Interview: Maria Ramos, Sizwe Nxasana, Michael Brown, Sim Tshabalala

How would you rate the structural soundness of South Africa’s banking system?

MARIA RAMOS: There are a number of factors that have differentiated South African banks from their counterparts, elsewhere in the world and insulated them from the toxicity of the global fallout. Our banks are rigorously regulated by the South African Reserve Bank (SARB), irrespective of their business model. Foreign exchange regulations and a strong culture of risk management have prevented large-scale investments in dollar-denominated assets and investment vehicles such as collateralised debt obligations and structured investment vehicles. Exchange controls and the structure of the domestic money market have prevented an exodus of liquidity from the country. And in the event of a liquidity shortage, domestic banks can satisfy their funding requirements through the interbank market. Early implementation of the Basel II requirements resulted in improved risk management – in terms of capital adequacy, liquidity risk, market risk, credit risk and operational risk – well in advance of the crisis having an impact. The process of improving risk and capital management continued as we enforced Basel II.5 requirements. In addition, South African banks are committed to ensuring that they keep pace with leading practice and regulatory developments. For its part, the SARB has shown itself to be an effective regulator as South African banks have faced challenges emerging from the crisis. The SARB has proved to be more conservative than other central banks from a solvency perspective by requiring local banks to be capitalised at higher minimum levels compared with banking sectors in other countries.

SIZWE NXASANA: Sound regulations and governance shielded the sector from the worst of the financial crisis. Throughout the crisis, banks remained profitable and capital adequacy ratios were maintained considerably above the regulatory minimum. The banking registrar’s direct access to the board and the audit committee, combined with sound governance requirements, have been effective in raising board awareness of regulatory and supervisory matters and ensuring strong risk management. Additionally, bank executives’ compensation in the South African financial services sector appears not to be substantially out of line with those in other sectors in our economy, including state-owned enterprises.

MICHAEL BROWN: In a 2012 World Economic Forum report South Africa was ranked second in “soundness of banks” behind only Canada, pointing to a very stable and strong banking system with banks showing reasonable earnings growth and strong levels of capitalisation. If you dig deeper, some pockets of the market are definitely growing faster than others, with unsecured lending growing at around 30-35%. The challenge for anybody running a bank in this environment is to hold back from pursuing this growth opportunity too aggressively without proper caution. South Africa has an emerging middle class and there are a lot of structural reasons for why this sector should be growing faster than others. However, you need to balance the opportunity for growth with the inherent risk of bad debt while also trying to ensure that there is a good outcome for society and that people do not become over indebted.

It appears the regulators are addressing the growth rate seen in unsecured lending in the right way, while we as an industry through the Banking Association of South Africa have drafted our own code of conduct for lending to this market. I do not see the risk of a “credit bubble” ahead, and anticipate the growth rate in unsecured lending to moderate over time.

Overall, there do not appear to be internally driven systemic risks and the bigger worry stems from sluggish external conditions translating into slower growth for the domestic economy. Throughout the system as a whole, we are experiencing relatively slow asset growth as individuals and corporates are currently in “wait and see” mode. And a lot of that is due to global uncertainty, which is likely to remain for a while as nobody sees a quick fix to the global financial crisis.

SIM TSHABALALA: Our regulators are among the best and toughest in the world, and our management culture is conservative and cautious. As a result, we have had less distance to travel than some of the global banks to meet the more stringent regulatory requirements that define post-crisis banking. We also have deep expertise in the practicalities of compliance with tight regulation, so we do not have to retool or staff up to nearly the same extent as some of our international competitors. The post-2008 history of banking has shown that those countries in which the banking sector has been dominated by relatively few large universal banks (South Africa, Canada and Australia, for example) have been among those with the most stable financial sectors. One reason for this has been excellent regulation, but another reason for their systemic soundness is the inherent stability of internally diversified universal banks, which can reduce their risks by operating in markets that respond in different ways and at different rates to economic conditions. Another consideration is that big universal banks can create efficiencies and economies of scale that serve our customers and shareholders better – in many situations – than smaller banks could.

