(John McCann)
The threat of further credit ratings downgrades and the risk that billions of rands may leave South Africa has thrown a light on the Public Investment Corporation’s exposure to any potential hit to the country’s stock market, and particularly its banks.
The PIC manages R1.8-trillion in pensions on behalf of the Government Employee Pension Fund. The state asset manager is a main shareholder in the country’s major banks, which together have assets of roughly R4.8-trillion, according to a PwC banking survey.
At the end of 2016, the PIC owned about 6.9% of Absa, 6.2% of Nedbank, 11.8% of Standard Bank, 9.5% of First Rand and 7.4% of Capitec.
The PIC’s exposure to the local banking system would be one of the things the Reserve Bank is aware of, because its size makes it systemically significant to the financial sector, said Kuben Naidoo, registrar of banks at the Reserve Bank.
But the bank has not considered the risk to be high, given the local banking sector’s ability to withstand a severe market shock. In addition, the PIC is well capitalised, he said, and the nature of the government pension fund, which is a defined benefit pension fund, as well as its high funding levels of about 100%, makes it a stable investor in the local stock exchange.
If there was a major market event that required the PIC to recapitalise the banks, this could potentially increase contingent liabilities for the state, Naidoo said.
The concentration of the PIC’s holdings in the banks means it is not an insignificant element in the wider financial system. This is partly thanks to Basel banking regulations, which place stringent capital requirements on banks, including holding tier-one capital — essentially, shareholder equity and retained earnings that can be used to absorb losses and keep a bank running during an adverse event.
On Tuesday, in its latest financial stability review, the Reserve Bank said that, despite the recent credit ratings downgrades by S&P Global and Moody’s, the local financial sector could withstand any adverse shocks.
Following the president’s recent Cabinet reshuffle, the country’s sovereign ratings were downgraded, as were the credit ratings of all the major banks. The rand fell 12.2% during this period before recovering, and the banks saw a drop in their market capitalisation of R140-billion, according to the review.
Deputy Reserve Bank governor Francois Groepe said the central bank believed that local banks could withstand a major market event.
Last year, the Reserve Bank conducted a common scenario stress test, which consisted of four macroeconomic scenarios including a severe scenario of protracted recession and a most adverse scenario, characterised by excessive financial market volatility and risk aversion.
In this scenario, portfolio outflows would spike and inflows would dry up, resulting in an assumed 56% depreciation in the currency. Inflation would rise because of a weakening exchange rate, and so would interest rates to counter the inflationary effects of the currency depreciation. Groepe said the banks were so well capitalised that even in such a scenario far worse than the impacts seen recently, they could withstand a severe shock.
Although banks were well insulated against a crisis, the Reserve Bank warned of the likelihood of further credit ratings downgrades and more financial losses for South Africa. Should the local currency debt be further downgraded, this could have a “significant impact on the country’s cost of funding and investment flows into the country”.
Increased market volatility could see losses in the currency, bond and equity markets, negatively affecting domestic financial system stability.
The potential exclusion of South Africa from key global bond indices as a result of further downgrades was particularly “disconcerting” given the country’s dependency on portfolio inflows to finance its current account deficit.
It viewed the probability that South Africa would continue to be downgraded as high. This was likely as a result of, among other things, weak economic growth, political developments, fiscal sustainability, notably concerns over contingent liabilities linked to state-owned enterprises, and the slow progress with structural reforms.
Expected impacts on South Africa’s financial stability included capital outflows, further downgrades for the banks, leading to higher cost of and reduced access to funding for banks.
Nevertheless, the banking sector’s strong capital buffers were reflected in a total capital adequacy ratio of 15.9%, well over the minimum regulatory requirement of 9.75%, according to the Reserve Bank.
Other key indicators aimed at ensuring the banking sector’s robustness include the liquidity coverage ratio, which, according to the review, rose to 110% in January, far above the minimum level of 70%.
The liquidity coverage requirements are aimed at ensuring that a bank has sufficient high-quality liquid assets to cover a short-term outflow of funds.
Aside from the various capital and liquidity buffers, there are a range of mechanisms available to banks to mitigate against an “unlikely” crisis, according to Costa Natsas, banking and capital markets leader at PwC.
These “mitigating management actions” could include halting dividend payments, revaluating staff requirements and making an effort to contain costs.
PIC mindful of the risks of further downgrades.
The Public Investment Coporation (PIC) was mindful of the risks of a further credit ratings downgrade on the country’s local currency debt and the adverse effect it may have on South African companies, said its head of corporate affairs, Deon Botha.
But the state asset manager had full confidence in the South African Reserve Bank’s view that local banks were adequately capitalised to deal with the effects of a cut to a sub-investment grade, he said.
There had not been any need for the PIC to discuss its holdings of bank shares with the reserve bank as these holdings remain within its clients’ mandated parameters and within the regulatory limits of the Banks Act said Botha.
The PIC’s clients include the Government Employees Pension Fund, as well as smaller funds such as the Unemployment Insurance Fund (UIF) and the Compensation Commission Fund.
Any changes to these shareholdings are driven by client mandates and the PIC’s investment strategy he added.
The PIC is “not a short-term investor”, and all investments are managed with the objective of ensuring that the growth in client assets meets or exceeds the growth in their liabilities. This reduced risk for clients and ultimately for government he said.
This story has been updated to include comments from the PIC which did not arrive in time for our print deadline.