent; NPLs also above WAEMU average in Guinea-Bissau, Mali, and Senegal.
- Loan loss provisioning (aggregate): improved from 63.7 percent in 2010 to 68 percent in 2022.
  - Cross-country provisioning dispersion: range from 39.6 percent in Niger to 80.2 percent in Burkina Faso.
- Capital Adequacy Ratio (CAR): WAEMU average around 13 percent at end-2022 (regulatory minimum 11.25 percent).
  - Country outliers: Guinea-Bissau CAR -11.6 percent in June 2023; Togo CAR 6.4 percent in June 2023.
- Profitability: return on assets (ROA) persistently around 1.2–1.5 percent in recent years.
- Observation: some banks (mainly state-owned) still need recapitalization despite overall upward trend in CAR since 2018.

### Concentration risks
- Sectoral loan portfolio (2022): Retail, wholesale trade, restaurants and hotels; manufacturing; and other services together 63.5 percent of total loans; agriculture only 3 percent of bank loans to the private sector.
- Largest exposure concentrations:
  - Median largest single exposure ≈ 49 percent of regulatory capital.
  - 65 percent of banks (62 out of 96) have their three largest exposures exceeding all their capital.
  - Many banks breach the regulatory large exposure limit of 35 percent of Tier 1 capital.
- Liability structure (June 2022): sight deposits 49 percent; term deposits 20 percent; other deposits 3 percent; interbank loans 7 percent; loans from BCEAO 11 percent; equity and reserves 10 percent.
- Deposit base composition: large corporations 40 percent; households 37 percent; public sector 12 percent.
- Deposit concentration (2021): five largest depositors account for 25 percent of deposits; largest depositor averages 10 percent of total deposits.
- Risk implication: high concentration of exposures and depositors poses material solvency and liquidity risks.

### Liquidity risks
- Liquid assets (end-2022): about 24 percent of total assets (heterogeneity: Benin 12.3 percent; Mali 31.6 percent).
- Trend: liquid asset positions have been decreasing in recent years.
- Dependence on BCEAO: increasing central bank refinancing reliance; several banks persistently depend on this funding.
- Market liquidity issues: non-marketable debt and limited liquidity of government securities; underdeveloped and shallow interbank market.
- Implication: limited diversification of liquid assets and concentrated deposits hamper banks’ ability to absorb liquidity shocks.

### Interest rate risk: channels and WAEMU exposures
- Interest rate channel: rising policy and short-term rates raise funding costs rapidly for wholesale-funded banks; pass-through to income can be slow because of fixed-rate loans that reprice slowly.
- Balance-sheet exposures: higher share of government securities with longer maturities increases interest rate and maturity mismatch risk.
- Government securities held to maturity limit realized valuation losses but increase duration mismatch.
- Outstanding stock of sovereign bond securities issued through the auction segment and held by banks in mid-June 2023: CFAF 8 trillion or around one-third of WAEMU banks’ sovereign exposures.
- Average residual maturity of these securities: 3.5 years, implying an estimated average yield of about 7.5 percent under current market conditions, or 1.8 percentage points higher compared to an average yield of 5.7 percent at issuance.
- Securities held for trading: less than 1 percent of the securities portfolio.
- Implication: decreased access to low-cost funding forces competition for deposits, raising deposit costs; tightening financial conditions and a deepening bank-sovereign nexus could adversely affect banks if BCEAO hikes interest rates or maintains them at high levels.

### Sovereign–bank nexus: exposure, channels, and concentration
- Public debt-to-GDP ratio: rose from 44.8 percent in 2019 to 59.1 percent in 2022.
- Bank exposures to public debt instruments: 38 percent of total banks’ assets at end-2022 (from 30 percent at end-2019).
- Drivers of increased sovereign exposure: expansion of regional government securities market, pandemic financing needs, zero regulatory risk weight treatment of sovereign debt, perceived lower risk of public assets, limited alternative safe collateral.
- Three adverse feedback channels:
  - Exposure channel: direct bank exposure to sovereign debt can lead to collateral value declines, tightening capital constraints and credit crunches.
  - Safety net channel: sovereign distress can limit government ability to provide guarantees/support.
  - Macroeconomic channel: sovereign weakness raises borrowing costs, may require fiscal consolidation, and can crowd out private lending.

### Concentration and distribution of sovereign exposures
- National bias in sovereign securities portfolios: as of June 2022, securities issued by the state where banks reside ranged from 4 to 19 percent of assets depending on the country.
- Ivoirian banks: sovereign exposure significantly concentrated in Côte d’Ivoire government securities; Côte d’Ivoire and Burkina Faso securities represent the second-largest shares in banks’ security portfolios.
- Concentration by bank size:
  - On average, 40 banks accounting for 45 percent of the banking system's assets hold government securities representing 20 to 40 percent of their assets and have the lowest solvency ratios.
  - A few banks, representing 7 percent of the banking system’s assets, hold government securities of more than 50 percent of their assets and show high solvency ratios.
- Rise in sovereign exposures and greater reliance on BCEAO short-term funding exacerbate interest rate risk and asset-liability mismatches.

