Banks get unreserved backing

South Africa can rest assured that the domestic banks are healthy, according to the incoming Reserve Bank governor, Lesetja Kganyago.

But the risks are mounting. A stress test on European banks found 25 institutions wanting and, in the light of the recent failure of African Bank, whether domestic lenders will measure up could be cause for concern.

The South African Reserve Bank’s financial stability review, released on Wednesday, shows the financial system remains resilient despite a volatile and uncertain global environment and domestic socio-economic concerns.

“Although the current conjuncture is uncertain and several challenges remain, the financial system remains sound,” Kganyago said.

According to the review, domestic banks are well capitalised, adequately liquid and profitable. Their lending criteria are tight, growth in unsecured lending has moderated and impaired advances have decreased overall. But an overvalued stock market, rising global rates and geopolitics pose a threat.

The six-monthly review follows the release of European Central Bank stress test results earlier in the week, which found that out of 130 euro­zone lenders 25 needed to raise a total of €25-billion in new capital to withstand a worst-case scenario, like the 2008 financial crisis. But the outcome of the tests was perceived to be positive.

According to the Reserve Bank, South African banks would pass a stress test with flying colours, despite the African Bank saga this year. The flailing unsecured lender, following significant losses, was rescued and placed under curatorship by the Reserve Bank.

“African Bank has put a bit of a blotch on our reputation globally,” said Jean Pierre Verster, an analyst at 36one Asset Management. “A significant bank failure under the watch of our regulator is disappointing. But I do think that our banking industry remains one of the best regulated in the world.”

Although the review said the Reserve Bank managed to avoid systemic risk materialising, it acknowledged some spillover did occur, “especially to bond markets, money-market funds and pension funds”.

When the lender was placed under curatorship in August, the registrar of collective investment schemes confirmed that the assets of 43 money-market funds active in South Africa were valued at R270-billion, of which 1.3% was exposed to African Bank.

The Reserve Bank said money-market fund managers offset the write-downs on African Bank debt securities against the interest payments to investors. Generally, money-market fund managers said they had sufficient interest to offset the 10% depreciation.

But negative investor sentiment as a result of the African Bank saga hit fixed-interest portfolios, the Association for Savings and Investment South Africa said in a media release this week. 

This resulted in the local collective investment schemes industry recording “anaemic” net inflows of only R1.8-billion in the third quarter, a fraction of the total R95-billion total net inflows for the 12-month period to the end of September 2014.

“Severely spooked fixed-interest investors took flight out of South African money-market portfolios resulting in net outflows of R32.2-billion in the third quarter [having recorded net outflows of R36-billion for the year ended September 2014].”

Corporate bond spreads widened, becoming more expensive compared with government bonds, as a result of concerns about the domestic banking sector.

“While the sell-off in corporate bonds focused mainly on African Bank Limited, there were visible spillover effects to the wider corporate bond market,” the review said.

As a result of the rescue requiring institutional investors to bear some of the brunt of the failure, the credit rating of South Africa’s four major banks was downgraded, but that did not have an adverse effect.

“Despite being a small bank, we did see that African Bank was highly interconnected with the rest of the financial system and that is something to be monitored and managed,” said Hendrik Nel, the acting head of the Reserve Bank’s financial stability department.

“The banking sector remains sound despite the African Bank curatorship.”

Verster said: “I do not foresee any material banking failure. Our capital adequacy ratio puts us in a much better position than most other banks around the world, compared to those with single digit ratios in Europe and the United States.”

Basel III, global reforms to strengthen bank supervision and regulation, which are being phased in, require banks to have certain levels of capital and liquidity to withstand a worst-case scenario.

“If you look at the capital levels of our banks, the minimum required by Basel is actually 8%. Our aggregate is 14.6%. In that context our banks are extremely well capitalised and I think that is very important,” Nel said.

Liquidity was very important and  had increased as a result of the requirement that the banks increase  their high-quality liquid assets. All the banks would be able to meet Basel’s liquidity coverage ratio from January next year, Nel said. According to the review, lending conditions have been tightened up. 

The total gross unsecured credit exposure of the six local banks that provide these types of loan increased to almost R490-billion in June 2014 from R479-billion in December 2013. But the year-on-year growth in total unsecured lending has been moderating since its peak of 30% in November 2012 and increased by 2.3% in the first half of 2014. 

Nel said bank profitability was lower but still strong compared with eurozone, South Africa’s major trading partner, would have a negative global levels.

The ratio of impaired advances to gross loans and advances dropped from 3.6% in December 2013 to 3.5% in June 2014, the Reserve Bank reported. But “it was mainly as a result of the growth in gross loans and advances and, to a lesser extent, the decline in impaired advances”. 

There are indications of increasing credit stress with credit card default exposures increasing by 11% and vehicle and asset finance default exposures increasing by 14.8% in the first half of 2014.

The review flagged several risks, largely emanating from global and regional hazards, ranging from economic recovery to monetary policy and Ebola.

Lower economic growth in the global project to monitor and measure shadow banking and to adapt impact on the domestic economy, but the recovery in the US was of more concern, with an end to quantitative easing being imminent. The markets were also watching closely for any sign of interest rate hikes in the developed world. 

South Africa’s household wealth grew strongly, partly because of the high value of financial assets, which the review highlighted as a concern. Equity was at fairly elevated levels “and a sudden and sharp correction in equity markets could expose vulnerabilities that could have certain significant indirect effects on the financial system,” the review said.

Since 2011, the official financial sector, acting through the Financial Services Board, has been part of a the regulatory framework to better address the risks it poses. Shadow banks are non-bank intermediaries that can provide services similar to a bank, such as financing a vehicle, but cannot take deposits.

Results show that these intermediaries’ share of the financial assets of all the financial intermediaries increased from 13% in 2008 to 18% in 2013 and currently provide about 11% of total credit in the South African financial system. The review said better data was needed to identify risks in this sector as aspects such as the links between these entities and the banks were opaque. 

Kganyago said: “Shadow banking plays an important role in our economy … but it is important you are alive to it and monitor any trends that may be disturbing that coming from them.”

The assets of non-bank financial institutions, such as the life insurance industry, represented 65.4% of gross domestic product in the second quarter of 2014. If they were to suffer financial distress, it could be transmitted to the other financial institutions, creating distress throughout the system.

The review said the life insurance industry was showing signs of being affected by slower economic growth. The Reserve Bank said the outbreak of the Ebola virus in West Africa was also a serious concern. “South Africa may also be affected by the decline in tourism as roughly 72% of non-residents who visited the country between 2010 and 2013 originated from Africa.”