The South African banking sector is well regulated and capitalised, as well as efficiently run. Its institutions are not only the top in the region by many measures, but rank highly globally and are potentially competitive in the developed world. Regulatory changes are set to further improve banking in South Africa in terms of soundness, stability and the treatment of customers. The sector is, however, facing a number of challenges. Economic growth in the country has slowed, which has in turn resulted in slower loan growth for banks, while high consumer credit levels, ratings downgrades and the failure of one bank have raised concerns. In addition, the overhaul of the regulatory system will result in higher costs and more restrictions for the country’s banks.
For South African institutions, stability is almost assured, but maintaining high levels of growth and profitability are the main tasks ahead. For those players with a regional footprint, there is also the tricky equation of how best to balance growth between a sluggish home market and a fast-growing but inconsistent continental market.
A Long History
Paper money was introduced in the Cape in 1782, and the first bank, Lombaard Bank, opened 1793 in order to bring liquidity to the market. The first private institution, the Cape of Good Hope Bank, was formed in 1837. Its founding was followed by the introduction of about 30 more banks, many producing their own currency. The Standard Bank of British South Africa, an imperial bank, arrived in 1877 and with two other similar institutions began to consolidate the sector and take over the issuing of paper money. A central bank was first suggested in 1879, but the South African Reserve Bank (SARB) did not begin operations until 1921.
The banking sector at present has a total of 36 local institutions in the market: 17 registered banks, three mutual banks, two cooperative banks and 14 local branches of foreign banks. A total of 39 foreign banks also have representative offices in South Africa. On the whole, the sector has been doing well. In the first half of 2015, headline earnings were up 17.7% from the same period the previous year. Net interest income increased by 9%, operating income by 8% and core earnings by 6.6%. Average return on equity was 18.2%. Metrics of soundness have also been good. In July 2015 the capital adequacy ratio was 14.35%, while the Tier 1 capital ratio was 11.51%. “All of the banks remain comfortably in compliance with present minimum required capital ratios across all capital tiers,” wrote PwC in a September 2015 report titled “Resilient Through Challenging Times: Major Banks Analysis – South Africa”.
But while business has been good, it has not been without its challenges, much of which is the result of the macroeconomic environment. The recovery from the 2008-09 economic slowdown has been weak, and lending growth has not picked up to match the rates of earlier years. Political tensions, low commodity prices, strikes and high consumer debt have weighed on banks’ business as demand has slowed and risks in some areas have increased. During the period between 1998 and 2003, credit to commercial enterprises grew nearly 15% a year; between 2003 and 2007 this same figure was above 15%. Between 2009 and 2015, commercial lending growth was under 10%, while overall private sector credit growth, after peaking at 28% in October 2006, is also stuck under 10% and has shown no signs of rising. “The economy is changing,” Cas Coovadia, managing director of the Banking Association of South Africa, told OBG. “The level of borrowing is subpar.”
Concentrated & Innovative
The sector is highly concentrated, with an estimated 90.5% of banking assets in the hands of five institutions. It is dominated by the so-called Big Four, consisting of Standard Bank; FirstRand’s First National Bank; Nedbank, which is owned by Old Mutual; and Absa Bank, which is a Barclays institution. Overall, the sector has consolidated somewhat, falling from 22 registered banks in 2003 to the current 17, with most of the activity involving smaller institutions. There have only been a handful of major acquisitions, including Barclay’s 2005 purchase of a majority stake of Absa, and Industrial and Commercial Bank of China’s (ICBC) purchase of a 20% stake in Standard Bank in 2008, but consolidation among the Big Four has not been encouraged by the regulators.
And despite the high level of concentration, there is still plenty of dynamism in the market, with smaller institutions challenging the larger players. Capitec, which was founded in 2001, has aggressively targeted interest rates and fees, offering a R5 ($0.43) flat rate monthly account and promising to slash loan rates, which has had notable results in the income-sensitive market. Capitec also announced that as of the end of 2014, 18.9% of the people in the country considered the institution its primary bank, up from 16.8% from the period ended in June 2014.
