The banks have come out swinging over comments by Reserve Bank Governor Tito Mboweni that they are making “prosperous” margins.
Mboweni told the Financial Mail he saw no justification for the 3,5% margin between the Reserve Bank’s 7% repo rate and the 10,5% prime rate charged by the banks.
“If a bank is borrowing money from the central bank at 7%, why shouldn’t it lend that money on at 7%?” he told the Financial Mail.
In reply, a report by Merrill Lynch research analyst Alan Hartdegen suggests South African banking margins are already lower than in many other developing countries. “We suspect his comments were taken out of context. For starters, the gap is a poor measure of sector lending margins, as banks generally do not lend at prime, but merely price their loans off it.”
Leon Claasen of CA Ratings says banking margins have been falling in recent years owing to competitive pressures. “The average margin earned by banks has been falling steadily over the past five or six years, which is why banks have developed alternative non-interest income sources,” he says.
Mboweni told the Financial Mail he has researched the issue and found there is no theoretical or clear market basis why the margin can’t be 2,5% or even 0%, other than that it’s become a highly profitable convention for the banks.
Repo is the rate at which the Reserve Bank lends to commercial banks in its role as lender of last resort. Banks typically borrow from each other through the inter-bank market to meet their daily funding demands, but will approach the Reserve Bank if there is any shortfall. In this way the Reserve Bank ensures the repo rate is the benchmark lending rate throughout the economy.
Reserve Banking lending typically forms a small part of a commercial bank’s funding mix. A far larger part comes from deposits, which, in the case of cheque accounts, are often free. This means the banks’ average cost of funds is usually less than the repo rate, but the rate at which some of this money is on-lent is also less than prime.
Several years ago only large corporations could borrow at less than prime. Today, a larger percentage of home owners are able to finance their properties at one or two percentage points below prime.
Credit card debt, because it is more risky, typically attracts interest at well above prime.
Research by CA Ratings shows Standard Bank has reduced its reliance on interest income in recent years: net interest income as a percentage of total income was down to 39% in 2004 from 51% in 1999. The trend is the same in the other banks. Absa’s net interest income as a percentage of total income was down to 47% from 59,9% in 1999.
One banking treasurer, who wishes to remain anonymous, says South Africa is relatively unique in having an actively traded prime rate. “Other countries have a prime rate but it is not much used. Part of this 3,5% repo-prime rate gap that Mboweni is referring to is the Reserve Bank’s own doing. In September 2001 the Reserve Bank disallowed the use of cash notes and coins in calculating a bank’s reserve balance. The Reserve Bank then dropped the repo rate and instructed the banks not to drop prime, so we ended up with a 3,5% margin.”
Merrill Lynch says lending margins among the big-four banks (Standard, Absa, FirstRand and Nedcor) fell 68 basis points, or 0,68%, between 1998 and 2004, equivalent to a R7,7-billion drop in sector revenues.
Coronation Asset Managers banking analyst Neville Chester says banks need a return on capital to cover their costs, a large part of which goes to funding their branch and ATM networks. “In addition, banking regulations require that you have to hold 10% capital against any loan you make. Banks have to make a return on this capital to justify shareholders giving it to them. Finally, sometimes people don’t pay you back, and that also has to be factored into the margin.
“South African banks margins have been coming down for the past 10 years … On the retail side, the advent of mortgage originators, the SA Home-loans securitisation vehicle and aggressive competing for market share by the big four banks has seen mortgage loan margins being whittled away to extremely low levels.
“Similarly, despite the strong growth in demand for vehicle loans, pricing here has also come under pressure. At the same time, the advent of large money-market funds has seen upward pressure on banks’ funding rates.
“The only reason banks have managed to maintain their levels of profitability has been owing to the volume growth and unexpected low level of bad debts, both of which will not continue for ever.”