To what extent does competition from non-traditional providers pose a threat to banks?

NXASANA: Non-traditional providers are both a threat and potential new partners to be leveraged. There is substantial evidence of attempts by non-traditional providers to deliver financial transactional services, with the failures significantly outweighing the successes. Often the same few success stories are repeatedly quoted as examples of non-traditional financial service providers addressing a market need. Yet seldom have successfully implemented solutions been replicated in other geographies. On the other side of the coin, banks have traditionally been slow movers in delivering services to the markets that non-traditional providers seek to target. Slow progress in this regard has been exacerbated by the challenge of engaging lower-income communities cost effectively, which traditional banks seem unable to do for various reasons.

Our view is that through partnerships between large banks and non-traditional players, we are each able to supplement our weaknesses with the partner’s strengths, thereby significantly enhancing the potential for success. The non-traditional player contributes its footprint and efficiencies, derived through providing low-cost channels and an existing trust relationship with the community. The banking partner can then contribute its insight of financial risk and the regulatory and compliance environment, in addition to its own support and delivery network. This scenario presents an opportunity to not only improve the likelihood of success, but to significantly decrease the cost to goto-market and deployment time. Additionally, each partner is able to leverage cross-, up- and down-selling opportunities into their existing businesses.

BROWN: Many cite the success of Kenya’s M-Pesa and question why it has not been replicated here. South Africa has a very developed banking infrastructure, whereas in Kenya mobile phone-based banking was established in an environment where there were no other alternatives. In South Africa, mobile wallets present just another product that people can use, while in Kenya it is almost a necessity as the only alternative was cash. While mobile transactions present another channel people can choose from, the key to mobile banking and what will differentiate it over time in South Africa is security. As security and encryption improve, people will start using their mobile devices to not only transfer funds, but will also employ mobile applications for personal financial management and share trading. The banks, mobile companies, bill providers and municipalities need to team up to allow their customers to jointly do things electronically and seamlessly. There is a lot of exciting energy that is going into this space.

TSHABALALA: We are certainly seeing increased competition from non-traditional providers. While most customers still use banks for transaction accounts, savings and credit cards, they may choose a non-banking institution for non-core products such as personal loans and vehicle credit.

We have to serve the public on their terms by ensuring that interactions are simple and streamlined. Therefore, we are expanding strongly into digital and mobile channels, and increasing our use of social media to communicate and transact with clients. Banks are already leveraging partnerships with technology companies to expand financial access. Given our strong focus on inclusive banking and the movement of banking into the mobile space, we are keen to explore partnerships that enable us to extend our footprint, particularly in areas and communities that are not well served by traditional banking infrastructure.

RAMOS: Much is often made of the threat of non-traditional entrants to an industry, and indeed a number of non-banks are driving innovations in financial services that attack incumbents with disruptive business models aimed to substantially change industry economics. Being alive to such threats is vital. That said, many would-be disruptors, while improving offerings in certain dimensions, often lack key capabilities to effectively compete on a broader basis.

Responding appropriately to changing market dynamics in the interest of customer service is central to any business’s sustainability. Customer attitudes and preferences towards banking are clearly changing. South African customers remain concerned about the security of their money, and trust in a financial institution remains important. However, single brand loyalty is decreasing as customers are becoming more and more multi-banked. Banks, like other businesses, need to adapt to live in the customers’ world by building new capabilities and developing partnerships with other businesses in the interests of serving customers much better. Every bank needs to be on top of trends in technology innovation and leveraging the impacts on the financial services sector in areas such as increased mobility and the move to online and self-service banking, and in the growth and potential of mobile payments.

We recognise the value of collaboration to leverage complementary capabilities and to bring better quality joint services and convenience to customers faster, accelerating speed to market. Retailers have wide distribution footprints enhancing access for customers and reach and they also have tremendous customer loyalty, deep customer information sets and agile trade marketing capabilities. While banks bring complementary products and services, extensive risk management expertise and powerful customer insights with which to support retail sales and service.

