Cape Town – A sudden interest rate increase of between 150-200 basis points or an inflation rise to 6% could have a detrimental effect on South Africa’s banks, according to ratings agency Standard & Poor's (S&P) on Monday.
The report, Negatives tip the scale for Europe, the Middle East and Africa’s emerging banking systems in 2016, highlighted the effects that low oil prices will have on about half of the banking sectors in the region.
While S&P said the economic slowdown will “likely lead to very weak lending growth, narrower margins, higher credit costs, and lower profits for banks”, it had mostly positive views regarding South Africa’s banking sector, saying its “performance has been fairly resilient”.
S&P said South African banks’ “dependence on external debt remains limited, protecting them from the effect of the rand's depreciation and risks related to changes in the Fed's monetary policy”.
“Profitability has improved moderately, and we expect this will continue in 2016,” it said. “The corporate sector's performance was largely sound in 2015, which should support banks' asset quality.”
S&P said the performance occurred despite business confidence reaching its lowest level in 10 years, due to weak economic growth prospects, uncertain political leadership, unreliable electricity supply, drought, and economic slowdown in China, the country's major trading partner.
Mortgage loans a latent risk for banks
A latent risk for banks stems from residential mortgage loans, which are exposed to a spike in interest rates, explained S&P.
“A sudden interest rate increase of more than 150-200 basis points, depending on its timing, could result in asset quality problems,” it said. “Moreover, slower economic growth, the increasing threat of higher inflation, drought, and the weaker South African rand are heightening the risk that households' real income will not stay in step with their debt-servicing capacity.”
S&P believes that if inflation exceeds the South Africa Reserve Bank's 6% target, it will pose a bigger threat to banks' unsecured or instalment finance books. “They are often at fixed rates and borrowers tend to be rather inflation sensitive,” explained S&P.
“A ratio of debt service to disposable income greater than 10%-11% could cause credit losses across the sector to increase markedly.”
SA banking evolving due to regulation
The banking industry in South Africa is evolving due to regulation, said S&P. “Compliance with Basel III funding ratios remains a challenge, given the banking system's reliance on short-term wholesale funding from financial corporations, and the lack of retail savings,” it said.
“But system-wide capitalisation remains largely sound,” said S&P.
The implementation of a resolution framework, which already has many but not all the hallmarks of a fully effective regime, is still ongoing, it said.
“Combined with Basel III, this will likely lead to changes in the amounts, characteristics, and hierarchy of debt instruments that banks and their holding companies issue in the future.”
Gloomy outlook for the rest of region
The outlook for the rest of Europe, the Middle East and Africa is that the economic slowdown will likely lead to very weak lending growth, narrower margins, higher credit costs, and lower profits for banks.
“The currencies of several countries have lost ground against the US dollar over the past 12 months, affecting banks' balance sheets and borrowers' ability to repay debt,” it said.
“We believe banking environments will deteriorate further; therefore we foresee risks increasing for banks in 2016.
Of the 153 bank ratings for S&P in this region, 79 carry negative outlooks or are on CreditWatch negative. “Our outlooks on only three ratings are positive, while one is developing and the rest are stable,” it said.
“Generally, we expect that negative rating actions will outweigh positive ones in the region's emerging banking markets.”