### Stress-test findings and systemic impact
- WAEMU FSAP 2022 interest rate stress tests model inflation: base scenario at 2 percent over the period; adverse scenario rising to 7 percent before decreasing.
- Under the adverse scenario (highest risk): ROA could contract by up to 2.5 percentage points, and capital ratios could decline by as much as 8 percentage points, requiring capital needs equivalent to approximately 1.5 percent of regional GDP.
- FSAP sovereign-default simulation: outstanding debt maturing by 2022 represented 34 percent of total outstanding securities at end-September 2021 (range: 20 percent in Togo to 48 percent in Niger).
- Results of sovereign default simulations:
  - Almost 50 banks (of 100 included) would not have sufficient capital buffers to cope with a default by Côte d'Ivoire on its short-term maturities.
  - Defaults of Senegal and Togo would cause failure of 7 and 11 banks, respectively.
  - Defaults by Niger, Mali, Burkina Faso, Benin, and Guinea-Bissau would result in 16, 13, 13, 9, and 6 banks, respectively, with insufficient capital buffers.
- Aggregate bank capital losses due to contagion from all sovereign defaults could reach 3.6 percent of the 2021 regional GDP.
  - Maximum loss from a Côte d'Ivoire default: 1.7 percent of regional GDP.
  - Defaults in Burkina Faso, Niger, and Mali: about 0.4 percent of regional GDP each.
  - Defaults in Senegal, Togo, and Benin: maximum losses about 0.2 percent of regional GDP each.
  - Guinea-Bissau: about 0.06 percent of regional GDP.
- Additional total capital needed to cover contagion risk from common sovereign exposures: estimated at 1.4 percent of regional GDP.
  - Additional capital needs as high as 0.8 percent of regional GDP in the event of a default by Côte d'Ivoire and 0.04 percent of regional GDP in case of a default by Guinea-Bissau.

### Potential macrofinancial consequences
- Rapid expansion of sovereign debt exposure could crowd out private sector credit:
  - At end-2022, banks’ claims on the public sector: 21.7 percent of GDP, up from 14.2 percent at end-2019.
  - Claims on the private sector: grew from 22.8 percent of GDP before the pandemic to 24.7 percent as of 2022.
- Rising sovereign exposures and funding pressures can amplify concerns about debt sustainability, reduce governments’ ability to support banks, and undermine government creditworthiness.

### Policy recommendations and prudential measures
- Enhance resilience through prudential measures while avoiding unintended macrofinancial dynamics:
  - Contain sovereign exposure using concentration limits.
  - Introduce positive risk weights on sovereign holdings (replace zero risk weight treatment).
  - Discourage excessive risk concentrations by applying Pillar 1 or 2 capital surcharges.
  - Develop the domestic institutional and retail investor base to diversify the investor base for government securities.
- Calibrate Pillar 2 capital surcharges to discourage excessive sovereign concentration:
  - WAEMU FSAP 2022 recommends a nonlinear calibration, with additional capital requirement increasing gradually beyond a minimum concentration threshold based on a bank’s exposure to a specific sovereign relative to its risk-weighted assets.
- Additional recommended measures (consistent with WAEMU FSAP 2022):
  1. Impose extra capital requirements within the Basel Pillar 2 framework to address interest rate and concentration risks.
  2. Ensure full operationalization of the banking resolution framework.
  3. Introduce measures to reduce excessive reliance of certain banks on BCEAO refinancing.
  4. Improve monitoring of maturity mismatches and interest rate risk.
  5. Implement Basel-type liquidity ratios.
  6. Mitigate balance sheet risks.
  7. Consider activation and implementation of the broad-based capital (CCyB) tool if cyclical risks increase.

