The big South African banks have strengthened their hold on the market, but are likely to be transformed by the country’s proposed financial empowerment charter, says Moody’s Investors Service in a new Banking System Outlook on South Africa.
Although Moody’s long-term view is positive, it believes the country’s banks face operational and strategic challenges over the medium term.
During 2002, it notes, the South African banking sector suffered a liquidity and confidence crisis that led to the disappearance of several second-tier banks but benefited the major banks which now have an even stronger hold on the market.
“Although underpinning the franchise of the big banks, Moody’s believes that these developments have resulted in lowering the level of competition in the market,” the rating agency stated.
“Nevertheless, options for business growth within South Africa in a low-risk and cost-efficient manner remain scarce,” says Mardig Haladjian, a Moody’s senior vice president and author of the new report. As a result, Moody’s believes that in the future, the risk profile of South African banks will rise as they seek to enlarge their target customer base beyond the well served affluent sectors.
“An obvious area, that of serving the low-income earners — a large section of the population that remains outside the formal banking sector — remains one that the large banks are still reluctant to enter directly due to the perceived high risk,” says Haladjian.
“However, in addition to growing pressure from the government to support the sector, we believe that the prospective financial sector charter will provide banks with greater urgency to become more meaningfully involved,” the analyst adds.
Moody’s envisages that the prospective financial charter will pose medium-term challenges to the banks, as they strive to undergo rapid changes to reach the desired objectives.
“Undoubtedly, the banks will need to include more black South Africans and empowerment groups in their shareholders, directors, management and employee base, suppliers, and customers,” explains Haladjian.
These changes are likely to expose the banks to greater operational and strategic challenges.
“However, on the benefits side, as banks undertake such changes, they will be recognised as empowered groups and will be eligible for government-related contracts, as well as offering an empowered counterparty option to other companies,” the analyst comments.
Moody’s also believes that the banks will face further challenges from falling interest rates, which have just seen their first cut of 150 basis points on June 12. During 2002, interest rates were raised by 400 base points, pushing the prime lending rate to 17%. The rating agency says that high interest rates have given the banks nice spreads, but these are expected to be reduced as interest rates follow the downward trend of the inflation rate, which is firmly moving towards the government’s target band of 3%-6%.
Based on these expectations, Moody’s believes that over the next few years, the government’s inflation targeting framework of monetary policy will change the interest rate environment and challenge the banks’ earning power. Banks that fall behind in tapping higher margin businesses in a cost-effective way, and in growing non-interest revenues and raising their operating efficiency, will feel profit pressures. However, all the banks rated by Moody’s have policies that address these issues. – I-Net Bridge