The initial shock of the Covid-19 coronavirus pandemic caused global financial market dysfunction and sharp declines in asset prices. In line with crisis expectations, South Africa experienced solvency challenges that are set to increase amid elevated debt levels.
The pandemic also placed further pressure on incomes, but, according to the SA Reserve Bank, most recent stress tests indicate that South Africa’s banking sector will remain adequately capitalised.
The Reserve Bank published its second Financial Stability Review (FSR) 2020 on Tuesday, which identifies and analyses potential risks to financial system stability.
Reserve Bank governor Lesetja Kganyago said both the finance minister and the financial sector oversight committee provided comments on the FSR prior to publication.
Speaking on the bank’s YouTube channel, Kganyago said the scars of Covid-19 would persist for years to come and that the pandemic is likely to remain the primary risk to financial stability over the near term.
The governor said the impact of the pandemic on financial stability was likely to play out over at least two phases.
“Phase one occurred during the first half of this year. This was characterised by a large capital flow shock, financial market dysfunction, a flight to cash by institutional investors and a sharp drop in economic activity.”
“Phase two is characterised by a transition from liquidity to solvency challenges for households and firms. Following the disruptions to economic activity, business closures and large-scale job losses, a sharp rise in non-performing loans and insurance policy lapse rates is being experienced by financial institutions. These will continue into 2021,” said Kganyago.
He said the second phase puts the profitability and capital positions of financial firms under pressure and the additional solvency challenges faced by smaller banks that were making losses before the pandemic had increased their risk of failure.
Kganyago said that there was a significant risk that Covid-19 could depress investment and drive up the degree of precautionary saving as households and firms attempt to rebuild wealth depleted by the effects of the pandemic.
“Furthermore, the fact that the economy is not expected to recover to previous levels of output over the medium term raises the risk that economic capacity could be permanently damaged.”
“Given the weak growth outlook, the most recent Reserve Bank forecast suggests that the repo rate is likely to remain well below its 2019 level over the medium term. A low level of interest rates has supported the debt service capacity of borrowers, but it may weigh on the net interest margin of banks, particularly if it persists in an environment of muted economic activity,” he said.
According to the report, public debt is set to rise sharply over the medium term.
National Treasury’s medium-term budget policy statement released in October showed that public debt is expected to reach 82% of GDP in the current fiscal year, and to stabilise at 95% in 2026.
“This is a substantial upward revision from the projected stabilisation of debt at 60% of GDP as recently as the 2019 national budget. Budget deficits for the fiscal years ending in 2021 and 2022 are projected at 15.7% and 10.1% of GDP, respectively.”
“This places South Africa’s near-term public sector funding requirements among the largest of its peers in emerging markets. Government also faces significant execution risk in stabilising debt, including implementing approximately R300 billion in spending reductions over the next three years, relative to the 2020 national budget projection,” said Kganyago.
Reserve Bank lead macroprudential economist Alex Smith presented the November FSR and said the magnitude of the current domestic economic downturn was difficult to overstate, but signs of a rebound are emerging.
Smith said financial market volatility and dysfunction had started to subside, in part due to aggressive policy measures from the Reserve Bank, National Treasury and other authorities globally.
“The gradual reopening of the domestic and global economy has supported an uptick in economic activity in recent months,” said Smith.
The FSR shows that in the second quarter of 2020 South Africa’s GDP contracted by 17.1% year-on-year, an outcome unparalleled over the past half century.
This massive shock to the economy was broad-based across sectors and was driven largely by the effects of Covid-19 and the measures taken to contain it.
He said South Africa’s financial system has proven its resilience through the initial phase of the Covid-19 shock. He said conditions in financial markets had started to normalise after an initial wave of volatility in the first half of the year.
“South Africa’s banking sector remains well capitalised, with high levels of liquidity. The capital adequacy ratio of the sector has remained near levels seen at the end of last year and well above the average levels over the past decade despite a recent deterioration in credit quality.”
“This, in part, reflects increased provisioning, new capital issuances by various banks demonstrating their ability to continue to raise capital during this difficult time, as well as the suspension of dividend payments. The banking sector has also increased its liquidity buffers in recent months to levels well above the minimum regulatory requirement,” said Smith.