### Macroprudential toolkit and calibrations (annex highlights)
- CCyB: allowed up to 2.5% of total RWAs; criteria for activation to be determined by BCEAO instruction; January 2018; current rate 0%.
- CCoB: set at 2.5% with phased increases (0.625%; 1.25%; delays; 1.875%; 2.5% effective January 1, 2022).
- Minimum leverage ratio: 3% effective January 1, 2018; SIBIs may face higher ratios.
- Distribution limits by CET1 ranges (examples preserved verbatim):
  - 5% and 5.625%: retain at least 100% of distributable profits;
  - 5.625% and 6.25%: retain at least 80% of distributable profits;
  - 6.25% and 6.875%: retain at least 60% of distributable profits;
  - 6.875% and 7.5%: retain at least 40% of distributable profits;
  - 7% or above: retain 0% of distributable profits.
- Capital surcharge for systemically important institutions: buffer set to 1% effective March 27, 2020, with transitional build-up: 0.40% effective June 30, 2021; 0.70% effective June 30, 2022; 1% effective June 30, 2023.
- Liquidity monitoring: provisional liquid asset ratio (three months maximum) implemented April 2018.
- Sectoral risk weights and thresholds effective January 1, 2018 (retail risk weight 75%; residential property weights 35% with DSTI and LTV limits).
- Limits on FX positions: generally not allowed; BCEAO dispensations allow up to equivalent of 5% of total customer demand deposits.
- Measures to mitigate interconnectedness: additional risk weights on exposures between financial institutions: 250% when counterparty fails solvency ratios; 1250% when counterparty has negative capital (January 2018).

### Regulatory treatment of sovereign exposures and forbearance
- No explicit regulatory restrictions on bank lending to sovereigns under current BCEAO Prudential framework.
- Large-exposure limit to a single counterparty: 25 percent of Tier 1 capital, but sovereigns are excluded (PF:457); PF:460 allows BCEAO to introduce sovereign concentration limits (not used to date).
- Pillar 1 risk-weighting: 0 percent risk weighting for sovereign exposures in local currency (PF:117).
  - WAEMU Eurobonds in banking book: risk-weighting ranges from 0 percent to 150 percent depending on external rating (PF:115).
- Classification and provisioning for sovereign exposures:
  - Sovereign exposures are categorized as non-performing after 180 days of default (Ins.26:8 and PF:155) versus the standard 90 days; provisioning is optional (Ins.26:16).
  - Once classified non-performing, risk weight jumps from 0 to 100 percent (if provision coverage at least 20 percent) or to 150 percent (if provision coverage smaller than 20 percent) for the uncovered portion (PF:157).

### Niger sovereign exposures, forbearance, and arrears
- BCEAO regulatory forbearance (January 22, 2024): exonerated Niger securities from classification as “non-performing” after 180 days to forestall adverse effects on bank capitalization.
  - Rationale: Niger’s halt on servicing public debt is due to operational inability because of sanctions, irrespective of capacity to service.
  - Forbearance scope: only securities (accounting for 88 percent of total bank exposure to Niger sovereign) were subject to forbearance; direct loans represent 12 percent of total bank exposures to Niger (mostly held by Nigerien banks) with no spillovers beyond the individual affected loans.
  - BCEAO conducted stress tests to identify banks most exposed to Niger’s debt servicing halt; identified banks will be instructed to take capital preservation measures (such as dividend withholding) and subjected to intensified supervision.
  - In absence of forbearance, exposure to securities not serviced by Niger government would have worsened capitalization of affected banks starting from end-January, 2024, and arrears would accumulate.
- Classification implications after 180 days (end-January):
  - Banks’ exposures to Nigerien sovereign would have been classified as “non-performing”.
  - For securities: all exposures to Niger government debt of the same bank with missed payment beyond 180 days would become NPLs; no contagion to other banks unless they experienced missed payment on the same security.
  - For direct loans: only that loan would become NPL after 180 days.
- Risk-weight and provisioning implications after NPL classification:
  - Risk weight would jump from 0 percent to at least 100 percent, and likely to 150 percent (associated with NPL provision cover smaller than 20 percent, given that provisioning for sovereign lending is generally low).
  - Effects on capital adequacy: CAR would be reduced due to an increase in the denominator (higher risk weighted assets) and due to provisioning impacts on capital.
  - Dynamic deterioration as debt service arrears reach and exceed 180 days.
- Holdings and arrears statistics:
  - As of end-2023: over 80 percent of Niger debt issued through the auction segment (UMOA-Titres) was held in other WAEMU countries and by the BCEAO.
  - By February 5, 2024: Government of Niger accumulated CFAF 300 billion (about US$480 million, 2.9 percent of GDP) of arrears on debt service.
  - In 2024: CFAF 265 billion is due in debt service (of which CFAF 216 billion principal, and CFAF 49 CFAF interest payments).
- ECOWAS development: On February 24, 2024, the ECOWAS Commission issued a decision to lift most sanctions (notably economic and financial ones) on Niger with immediate effect.

