Benin [UMOA (2001)]. The share of nonperforming loans to the service sector is much lower in other countries, especially in Mali, where it consistently accounts for less than 10% of the total portfolios of problems loans. Most impaired loans in this country are owed to the agricultural and fishing sectors, which account for 53 percent of all problems loans [UMOA (2001)], a reflection of high vulnerability of banks to undiversified economies.

# **III. Determinants of Nonperforming Loans: Stylized Facts and Causal Analysis**

The accumulation of nonperforming loans is generally attributable to a number of factors, including economic downturns and macroeconomic volatility, terms of trade deterioration, high interest rates, excessive reliance on overly high-priced interbank borrowings, insider lending and moral hazard [Goldstein and Turner (1996)].<sup>26</sup> In a context of low equity and absence of diversification, terms of trade deterioration and interbank loans played a key role in the accumulation of nonperforming loans in Sub-Saharan Africa. The latter also increased the risks and prospects of moral hazard. Moral hazard in the banking sector context refers to the adverse incentives created by the prospects of implicit coverage of banks losses by governments. It can be particularly high when banks’ capitalization is low; in such cases, it often leads to adoption of imprudent lending strategies with direct implications for banks’ loans portfolios which tend to be heavily skewed toward high risk projects. When these projects are owned by investors and entrepreneurs directly or indirectly connected with the lenders, the financial transaction is termed as insider lending.<sup>27</sup> The minimum capital requirement for banks remains relatively low during most of the 80s and beyond, a deliberate policy adopted by countries in support of the emergence of a domestic banking system. In light of the inverse relationship between moral hazard and banks’ capital, this deliberate policy exacerbated the banking crises and its inherent costs for Sub-Saharan African countries, however [Brownbridge (1998)].<sup>28</sup> Indeed, moral hazard was pervasive in the practice of banking in the nineties, and at such was singled out as one of the leading causes of a dramatic increase of nonperforming loans. In Nigeria for instance, moral hazard which fueled insider lending is believed to have accounted for over 65 percent of impaired loans in four banks liquidated in 1995. Similarly, most of large local banks failures in Kenya involved extensive insider lending [Bronwbridge (1998)].

This section investigates the determinants of nonperforming loans using correlation and causality analysis. The analysis is based on data drawn from 16 African countries (7 CFA and 9 non-CFA). The sub-panel of CFA countries includes: (1) Benin, (2) Cameroon, (3) Chad,

> 26 With the distressed financial system, interbank borrowings became the source of funds for most financial institutions. In Nigeria for instance, two of the failed Merchant banks had mobilized 84% and 68% of their total deposit liabilities from interbank deposits, respectively [Manu (1994)], a situation that led to rapid increase in interest rate. Real interest rates at over 20 percent were not uncommon for interbank borrowings.

> 27 Insider lending is not specific to Sub-Saharan Africa however; over the years, it has been singled out as the major cause of banks failure around the world [Caprio (1997)].

> 28 For instance, during that period, the minimum capital requirement was less than US$50,000 in smaller countries and no more than half a million dollars in larger economies such as Kenya and Nigeria. However, an increase in the capital requirement and banks capitalization was part of the restructuring measures. Over the past few years, capital requirements have been significantly increased in most countries. For instance, in Kenya, all banks were obliged to raise their minimum capitalization from US$1.2 million to US$3.2 million in 1999. Since then this amount has been increased further. Similar measures were undertaken in other countries in Sub-Saharan Africa. In late 2004, the Central Bank of Nigeria announced a new minimum capital requirement of over US$180 million, representing more than 1150% increase from its previous level of US$14.5 millions.

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