South Africa: Rating banking stability

The recent credit downgrade of five of South Africa’s largest domestic banks by one notch has prompted quizzical reactions from the government and local financial community, coming just as four of the banks announced improving earnings growth and a decline in bad debt.

In late February 2012, international credit ratings agency Moody’s announced that it had downgraded the senior debt and deposit rating of South Africa’s five largest domestic banks by one notch.

The South African banking sector is vast. Currently operating within the sector are 17 registered banks, two mutual banks, 12 branches of foreign banks and 41 foreign banks with local representative offices.

However, according to the Banking Association of South Africa, four of the five downgraded banks – Absa, First National Bank, Nedbank and Standard Bank – accounted for around 84% of total banking assets at the end of 2011. Investec, the fifth of the banks recently downgraded, is considered to be the country’s largest specialist bank. Given the collective market share of the five institutions that were downgraded, the decision has ramifications for the industry as a whole, both in terms of debt pricing and investor confidence.

According to Moody’s, the rationale for the downgrades is the concern that South African authorities could face challenging policy choices and fiscal constraints if multiple financial institutions required financial support at the same time. The ratings agency considers there to be less capacity to intervene and provide systemic support in the event of a sustained shock. Additionally, Moody’s said that any indication of a weakening of the authorities' willingness or ability to extend financial support could negatively affect the banks' deposit and debt ratings.

The announcement from Moody’s came just before the reporting period of country’s four leading banks, with each announcing growth in earnings exceeding 20% and a decline in bad debt. The Johannesburg Stock Exchange’s bank index rose 19.4% year-on-year between February 2011 and February 2012, reflecting strong overall market confidence in the sector. Unlike in Europe or North America, the South African Reserve Bank has not been called upon to support its banks, nor have the banks been required to write off bad debts or been subject to any form of liquidity crisis.

Critics of the downgrade, who ranged from the banks themselves to the minister of finance, Pravin Gordhan, argue that Moody’s decision failed to take into consideration specificities of the local sector, which exhibits a number of traits that distinguish it from the other major banking markets.

“The level of domestic oversight is strong and we have never had light touch regulation, which has led our banks to focus more on clients rather than trading,” Mike Brown, the CEO of Nedbank, told OBG. “This has served us well, with minimal systemic exposure to either the US subprime market or large sovereign debt.”

Sim Tshabalala, the CEO for Standard Bank, echoed the sentiment towards a clean bill of health, telling OBG, “Without exception, the leading industry players are well-disciplined, practice strong risk management, and adhere to strong governance. Capital adequacy ratios are in the low teens, and the banks have solid loan-to-deposit ratios and are not heavily leveraged. Most of our assets are held in-country, and what is held abroad is mostly in emerging markets, which have extremely limited exposure to Europe."

While South Africa’s banking sector looks to have emerged in relatively good shape following what has been a tricky 2011 for financial institutions worldwide, this does not mean that challenges do not lie ahead. Regulatory reforms in particular have provoked some concern among bankers. According to a 2011 survey of the South African banking sector by PricewaterhouseCoopers, the implementation of Basel III was revealed to be the sector’s largest challenge.

While banks in South Africa are well capitalised, the new liquidity rules brought by Basel III will require them to make fundamental changes to their business models.

“There is a weak savings culture in South Africa, with most savings being contractual with the big insurance groups, rather than the banks,” Roland Sassoon, the CEO of Sasfin Bank, told OBG. “As a result, the major banks fall short of the liquidity ratios prescribed by Basel III, which is inhibiting bank lending.”

Pressures from new liquidity requirements and prospects for declining growth are not challenges unique to the South African banking environment but given the sector’s sound financial health and high levels of regulatory oversight, any complications likely to result from the implementation of the new global regulations are not expected impact long-term growth.