*Source: IMF staff chapter "1. Systemic Vulnerability Heatmap, 2010–22" and related sections from sipea2024014.*

### 1. Systemic Vulnerability Heatmap, 2010–22 __________________________________________ 5

### 1. Systemic Vulnerability Heatmap, 2010–22

### Overview and system structure
- The WAEMU banking system had total assets of CFAF 64 trillion—or 58 percent of regional GDP—at end-2022.
- The banking sector accounts for around 72 percent of the financial system’s assets; other financial institutions account for around 28 percent.
- Number of credit institutions operating in the WAEMU at end-2022: 155 (of which 132 were banks).
- Geographic concentration of banking assets: Côte d’Ivoire 34 percent; Senegal 19 percent.
- Regional banking groups: 34 groups hold nearly 85 percent of banking sector assets.
- Public majority-owned banks: 13 banks hold 10 percent of banking assets and 13 percent of banking capital.
- Bank business model and asset composition (end-2022): 58 percent short- to medium-term loans to non-financial corporations; 35 percent securities (mostly WAEMU sovereigns held to maturity); 7 percent other assets.
- Main funding sources: mostly short-term deposits and refinancing from the regional central bank (BCEAO).
- System segmentation: banks with excess liquidity versus banks with structural liquidity deficits and significant reliance on BCEAO refinancing.
- Systemic vulnerability heatmap finding: systemic vulnerability indicators are generally low, but pockets of weakness persist (credit, concentration, liquidity, and sovereign risks), with a rising sovereign–bank nexus.

### Regulatory framework and reforms
- Transition to Basel II/III completed in 2023, except for introducing liquidity requirements and Pillar II capital and liquidity surcharges.
- BCEAO decision: doubling the minimum share capital of banks to CFAF 20 billion.
- 2023 regional banking law features:
  - Extended scope for supervision (payment institutions, electronic money institutions, bank holding companies, financial companies).
  - Designates the macroprudential authority, incorporates Islamic finance and macroprudential supervision, strengthens consolidated supervision of banking groups.
  - Outlines arrangements for early intervention, resolution, and liquidation measures.
- Recent reforms align with 2022 FSAP recommendations; effective implementation expected to address persistent vulnerabilities.

### Key policy recommendations (textual emphasis)
- Build on recent reforms in line with 2022 FSAP recommendations.
- Enhance macroprudential policy effectiveness and banking supervision frameworks.

---

### Credit risks
- Private sector bank credit growth: 14.2 percent in 2022 and 10.3 percent in 2023.
- Credit-to-GDP gap for the union: stabilized at around a modest 1 percent in 2022 (BIS credit-to-GDP gap estimates using a Hodrick-Prescott one-sided filter with λ=400,000).
- Country heterogeneity: credit gap negative in Benin, Niger, and Togo (not particularly large).
- Cautions on methodology: BIS credit-to-GDP gap methodology limitations noted (length of variables, structural breaks, starting point problem, real-time inefficiency, parameter dependence); BCEAO also uses Castro, Estrada and Martinez (2016) methodology.

---

### Asset quality and capital adequacy
- Gross NPL ratio for WAEMU banks: 8.4 percent in 2022; increased to 8.7 percent by June 2023.
- Country extremes in NPLs: Niger 16.1 percent; NPLs also above WAEMU average in Guinea-Bissau, Mali, and Senegal.
- Loan loss provisioning (aggregate): improved from 63.7 percent in 2010 to 68 percent in 2022.
  - Cross-country provisioning dispersion: range from 39.6 percent in Niger to 80.2 percent in Burkina Faso.
- Capital Adequacy Ratio (CAR): WAEMU average around 13 percent at end-2022 (exceeds regulatory minimum of 11.25 percent).
  - Country outliers: Guinea-Bissau CAR -11.6 percent in June 2023; Togo CAR 6.4 percent in June 2023.
- Profitability: return on assets (ROA) persistently around 1.2–1.5 percent in recent years.
- Observation: some banks (mainly state-owned) still need recapitalization despite overall upward trend in CAR since 2018.

---

### Concentration risks
- Sectoral composition of loan portfolio (2022): Retail, wholesale trade, restaurants and hotels; manufacturing; and other services together 63.5 percent of total loans; agriculture only 3 percent of bank loans to the private sector.
- Largest exposure concentrations:
  - Median largest single exposure ≈ 49 percent of regulatory capital.
  - 65 percent of banks (62 out of 96) have their three largest exposures exceeding all their capital.
  - Non-compliance risk: many banks breach the regulatory large exposure limit of 35 percent of Tier 1 capital.
- Liability structure (June 2022): sight deposits 49 percent; term deposits 20 percent; other deposits 3 percent; interbank loans 7 percent; loans from BCEAO 11 percent; equity and reserves 10 percent.
- Deposit base composition: large corporations 40 percent; households 37 percent; public sector 12 percent.
- Deposit concentration indicators (2021): five largest depositors account for 25 percent of deposits; largest depositor averages 10 percent of total deposits.
- Risk implication: high concentration of exposures and depositors poses material solvency and liquidity risks.