Regulators recognise that the sector is facing macroeconomic headwinds, but the challenges confronting institutions in South Africa are very different from those in other parts of the world. Unlike in other OECD countries, where risk is elevated and institutions have faced concerns over stability, the local institutions are sound and they are not in a situation where they have to build up their capital. Changes are being made to improve an already strong sector and to work on problems at the margins. Concerns are centred not on safety, but the relative speed of expansion, and this is mostly the result of macro issues, not bank management or supervision. “There are challenges,” said Rene van Wyk, head of bank supervision at the SARB, “but by all accounts, the numbers show a healthy sector. It is not like in Europe, where you have to raise capital.”
The major regulation impacting the sector is the introduction of the so-called Twin Peaks. Following the global financial crisis of 2008-09, the authorities in South Africa started developing reforms in line with those being undertaken in markets elsewhere. Though the country did not face the same sort of troubles as the markets in the West, it needs to keep its regulations harmonised with other G20 countries and robust enough to handle future exogenous shocks. The Treasury issued a policy paper outlining the move towards the new structure, and it is expected that Twin Peaks will be introduced in 2015. Under the new law, which is formally known as the Financial Sector Regulation Bill, the SARB will be responsible for prudential regulation of banks and insurance companies and for overall financial stability. A new body will be responsible for market conduct, while the Financial Services Board will be dissolved. Coordination will be improved and a central ombudsman will be formed.
Dennis Evans, the chief country officer for Citigroup South Africa, told OBG, “The robust regulatory framework in the country’s financial services sector is welcomed by all players, especially multinationals that can now harmonise operations globally. The banking sector is well positioned to meet Basel III requirements and, along with deep and entrenched equity markets, the financial services infrastructure will continue to provide confidence to investors.”
Some concern has been expressed about the cost of compliance and how that will feed into the banking system. As banks use funds to build capacity and implement the Twin Peaks programme, they will have to raise or commit more capital, which in turn will affect margins and make banks less likely to make more risky loans or investments. According to research and consultancy KPMG’s 2013 report “Twin Peaks”, increased regulation could have both negative and positive impacts. The report said, “It will increase compliance costs, increase the need for additional staff to monitor compliance, which in turn can reduce the availability of resources for innovation, change and can impact the way investors see their opportunity of return. For customers, this may mean reduced credit offering, trade finance and risk management services.” However, KPMG was quick to concede that there was much to be gained by improving the regulatory framework, despite any risks, saying, “Similarly, we cannot discount the benefits of regulation. The objective of the regulation reforms is to enhance stability, consumer protection, access to financial services, coordination between regulators and comprehensiveness whereby businesses operating in the financial services sector are licensed and registered.”
In addition to Twin Peaks, some other regulatory steps are being taken that are relevant to the banking sector. A Treating Customer Fairly (TCF) framework is being developed. TCF is an outcomes-based approach that sets specific targets to be achieved by financial institutions. It aims to ensure the following: products are designed for the customers they are sold to and meet their needs; clients are given clear information and kept informed; advice is appropriate for customers; and customers do not face unreasonable barriers if they want to change their purchase or lodge a complaint. TCF will not itself come out as its own regulation or piece of legislation, rather it will be introduced into existing and future regulations and frameworks.
The National Credit Act was amended in 2014, effective as of March 2015. According to the amendment, banks must conduct strict affordability assessments, requesting three months of pay slips and three months of bank statements. Affordability assessments have been required in the past, but there were no rules as to how exactly they should be applied. While the new statute is welcome by the sector, it is seen as possibly leading to a lending drought in the market as banks tighten standards.
For 2015 the government said that the maximum rate for unsecured lending should fall from 32.65% to 24.78% and put the proposed move out for comment. It noted that the country suffers from high indebtedness and that lowering the rate is one way to help consumers. There has been considerable resistance to the change. Banks complained that with these rates they would not be able to make loans to the less creditworthy, forcing these people into the underground market. Gerrie Fourie, Capitec CEO, told local press in September 2015, “In the next year to two years we will reduce prices on a constant basis. Our long-term plan was always to reduce interest rates dramatically, by between 5% and 10%. But you need time and stability. Traditional banks are starting to become very active in the unsecured market. The moment bigger players come in, they bring stability and market forces will bring rates down.”
Banks also argued that the cap does not take into account the costs of making the loans, in particular provisioning, which has increased in recent years. Some lenders might be forced to withdraw from the business, with Hennie Ferreira, CEO of MicroFinance South Africa, calling the proposed rates “impossible to sustain” and warning that it could lead to the growth of an unregulated market. If implemented, the cap may also reduce turnover at financial institutions by around a fifth, though some observers have said they see the cap as helping the better banks at the expense of less-efficient institutions. Stuart Theobald, columnist for Business Day, wrote, “A reduction in the cap will favour more efficient lenders, allowing them to gain market share and forcing out the less efficient. That’s good for everyone, including shareholders.”
