Retail banks continue to feel the strain of burdened consumers, as higher interest rates and lower disposable income slows down the appetite for new debt, the latest Ernst & Young bank index released on Tuesday indicates.
The index results show that banking confidence fell once again, from 68 points in the second quarter of 2008 to 61 points in the latest quarter.
The fall in bank confidence was entirely attributable to the retail banking sector, with retail bank confidence continuing to decelerate from its first-quarter reading of 78 index points to its current reading of 40.
Investment banks, on the other hand, saw confidence levels remaining virtually stable, (moving from 79 to 81 index points). Although investment banks’ confidence has slipped from its highs of 2007, it remains nevertheless strong.
The survey is conducted by the Bureau for Economic Research in Stellenbosch.
Said Emilio Pera, lead banking director at Ernst & Young: “Lower retail banking confidence is in line with expectations, with higher inflation and interest rates likely to continue for a while yet.
“The demand for credit from the personal segment of the market is likely to remain pressured, particularly at the middle and lower middle segments of the market, where the burden of squeezed disposable income coupled with high interest rates is felt the most.
“The banking sector is being bolstered by strong corporate demand for credit. The large banks, which operate predominantly in the middle and upper segments of the personal market, are facing a profit squeeze in this segment. However, they are currently benefiting from their investment bank earnings.
“The large South African banks all have an element of diversification, hence their overall earnings are protected from a slower retail market. The structure of the South African banking market has allowed it to weather the current global financial market instability relatively well.”
Pera pointed out that there is still an element of retail banks that is trading well, despite current economic prospects.
“The banks operating in the lower segments of the market are generally the smaller banks, which have developed their expertise in growing this market over a long period of time. These banks are continuing to see rising demand for credit, given that consumers in this segment are largely un-mortgaged, and hence not feeling the impact of higher interest rates.”
The survey fieldwork was conducted prior to the collapses of Lehman Brothers and the bailout of American International Group by the United States Federal Reserve.
Said Pera: “It will be interesting to see if sentiment among corporate and investment banks changes on the back of current global events. While South African banks overall have minimal exposure to the latest round of US corporate failures, the risk of continuing International corporate failures grows, and with that, so does the ultimate risk to global financial stability, including local banks.
“Thus far, South African financial services companies have largely been insulated from offshore events. But there are secondary impacts on the local banking system. Most notably, the cost of funding rises, as global capital becomes scarcer. Local banks raising additional funding on global markets, will pay higher rates, and that higher cost in turn, will ultimately be passed on to clients.”
He added: “From a competitive perspective, there is likely to be less interest from foreign banks in the South African market right now. However, this may provide opportunities for local banks as they expand their footprint, particularly into Africa.”
Pera also commented on the growing gap between expenses and revenue growth, a theme that is common across all financial services segments.
He said: “Following the last few years of strong revenue growth, expenses rose in response to the increased capacity needs. In addition, the banking industry was subjected to sharply higher regulatory and compliance requirements, which pushed the cost base up strongly.
“The dual impact of having to increase capacity, while … facing greater regulatory disclosure, has led to a quantum increase in the cost base.
“While those costs were easier to absorb in a more favourable environment, revenues are no longer growing at the same rapid pace, and the banks have found it difficult to contain costs in line with the slowing revenues. As a result, efficiency ratios are rising, after having shown considerable improvement prior to 2008.”
However, continued Pera: “We are starting to see cost growth falling in the case of retail banks. Even so, a major cost driver in this economic environment is non-performance loans, which have grown substantially since the beginning of 2007.
“But retail and investment banks have slowed the pace of hiring, the retail banks particularly so. Fewer projects are being initiated, and some that have already started have been placed on hold for now, as banks seek to ensure that revenue growth remains in excess of cost growth.”
In conclusion, the retail market environment remains undoubtedly tough, with interest rates likely to remain high at least into next year, when inflation may start moving down again.
The corporate sector, on the other hand, has a stronger appetite for debt, even at higher interest rates, as the country’s infrastructure rollout continues. — I-Net Bridge