---

### Liquidity risks
- Liquid assets (end-2022): about 24 percent of total assets (heterogeneity across countries: Benin 12.3 percent; Mali 31.6 percent).
- Trend: liquid asset positions of banks have been decreasing in recent years.
- Dependence on BCEAO: banks increasingly rely on central bank refinancing; several banks persistently depend on this funding.
- Market liquidity issues: non-marketable debt and limited liquidity of government securities; underdeveloped and shallow interbank market.
- Implication: limited diversification of liquid assets and concentrated deposits hamper banks’ ability to absorb liquidity shocks and exacerbate liquidity risk.

---

*Source: IMF staff chapter "1. Systemic Vulnerability Heatmap, 2010–22" from sipea2024014.*

### 13.      In general, due to the structure of their business models, banks’ net income and asset

### 13.      In general, due to the structure of their business models, banks’ net income and asset

### Interest rate risk: channels and bank vulnerabilities
- Rising policy and short-term rates raise funding costs rapidly for wholesale-funded banks, while pass-through to income can be slow because of fixed-rate loans that reprice slowly.
- Banks whose expenses are more sensitive than their income to rising short-term rates can lose net interest income; some banks may benefit by earning higher interest from borrowers while keeping deposit rates low.
- Higher borrowing costs can increase loan losses as consumers and businesses face extended periods of higher borrowing costs, especially if they lose jobs or business revenues.
- Banks’ bond and debt securities holdings decline in value when interest rates rise; sudden deposit withdrawals or funding pressures may force asset sales at losses.

### WAEMU-specific interest rate exposures and mechanics
- Banks’ balance sheet exposure to interest rate risk has increased due to a rise in the share of government securities on their balance sheets, whose maturities tend to be longer than banks’ funding.
- Higher refinancing costs will impact net interest margins as asset yields are expected to rise gradually given the relatively long duration of government securities—typically held to maturity.
- Decreased access to low-cost funding forces banks to compete for customer deposits, pushing deposit costs higher.
- Tightening financial conditions and a deepening bank-sovereign nexus could adversely affect banks if high inflation expectations and declining foreign reserves require BCEAO to hike interest rates or maintain them at a high level for an extended period.

### Sovereign securities valuation and holdings
- Outstanding stock of sovereign bond securities issued during FRFA through the auction segment and held by banks in mid-June 2023 amounted to CFAF 8 trillion or around one-third of WAEMU banks’ sovereign exposures.
- The average residual maturity of these securities is 3.5 years, implying an estimated average yield of about 7.5 percent under current market conditions, or 1.8 percentage points higher when compared to an average yield of 5.7 percent at issuance.
- Securities held for trading purposes account for less than 1 percent of the securities portfolio, implying limited potential valuation losses for banks holding such securities given rising yields.
- Banks generally buy securities with relatively long maturities and hold them to maturity, which limits realized valuation losses but increases maturity mismatch risks.

### Sovereign-bank nexus: exposure, channels, and concentration
- Public debt-to-GDP ratio rose from 44.8 percent in 2019 to 59.1 percent in 2022; a significant share of public debt has been bought by regional banks.
- Bank exposures to public debt instruments reached 38 percent of total banks’ assets at end-2022 (from 30 percent at end-2019).
- Drivers of increased sovereign exposure: rapid expansion of regional government securities market mainly purchased by WAEMU banks; pandemic financing needs; preferential (zero) regulatory risk weight treatment of sovereign debt; perceived lower risk of public versus private assets; limited availability of alternative safe collateral.
- Three adverse feedback channels between sovereigns and banks:
  - Exposure channel: banks’ direct exposure to sovereign debt can lead to collateral value declines, tightening capital constraints and credit crunches.
  - Safety net channel: sovereign distress can limit government ability to provide guarantees/support, destabilizing banks and fiscal accounts.
  - Macroeconomic channel: sovereign weakness raises borrowing costs, may require fiscal consolidation, and can crowd out private lending, affecting credit risk.

### Concentration and distribution of sovereign exposures
- Bank sovereign securities portfolios are characterized by a national bias: as of June 2022, securities issued by the state where banks reside ranged from 4 to 19 percent of assets depending on the country.
- Ivoirian banks have sovereign exposure significantly concentrated in securities issued by the Côte d'Ivoire government; securities issued by Côte d’Ivoire and Burkina Faso represent the second-largest shares in the banks’ security portfolio.
- Large holdings of government securities are concentrated in medium-sized banks with limited capital buffers:
  - On average, 40 banks accounting for 45 percent of the banking system's assets hold government securities representing 20 to 40 percent of their respective assets and have the lowest solvency ratios.
  - A few banks, representing 7 percent of the banking system’s assets, hold government securities of more than 50 percent of their respective assets and show high solvency ratios.
- The rise in sovereign exposures and greater reliance on BCEAO short-term funding exacerbate interest rate risk and asset-liability mismatches.