Information is also central to telecommunications and mobile operators, which have broad subscriber bases, excellent billing capabilities and entrepreneurial adjacencies. Partnerships here support increased customer mobility and capabilities to drive mobile payments to become more pervasive, eliminating the risks and costs of cash from society. As mobile and retail businesses expand through Africa and globally, the leading South African banks have the scale and presence to be an ideal partner for cross-border operations.

What scope is there for increasing project finance?

BROWN: We have been a strong participant in renewable energy, and renewable energy projects are one area of infrastructure spending where things are actually happening and not just being announced and planned.

Consortiums are being formed and plants are being built. I am confident that in the near future there will be decisions around nuclear as well as shale gas going further ahead, as these are achievable and are crucially needed given the current impact energy constraints are having on our economy. If the government wants growth to reach the targeted 5%, we need to have more energy than is currently produced and available.

When you look at the next phase of announced and required projects in areas like rail corridors and ports, in many ways these are still in the planning phase and there is less interest from a banking perspective as they are not yet perceived as “real”.

Certainly, if you take the full infrastructure spend going forward there will be a need for both domestic and international funding. There should be ample appetite given the current global environment where there is a search for yield due to low interest rates in Europe and the US. As long as these projects are properly structured in an environment that has good legal systems, I think securing the required funding should not be a challenge. But more importantly, the projects need to gather momentum and avoid delays as this has plagued many in the past.

TSHABALALA: The recently adopted National Development Plan commits the South African government to greater use of public-private financing, and suggests further opportunities for public-private partnerships (PPPs) will result in more rigorous assessment, shareholder accounting and reporting. While we strongly endorse this view, we are mindful that how much we can lend, and what projects we can lend to, depends entirely on the prudential rules set by the authorities, and on our ability to protect our depositors and serve the interests of our shareholders. PPPs to finance infrastructure are complicated to get right. They need a regulatory environment that protects fair competition; an acceptable rate of return and a strong cost recovery system; effective dialogue leading to a mutually acceptable balance of risk; and well-established financial institutions, capital markets and stock exchanges. South Africa has much of this in place, but we need continued dialogue between the government, state-owned enterprises and private banks to ensure that PPPs are mobilised for maximum benefit with minimal risk.

RAMOS: The majority of the infrastructure spending will be funded through revenue and budget allocations from the National Treasury or against the budgets of state-owned companies, including Transnet, Eskom and the South African National Roads Agency. This provides limited opportunities for bank funding, other than short-term facilities, as the majority of these entities borrow in the capital markets.

The involvement of banks in project finance includes the current renewable energy programme launched by the Department of Energy, with plans to put 3625 MW of new generation capacity on the grid from renewable energy sources, mainly wind and solar. These are structured as independent power projects and require project financing with an estimated debt financing of around R80bn ($9.75bn) for the entire programme over three years. Banks are also actively involved in the Trans-Caledon Tunnel Authority’s water schemes, although these are effectively government backed.

Unfortunately, activity in the PPP market remains slow, with a number of transactions taking years to close and other bids never being evaluated. Activity is anticipated in the health care and education spheres, although the timing remains uncertain. Should the government accept further private sector involvement in infrastructure development, there will be increased potential for bank funding and project finance.

NXASANA: There is significant scope for project finance in all the 18 infrastructure projects identified under the National Infrastructure Plan, which range from big projects in energy, transport and logistics infrastructure, to smaller projects in schools, hospitals and nursing colleges. The renewable energy projects have seen billions being invested in a very short space of time since the government created a policy framework and invited bids. The government has further indicated that it is exploring options for boosting infrastructure funding by enhancing the role of the country’s development finance institutions and private sector capacity.

In November 2012 the government signed the first round of agreements with selected independent power producers, which will bring an estimated R47bn ($5.73bn) in new investment. This reinforces South Africa’s seriousness about using PPPs in its infrastructure development programme. We hope this can be replicated and extended to areas beyond energy.