Banks can’t do business as usual

The regulatory reform for banks is being transformed from post-crisis lip service into action, but the effect of these rules on profitability is forcing the sector to make fundamental changes to the way it does business.

South Africa is not exempt from this global movement and new pressures will force local banks to think twice about how and when they expand into the rest of Africa.

A KPMG report on evolving banking regulation, the second of 2015, details how regulatory and commercial pressures have changed the rules of the game in banking, and highlights where banks need to change.

Added to that are economic and commercial pressures that, on their own, would require a new approach from banks.

In 2015, the regulatory pressure is particularly high for banks in North America, Europe, the Middle East and Africa, KPMG’s regulatory pressure index found. Only Latin America and Asia are not affected.

The reforms have left many banks struggling to generate adequate profits. This year the European Central Bank became the single biggest banking supervisor in the eurozone, taking on the direct supervision of its major 123 banks.

These include Greece’s four largest that, this week, closed their doors and limited customers to a daily ATM withdrawal of €60 in the face of a potential exit from the European Union.

South Africa, as a signatory to the Basel III global reforms to strengthen bank supervision and regulation, is one of a number of nations phasing in capital and liquidity requirements intended to ensure that banks can withstand a worst-case scenario, such as the 2008 financial crisis, or worse.

The deadlines for implementation are staggered and began in January 2013.

South African banks are known to be fairly well capitalised and able to meet the capital requirements of Basel. But the new requirements do mean that banks considering expansion into other countries will need to hold sufficient cash in every economy in which they operate.

Pierre Fourie, KPMG South Africa’s head of financial services markets, said this was likely to slow down South African banking expansion in Africa.

In recent years, African operations have contributed significantly to the bottom line of South Africa’s largest banks, such as Absa and Standard Bank. Many banks have already begun to restructure and reduce their balance sheets, which are expected to increase the cost of doing business dramatically, KPMG noted in earlier reports on bank regulation.

“The Standard Banks, FNBs and Barclays have flexibility to move money in and out of the country. But the hanging requirement will restrict money moving in and out of countries’ ambits and that will mean that for those groups they will have to have more capital in each country they operate in,” Fourie said. “It’s a big challenge for the universal banking model.

“The capital and liquidity requirements mean it will be more difficult to operate in different countries and banks will have to be selective – they can’t plant flags everywhere.”

Maintaining or improving return on equity remains a priority for all the major banks, and the combined return on equity for South Africa’s four biggest banks in the second half of 2014 was 17.5%, according to PwC’s analysis of major banks reported in March this year. This compares well with a 7% return reported by major United States banks, 15.6% by major Australian banks and 16.8% by Canadian banks.

The efficiency of South Africa’s biggest banks was recorded as 54.5% – slightly more than Australian banks and slightly less than Canadian banks – and US banks recorded an efficiency rate of more than 70%.

“Balance sheet restructuring has generally been the first and most obvious response globally to increased regulatory and economic pressures,” Fourie said, but added that this had not increased what, in many cases, were very low returns on equity.

“Banks that are facing a large gap between return on equity and cost of equity need to consider a fundamental overhaul of their business models, including exiting many capital-hungry areas like private equity.”

Basel III also has a twofold liquidity requirement. Its short-term liquidity ratio requirement, the liquidity coverage ratio (LCR), stipulates that banks must have liquid assets (cash or assets easily converted to cash) to meet cash outflows during 30 days of stress. Banks now need to have more liquid assets than cash outflows, which results in the LCR exceeding 100%.

The second liquidity requirement, the net stable funding ratio (NSFR), requires long-term assets to be funded with longer-term liabilities. Longer-term liabilities are typically associated with increased funding costs.

This could negatively affect banks’ profitability unless the additional costs are passed on to the consumer. This means the NSFR ratio will also have to exceed 100%.

Nico Smuts, an analyst at 36One Asset Management, said the liquidity problems arose from South African banks experiencing a faster growth in credit extension than in deposit-taking. “It’s a problem fairly unique to South Africa. None of our banks, except Capitec, will reach the required NSFR threshold [as things currently stand].”

Banks have realised that they need to turn to more stable sources of funding. The uptake of new tax-free savings offered by the banks could also help them to meet their short-term liquidity needs.

The Basel committee continues to issue new regulations. These include consultation papers on standardised approaches to credit, market and operational risk. Also under consideration for EU credit institutions and all global systematically important banks are minimum requirements on long-term bail-ins on debt issued by the banks. This debt would require investors to take on more risk and governments to take on less. A bail-in of sorts took place when African Bank collapsed and investors took a 10% haircut.

Fourie said states were increasingly aware that they might need to take additional measures to protect themselves. “Each country needs to protect themselves, and country supervision is much stronger than it used to be.”

In South Africa, regulatory pressures emanating from the treasury have already forced one smaller player out of the market. African Bank, which struggled as a result of tighter controls on reckless lending, was placed under curatorship as signs of stress became apparent.

New measures of affordability and caps on credit life insurance, which, uncapped, had been used profitably by African Bank, were introduced by the government and have been cited as a significant factor that caused banks to tighten their lending criteria and to pull back on unsecured loans after mid-2013.

Smuts said a major South Africa-specific reform in the pipeline was the department of trade and industry’s proposed maximum interest rates and fees that could be charged on unsecured loans, which sought to bring down rates significantly.

Although this would be positive for banks’ risk, there were possible unintended consequences. “With excessive regulation on lending risk, consumers who need lending may find it more and more difficult to qualify for credit,” Smuts said.

Giles Williams, KPMG’s head of the European, Middle Eastern and African Financial Services Regulatory Centre, said: “This is a watershed moment for the industry as banks must respond to not only heightened regulatory scrutiny but [also to] increased competition, slowing economies and changing customer demands and behaviour. Just deleveraging and derisking alone will not address the myriad issues confronting banks. Banks that thrive will equally focus on improving profitability and strategies for growth.”

KPMG said the key question was whether banks could develop, or in some cases maintain, a viable strategy and business model, given these many constraints.

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