### Stress-test findings and systemic impact
- WAEMU FSAP 2022 interest rate stress tests model inflation impact on bank profitability: base scenario at 2 percent over the period; adverse scenario rising to 7 percent before decreasing.
- Under the adverse scenario and considered the highest risk, ROA could contract by up to 2.5 percentage points, and capital ratios could decline by as much as 8 percentage points, requiring capital needs equivalent to approximately 1.5 percent of regional GDP.
- FSAP sovereign-default simulation: outstanding debt maturing by 2022 represented 34 percent of total outstanding securities at end-September 2021 (range: 20 percent in Togo to 48 percent in Niger).
- Results of sovereign default simulations:
  - Almost 50 banks (of 100 included) would not have sufficient capital buffers to cope with a default by Côte d'Ivoire on its short-term maturities.
  - Defaults of Senegal and Togo would cause failure of 7 and 11 banks, respectively.
  - Defaults by Niger, Mali, Burkina Faso, Benin, and Guinea-Bissau would result in 16, 13, 13, 9, and 6 banks, respectively, with insufficient capital buffers.
- Aggregate bank capital losses due to contagion from all sovereign defaults could reach 3.6 percent of the 2021 regional GDP.
  - Maximum loss from a Côte d'Ivoire default could reach 1.7 percent of regional GDP.
  - Defaults in Burkina Faso, Niger, and Mali would result in losses of about 0.4 percent of regional GDP each.
  - Defaults in Senegal, Togo, and Benin: maximum losses about 0.2 percent of regional GDP each.
  - Guinea-Bissau: about 0.06 percent of regional GDP.
- Additional total capital needed to cover contagion risk from common sovereign exposures was estimated at 1.4 percent of regional GDP.
  - Additional capital needs are as high as 0.8 percent of regional GDP in the event of a default by Côte d'Ivoire and 0.04 percent of regional GDP in case of a default by Guinea-Bissau.

### Potential macrofinancial consequences
- Rapid expansion of sovereign debt exposure could lead to crowding out of private sector credit:
  - At end-2022, banks’ claims on the public sector amounted to 21.7 percent of GDP, up from 14.2 percent at end-2019.
  - Claims on the private sector grew from 22.8 percent of GDP before the pandemic to 24.7 percent as of 2022.
- Rising sovereign exposures and funding pressures can amplify concerns about debt sustainability, reduce governments’ ability to support banks, and undermine government creditworthiness, further limiting access to financing and harming economic growth.

### Policy recommendations and prudential measures
- Enhance resilience through prudential measures while avoiding unintended macrofinancial dynamics (e.g., significant decreases in liquidity or bond market pressures):
  - Contain sovereign exposure using concentration limits.
  - Introduce positive risk weights on sovereign holdings (replace zero risk weight treatment).
  - Discourage excessive risk concentrations by applying Pillar 1 or 2 capital surcharges.
  - Develop the domestic institutional and retail investor base to diversify the investor base for government securities.
- Calibrate Pillar 2 capital surcharges to discourage excessive sovereign concentration:
  - The 2022 WAEMU FSAP recommends a nonlinear calibration, with the additional capital requirement increasing gradually beyond a minimum concentration threshold based on a bank’s exposure to a specific sovereign relative to its risk-weighted assets.

_International Monetary Fund (West African Economic and Monetary Union chapter)_

### 32.      This paper aims to analyze the key cyclical and structural vulnerabilities within the

### This paper aims to analyze the key cyclical and structural vulnerabilities within the WAEMU financial system.

### Banking-sector vulnerabilities and systemic risks
- Banking assets account for almost three quarters of total financial sector assets, and amount to over half of WAEMU's GDP.
- Despite profitability, banks exhibit:
  - High level of portfolio concentration.
  - Limited capital and liquidity buffers.
  - Relatively persistent nonperforming loans.
  - Substantial sovereign exposures.
- Recent performance and trends:
  - Banks withstood the COVID-19 crisis well and remained stable, helped by liquidity support from the BCEAO and policies aimed at supporting domestic demand.
  - Solvency ratios of banks have improved in recent years.
  - Concentration, contagion, and interest rate risks in the system have been increasing, in part linked to high sovereign exposures.
  - The union’s banking sector remains heterogeneous in terms of solvency, risk exposures, and performance.

