The latest Ernst & Young Banking Confidence Index shows that both retail and investment banks faced slower growth in income flows in the first quarter of 2007. Coupled with this, there was definite pressure on interest margins.
Despite these concerns, all banks reported they remain satisfied with the current business conditions.
These are the findings of the 21st quarterly Ernst & Young Financial Services Index released on Monday. The research and analysis of the study were done in conjunction with the Bureau of Economic Research (BER) at Stellenbosch University.
Confidence is measured by satisfaction with prevailing business conditions, and the survey monitors both retail and investment banks.
Says Anton de Souza, lead financial services partner at Ernst & Young: “Investment banks particularly experienced margin squeeze during the first quarter. Although there is strong demand for corporate debt as the country gears up for 2010, and increases infrastructure capacity, the competition to finance these projects is often intense. The rates that corporate entities can negotiate often mean that the margins are severely pushed to the bone.”
“Retail banks also experienced margin squeeze. The interest rate increases of 2006 have meant that over time, banks have had to re-price deposits, particularly fixed-deposits, and this has resulted in margin squeeze. In addition, there has been a major competitive push for retail deposits, as the savings market has declined, and banks have had to pay considerably more to depositors to attract retail monies.”
The pressure of lower interest income and fee income for investment banks, coupled with considerably higher expenditure, resulted in a strong fall in net profits growth. Retail banks, on the other hand, were able to shrug off the effects of lower interest and fee income earnings, and continued to report growing net profits after tax in the first quarter of 2007.
Retail banks reported rising net profits, despite lower income and higher cost growth. Says de Souza: “There may not have been an impact on the bottom-line profits just yet, but should margin squeeze, coupled with lower fee income growth continue, it is only a matter of time before slowing net profits result.
Investment banks, on the other hand, reported a noticeable decline in net profits after tax. Close to all investment banks have seen rising operating expenses, on the back of strong growth in employee numbers, as they have beefed up capacity to cope with stronger business activity across most business units.
“However”, says de Souza; “investment banks have not faced rising non-performing-loans as yet, and it is unlikely they will face these for a while yet. Unlike their retail banking peers, who have already seen strong rises in NPL’s [non-performing loans] in the aftermath of 200 basis point increases in the repo rate last year, corporate entities are less interest-rate averse. This has to some extent provided a cushion for the bottom-line for investment banks.”
On the question of operating costs, De Souza said: “The banking industry has been a net creator of jobs for a number of years now. Unlike in the early 2000’s, and following the banking liquidity crisis which crippled a number of smaller banks, the industry has been a strong positive influence on economic growth, employing a few thousand additional employees each year.
The expectation for the second quarter of 2007 is that this trend will continue, both for retail and investment banks.”
Another feature of the survey’s findings is that NPL growth in the retail bank market remained flat, albeit at a high level, in the first quarter, whilst remaining marginal in the case of merchant banks.
Retail banks continue increasing their provisions against potential losses, while investment banks have understandably eased provisions, as their NPL situation remains benign.
“There is still a risk that interest rates continue to rise over 2007, and the volatile oil price could still lead to interest rate rises pushing more retail bank clients into default. In fact, should interest rates rise too rapidly, this could start hurting the investment bank environment too.”
The industry continues to be a net creator of jobs, although there are signs that in the case of investment banks, the rate of employment growth may have peaked.
Merchant banks anticipate that their employee numbers will remain constant in the first quarter of 2007. Retail banks, on the other hand, continue to anticipate strong growth in employee numbers. De Souza believes this may be driven by regulatory and compliance requirements, such as the National Credit Act and the Basel II Accord.
“The outlook for both retail and investment banks continue to look favourable. Provided interest rate hikes do not dent consumer spending too sharply, the banks should be in a position to continue benefiting from strong economic growth prospects. Although the National Credit Act takes effect in the second half of 2007, and will have an impact on revenue flows in the lower-income segments, this is unlikely to impact too negatively on the retail bank environment,” he said. – I-Net Bridge