Cape Town - South African banks are facing growing credit risks as the economy worsens, warned Standard & Poor's on Thursday.
The rating agency stated in a report that South African banks face profitability pressures over the next few years amid a weakening economy and rising credit risks.
"The outlook on all banks we rate in the country turned negative at the end of 2015," said S&P's credit analyst Matthew Pirnie.
He explained this reflects the negative outlook on the sovereign, the prospect of slower economic growth, rising interest rates, and inflationary pressures on the banking system's asset quality.
"We expect top-tier banks will face credit losses on their lending activities ranging between 0.9% and 1.2% in 2016, worsening by another 20 basis points in 2017," cautioned Pirnie.
Elements of market dislocation are also entering South Africa's banking system, noted S&P.
The rating agency was referring to Barclays' Africa unit Absa [JSE:BGA] which is up for sale, Old Mutual's Nedbank [JSE:NED] that is likely to be divested, the re-entry of African Bank, and Capitec Bank [JSE:CPI], which is shaking up mass market retail banking in the country.
"We expect regulation of the South African banking system to remain a supportive factor for the ratings on domestic banks, but we also believe it will be an increasing strain on profitability and management time in 2016."
Plans to introduce a twin regulatory structure - aimed at separating prudential regulation and market conduct of financial services - under the South African Reserve Bank and the Financial Services Board, respectively, have been delayed into 2016.
"With the exception of some additional managerial oversight and management time, and potentially some fee and commission changes, we don't anticipate any material changes for the banks under the new framework."
Funding pressures cool down
S&P added that funding pressures on banks have eased a little due to the proposed regulatory discretion on the requirements on banks of net stable funding ratio - this is the proportion of long-term assets which are funded by long-term, stable funding.
"The recent proposal for national discretion on the net stable funding ratio (NSFR) was positive news for the banks. It will allow a lower weighting for less-than-six-month funds from institutional investors. Using this discretion, the banks will meet the NSFR and have already met (with or without the use of the committed liquidity facility) the liquidity coverage ratio," the report stated.
However, the rating agency expects the restructuring of funding to continue, albeit at a slower pace.
S&P indicated that it still considers short-term concentrated wholesale funds to be a common idiosyncratic risk for most of the banks in the sector. Yet systemic risks are lower than in other emerging markets because of the closed rand system and minimal reliance on external and hard currency funding.
"We expect that changing funding profiles, regulatory changes, and rising credit costs will place pressure on the industry's profitability in 2016 and 2017, despite the endowment effect from increasing interest rates," said Pirnie.
Expansion into Africa
Another key change for the banking sector over the past few years has been its growth into Africa.
"This trend was driven by a perceived need to diversify out of South Africa and follow the domestic corporates into the continent. In 2015, banks' reported revenue contribution from Africa differed significantly between individual banks. The rest of Africa contributed approximately 25% of headline earnings in 2015 for Standard Bank Group [JSE:SBK] but only 6% of headline earnings in 2015 for Nedbank Group.
"We do not expect the banking sector's African exposure will be a material differentiator of bank ratings in 2016, but it could be a source of additional credit impairments, add some potential capital drain, and provide a lower contributor to revenues given the pressures faced on the continent."
The weakening economy
S&P expects the economy will grow by 0.8% in 2016 and 1.8% in 2017, slowing from 1.3% in 2015. It said the reasons for the weakening macroeconomic outlook are manifold.
They can broadly be bracketed into two groups: long-term domestic structural challenges, such as low wealth, poor labour market relations and infrastructure bottlenecks; and short-term domestic structural challenges, such as low business confidence, the prolonged drought, constrained electricity supply and somewhat restrained household spending.
Some external pressures are also dragging on growth, said S&P. For example, commodity prices are down, largely due to weaker demand from China, South Africa's biggest export destination. Meanwhile the weak growth, political mismanagement and generally negative sentiment against emerging markets, including South Africa, have weakened interest from foreign as well as domestic investors.
"The resulting portfolio outflows have caused significant currency deterioration, which has accelerated inflation and raised interest rates," said S&P.