### Key risk channels and amplifiers
- Credit risk:
  - Amplified by high asset concentration.
  - Concentration of bank exposures to private borrowers and sovereigns could amplify the impact of credit shocks and raise recapitalization needs.
- Liquidity risk:
  - Exacerbated by deposit concentration, increased interest rate risks and the limited liquidity of the secondary market for government securities.
- Interest rate and maturity risks:
  - Maturity mismatches and interest rate risk have increased, especially with the historical expansion of securities portfolios issued at low interest rates up to 2023 and with relatively long maturities compared to banks’ funding.
  - Market options to hedge these risks are limited, exposing banks to reduced intermediation margins when interest rates increase.
- Sovereign–bank nexus:
  - Systemic risks from the sovereign-bank nexus are elevated and could potentially threaten financial stability.
  - Elevated fiscal vulnerabilities, limited access to international financing, and the risk of tightening financial conditions (monetary policy contractionary) increase the relevance of sovereign stress.
  - Regional insecurity and geopolitical tensions could exacerbate macro-financial stability risks.
  - Increased holding of sovereign debt by the banking sector could limit banks' capacity to extend private credit.

### Regulatory progress and remaining vulnerabilities
- Regulatory and supervisory advances in 2023:
  - New statutes for the banking and microfinance sectors adopted by the WAEMU Council of Ministers.
  - Supervisory framework has become more risk-oriented.
  - Supervisory resources have increased and supervisor’s independence has been statutorily assured.
  - Prudential regulation enhanced and aligning with Basel II/III standards, with ongoing implementation.
  - BCEAO decision to double the minimum share capital of banks expected to promote resilience and enhance financial stability.
- Remaining concerns:
  - Pockets of vulnerabilities persist.
  - Authorities should actively support implementation of risk-based supervision and be prepared for further actions if vulnerabilities intensify.

### Policy recommendations and macroprudential measures
- Authorities should consider additional measures in line with WAEMU FSAP 2022 recommendations, including:
  1. Imposing extra capital requirements within the Basel Pillar 2 framework to address interest rate and concentration risks.
  2. Ensuring the full operationalization of the banking resolution framework.
  3. Introducing new measures to reduce the excessive reliance of certain banks on BCEAO refinancing.
  4. Improving the monitoring of maturity mismatches and interest rate risk.
  5. Implementing Basel-type liquidity ratios to enhance resilience to liquidity shocks.
  6. Adopting measures to mitigate balance sheet risks.
  7. Considering the activation and implementation of the broad-based capital (CCyB) tool in the event of an increase in cyclical risks.
- The authorities’ regulatory reform has consolidated the prudential base and established conditions for further strengthening banking supervision and macroprudential policy effectiveness.

### Annex highlights: macroprudential toolkit and calibrations
- Countercyclical capital buffer (CCyB):
  - Regulations allow a CCyB up to 2.5% of total RWAs; criteria for activation to be determined by BCEAO instruction.
  - January 2018. This rate is currently 0%.
- Capital conservation buffer (CCoB):
  - Set at 2.5% with phased increases: 0.625% effective January 1, 2018; 1.25% effective January 1, 2019; delays in 2020; 1.875% effective January 1, 2021; 2.5% effective January 1, 2022.
  - January 2022.
- Limit on leverage ratio:
  - Minimum leverage ratio of 3% effective January 1, 2018; SIBIs may face higher ratios.
  - January 2018.
- Limit on distributions:
  - Distribution restrictions by CET1 ratio ranges (examples preserved verbatim):
    - 5% and 5.625%: retain at least 100% of distributable profits;
    - 5.625% and 6.25%: retain at least 80% of distributable profits;
    - 6.25% and 6.875%: retain at least 60% of distributable profits;
    - 6.875% and 7.5%: retain at least 40% of distributable profits;
    - 7% or above: retain 0% of distributable profits.
  - January 2018.
- Capital surcharges for systemically important institutions:
  - Capital buffer set to 1% effective March 27, 2020, with transitional build-up: 0.40% effective June 30, 2021; 0.70% effective June 30, 2022; 1% effective June 30, 2023.
  - June 2022.
- Liquidity tools:
  - Provisional liquidity monitoring including a liquid asset ratio (three months maximum) implemented April 2018.
  - April 2018.
- Sectoral risk weights and thresholds (household and corporate exposures) effective January 1, 2018, including retail risk weight of 75% and conditions for residential property weights (35% with DSTI and LTV limits).
  - January 2018.
- Limits on foreign exchange positions:
  - Banks generally not allowed to maintain open FX positions due to surrender requirement; BCEAO dispensations allow balances up to the equivalent of 5% of total customer demand deposits.
  - January 2018.
- Measures to mitigate interconnectedness:
  - Additional risk weights on exposures between financial institutions: 250% when counterparty fails solvency ratios; 1250% when counterparty has negative capital.
  - January 2018.

