Warning of banks' exposure to sovereign risk

(Picture: Supplied)
(Picture: Supplied)

Johannesburg – Given the current economic situation, ratings agency Moody’s expects the banking sector to have a challenging operating environment going forward. Even though banks have adequate levels of capital to absorb these shocks, they are still highly exposed to sovereign risk.

This is according to Nondas Nicolaides, vice president and senior credit officer for the financial institutions group at Moody’s.  He was speaking on the challenges facing South Africa’s major banks at the Moody’s 11th annual South African credit risk conference in Sandton on Tuesday.

“We are likely to see a deterioration in the operating environment for banks,” he said. The low GDP growth, projected to be 0.2% for 2016, is likely to impact lending opportunities for banks, he explained.

The persistent low GDP growth environment  is expected over the next 12 to 18 months. This is coupled with pressures from inflation and the high interest rate environment. Higher interest rates have impacted borrowers’ debt affordability and the demands for loans, explained Nicolaides.

“Non-performing loans are likely to increase going forward,” he said. Profitability is likely to weaken due to rising credit costs and slower loan growth. Loan growth has come down from 10% in 2015 to 7% in the 2016 half year results, said Nicolaides.

READ: Tough macroeconomy impacts bank impairments

Moody’s rates seven commercial banks in South Africa, these include the top five. Their rating matches the sovereign rating of Baa2 with a negative outlook. This is driven by the exposure banks have to the sovereign, he explained. This is in addition to the asset quality and profitability pressures the ratings agency considers.

In 2011, the top four banks were rated at A1, this is four notches higher than the current rating. “The downgrade evolution since then has been driven by the sovereign.” Banks have not been downgraded because of their high sovereign exposures.

Besides the economic environment adding pressure to the banking sector, asset quality is also expected to come under pressure. The non-performing loan ratios are expected to increase to 4% in 2016/17, up from 3.1%. “There has also been increased defaults from the corporate side as well,” said Nicolaides. Corporate operability is coming under pressure and the deterioration is reflected in margins.

ALSO READ: Moody's underwhelmed by SA growth figures

Mortgages are holding up well, so far, but there may be an uptick in defaults, he added.

As for the liquidity and funding situation, South African banks are largely funded through institutional and corporate deposits. Only 22% of funding comes from households and retail, explained Nicolaides. This is driven by the low savings rate in South Africa.

Banks are not likely to have a liquidity crisis. “Liquidity buffers are solid,” he said.

As for the profitability and efficiency of banks, headwinds are on the way. Net interest income will be pressured from the higher cost of funding, despite the fact there is a positive endowment effect from the rising interest rates.

Credit costs are also expected to increase pressure on profitability and will grow faster than revenue.

Independence of banks

Given the proposed judicial inquiry into banks, Kristin Lindow, senior vice president of the sovereign risk group, explained that the independence of banks is mainly assessed by the need for government to support the banking system or its liquidity. “We look at the baseline credit assessment of the banking system,” she said.

READ: Gordhan: idea for bank inquiry arises from one company

Asset quality may deteriorate, but not to the extent that the government will have to step in and support banks. “We look at the source of funding to banks as a vulnerability.” Market funding has diminished since the global financial crisis. “The deposit ratio was above 100%, and now below 100%.”

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