The role of the banking sector has never been so clear as it is now during the Covid-19 pandemic.
The conversation has moved from fintech disruption, digitisation and falling fees, to payment holidays and relief loans. The spotlight is now on how the industry will assist government in salvaging what is left of the economy.
Our big four banks are systematically important, meaning the collapse of one could trigger a financial crisis. They are too big to fail and our economy is built on their robustness and stability. So how then are they expected to give loans to businesses that currently aren't generating revenue, especially during uncertainty around when the country will resume full economic activity?
The simple answer to this is that it's good business to assist your clients. A majority of the businesses that operate in the formal sector and are affected by the lockdown are clients of the major banks. As a result, banks now have a number of business clients that are financially distressed. That said, the three to six month loss in revenue that many will suffer should not negate their long-term viability.
Under normal circumstances, when a client is unable to meet a payment obligation and defaults for a month or two, the bank will show leniency where there is an underlying presumption that it’s a temporary setback. The client will repay what they owe and remain a loyal to the bank long after the default. The bank will still earn interest, and will charge more in instances where payments need to be renegotiated and the clients' credit risk profile has worsened.
The situation we find ourselves in now is quite different. It's happening on a mass scale and the financial impact reverberates through the all the sectors of the economy, which puts banks in the precarious situation of having to manage the risks on all fronts.
So is the R200 billion guaranteed loan scheme business as usual? Not exactly. In this instance there's a bit more risk due to the lockdown, and a little less reward from a profitability perspective. The scheme outlines that the interest rate charged will be a single rate agreed to by all the banks, which means banks cannot really price for risk - a principle that is core to bank profitability. The targeted client base is generally higher risk as long as economic activity is at a standstill, as is under the current lockdown conditions. The usual convention for banks is to charge higher interest rates to riskier clients. Our banks are, after all, still businesses trying to make profits.
Banks that are part of the Covid-19 Guaranteed Loan Scheme will possibly have to settle for lower profits, but the sweetener is that the biggest risk - that of a client defaulting - will be passed on to National Treasury as the guarantor of 94% of the loan losses. The remaining losses fall on the banks. This was probably a way to ensure the banks have some skin in the game and are not making riskless profit. And sure enough, the banks stand to earn some profits if scheme is successful.
We can’t ignore the role of the regulator in all this.
The South African Reserve Bank has kept its arsenal of monetary responses tucked away for the rainy day that is now upon us. Through the Prudential Authority, the regulator has ensured that banks kept reserves over and above the Basel-mandated minimums, and has relaxed capital requirements for banks as Covid-19 wreaks havoc on our economy.
Over the next few months payments to banks will decline. This is not only due to the many payment holidays granted, but also the aggressive rate cuts delivered by the central bank that have resulted in lower vehicle and mortgage instalments for households.
Despite lower inflows from repayments, disbursements will continue. The fact that the loan scheme makes provision for three months of operational expenses followed by a six months payment holiday gives an indication of the extent of impact on banks.
In common practice, a loan disbursed today will be followed by repayments the following month. However, due to the anomalous circumstances we find ourselves in, long after the economy recovers banks will still be carrying the torch for SMEs, awaiting for repayments to commence on the lifeline that came in the form of the Covid-19 loan scheme.
The same is true for larger corporates that will breach covenants and require relief from their bankers. I hope from this we realise that this is the role of our banking system that matters most, carrying the torch when we need them to.
* Nolwandle Mthombeni is an analyst at Mergence Investment Managers.