### Regulatory treatment of sovereign exposures
- No explicit regulatory restrictions on bank lending to sovereigns under current BCEAO Prudential framework.
- Large-exposure limit to a single counterparty is 25 percent of Tier 1 capital, but sovereigns are excluded (PF:457); PF:460 allows BCEAO to introduce sovereign concentration limits (not used to date).
- Internal bank limits on sovereign exposures exist in some bank groups.
- Risk-weighting under Pillar 1:
  - 0 percent risk weighting for sovereign exposures in local currency (PF:117).
  - For WAEMU Eurobonds held in the banking book, risk-weighting ranges from 0 percent to 150 percent depending on external rating (PF:115).
- WAEMU FSAP 2022 recommendation:
  - “Targeted” additional capital surcharges for banks most exposed to sovereign concentration risks (short-term priority), usable under Pillar 1 or Pillar 2.
  - Recommendation to introduce concentration limits for assets under BCEAO’s collateral framework to ensure diversity of eligible assets for refinancing.

### Defaults on sovereign exposures and forbearance
- Classification and provisioning:
  - Sovereign exposures are categorized as non-performing after 180 days of default (Ins.26:8 and PF:155) versus the standard 90 days; provisioning is optional (Ins.26:16).
  - Once classified non-performing, risk weight jumps from 0 to 100 percent (if provision coverage at least 20 percent) or to 150 percent (if provision coverage smaller than 20 percent) for the uncovered portion (PF:157).
- Temporary regulatory forbearance for Niger sovereign securities:
  - On January 22, 2024 BCEAO issued a regulatory forbearance decision exonerating Niger securities from classification as “non-performing” after 180 days, to forestall adverse effects on bank capitalization.
  - Rationale: Niger’s halt on servicing public debt is due to operational inability to execute payments because of sanctions, irrespective of capacity to service.
  - Only securities (accounting for 88 percent of total bank exposure to Niger sovereign) were subject to forbearance; direct loans represent 12 percent of total bank exposures to Niger (mostly held by Nigerien banks) with no spillovers beyond the individual affected loans.
  - BCEAO conducted stress tests to identify banks most exposed to Niger’s debt servicing halt; identified banks will be instructed to take measures for capital preservation (such as dividend withholding) and subjected to intensified supervision.
  - In the absence of forbearance, exposure to securities not serviced by Niger government would have worsened capitalization of affected banks starting from end-January, 2024, and over time debt service arrears would accumulate.
  - Niger government debt service arrears started on July 31,

*Source: sipea2024014 (selected issues paper chapter).*

### 2023. After 180-days, i.e. end-January, banks’ exposures to Nigerien sovereign would have normally (i.e. in

### sipea2024014 - 2023. After 180-days, i.e. end-January, banks’ exposures to Nigerien sovereign would have normally (i.e. in

### Classification of Niger sovereign exposures after 180 days
- After 180-days of missed payment (i.e., end-January), banks’ exposures to Nigerien sovereign would have normally (i.e. in the absence of regulatory forbearance) been classified as “non-performing” (NPLs, with loans referring to both direct and indirect loans, which are unlisted securities).
- In the case of a security:
  - All exposures to Niger government debt of the same bank holding the security with missed payment beyond 180 days would become classified as NPLs.
  - There would be no contagion to other banks unless those banks themselves experienced a missed payment on the same security.
- In the case of direct loans:
  - Due to their less standardized nature, only that loan would become NPL after 180 days of missed payment (PF:158).

### Implications for risk weights, provisioning, and capital adequacy
- As a result of NPL classification:
  - Risk weight of the sovereign exposures would jump from 0 percent to at least 100 percent, and likely to 150 percent (associated with NPL provision cover smaller than 20 percent, given that provisioning for sovereign lending is generally low, as it is optional).
- Effects on capital adequacy:
  - The capital adequacy ratio would be reduced due to an increase in the denominator (higher risk weighted assets).
  - There would also be an effect on provisioning and thus capital, as past-due interests would enter the income statement and must be fully provisioned.
- Dynamic deterioration:
  - As debt service arrears on Niger’s public debt reach the 180-day mark and continue to accumulate, the situation would deteriorate over time.

### Holdings and arrears statistics
- As of end-2023:
  - Over 80 percent of Niger debt issued through the auction segment of the regional sovereign security market (UMOA-Titres, which accounts for great majority of Niger sovereign securities) was held in other WAEMU countries and by the BCEAO.
- By February 5, 2024:
  - The Government of Niger accumulated CFAF 300 billion (about US$480 million, 2.9 percent of GDP) of arrears on debt service.
- In 2024:
  - CFAF 265 billion is due in debt service (of which CFAF 216 billion principal, and CFAF 49 CFAF interest payments).

### Policy and institutional developments
- On February 24, 2024:
  - The ECOWAS Commission issued a decision to lift most sanctions (notably economic and financial ones) on Niger with immediate effect.

*Source: sipea2024014 - 2023. After 180-days, i.e. end-January, banks’ exposures to Nigerien sovereign would have normally (i.e. in*

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_Source: https://www.imf.org/-/media/files/publications/selected-issues-papers/2024/english/sipea2024014.pdf_