While the rush of new guidelines has led to some concern in the sector and has prompted observers to question whether the regulators have gone too far, the regulators are confident the sector will be ready for Twin Peaks and other initiatives and that the market will not suffer from their introduction. Most banks are already in good shape and supervisors themselves have been preparing for a number of years for the challenges they are set to face. Though the regulators may be overdoing it a bit in the context of an already strong market, the safeguards can be introduced without causing too much instability. “There is not all that much left to do,” said Van Wyk.
The big opportunity for South African banks is regional expansion, a trend that was always there but has picked up considerably in recent years. For example, Standard Bank moved into Côte d’Ivoire, its first Francophone presence, in 2013, bringing its total markets in Africa to 19, and then opened a representative office in Ethiopia in first-quarter 2015. The bank’s revenues in Africa, outside its home country, are 30% of the total. In 2014 its personal and business banking unit earned R105m ($9m) in the rest of Africa, compared with a R366m ($31.6m) loss in 2013 in those countries.
Other banks in South Africa are also similarly active on the continent. In 2013 Absa took over the African business of Barclays. FirstRand, following an attempt to acquire the Merchant Bank of Ghana in 2013, started a greenfield project in that country in 2015; the bank has set aside R10bn ($864m) for regional expansion. Nedbank has also partnered with Togobased Ecobank, the pan-African institution active in 36 countries. Evans told OBG, “The sluggish growth in South Africa has not necessarily led to a reduction in corporate activity, but it has shifted the focus to more innovative solutions.”
The African strategy comes as the some institutions have started to withdraw from other international markets to concentrate on Africa and domestic lending. In 2011 Standard Bank sold its stake in Standard Bank Argentina to ICBC and divested its shares in Russia’s Troika Dialog. In 2015 the bank also sold a majority of its London global markets business to ICBC. Standard Bank said that its shift in focus back to the continent is conscious and deliberate. “Before the financial crisis, we thought we could become a bank for the emerging markets,” said Simon Dagut, from the office of the chief executive at Standard Bank. “Owing to the crisis, that was not possible. It did not work at all, and over the past 4 years we have made a deliberate shift.”
Given the long-term growth trajectory of continental markets, the Africa strategy offers a lot of upside potential, although it is not without some risk. Fitch warns that diversification increases exposure to other economies in the region and that could eventually be reflected in the banks’ credit profiles. As the strengthening US dollar and low commodity prices slow growth in places like Ghana and weaken balance sheets in Nigeria and Zambia, the level of risk inherent in those markets is becoming more prominent.
Domestic macroeconomic headwinds have also impacted banks that have helped to finance some government spending. In November 2014 Moody’s downgraded from “Baa1” to “Baa2” the long-term deposit and senior debt ratings of the five largest banks, due to the fact that South Africa’s sovereign rating was lowered a few days earlier and that banks’ have large holdings of government debt and are exposed to a weak economy and high rates of consumer debt. In another move that drew attention, in August 2014 Moody’s downgraded Capitec Bank’s financial strength rating from “D+” to “D” and its deposit rating from “Baa3” to “Ba2”, citing exposure to household lending. The bank and the SARB both objected to the downgrade, stating that the institution had a large customer base and was working within its risk appetite, with a stable outlook, diverse clientele and elevated capital levels.
While South Africa’s banking sector is one of the best capitalised and regulated in the world, 2014 did see a bailout plan for what had been one of the most prominent lower-income retail lenders: the African Bank. The bank was rescued after reporting an unexpected R8.5bn ($734.4m) loss. Originally founded in 1975 by informal traders, the bank had previously gone under in 1995. While catering to the low-income population, the African Bank had become overextended in unsecured lending space, and between a burdensome acquisition and a slow economy, a number of write-downs resulted.
Under the bailout plan, the SARB took on the bad loans, paying R7bn ($604.8m) for the loan book, while the institution kept good loans, was placed under curatorship and then recapitalised. The rescue perhaps set a precedent, because while the institution was not systemically important nor a key counterparty, it did help to prevent panic and shore up an important bastion of inclusive finance. The bank is recovering steadily. In the first half to the end of March 2015, it reported a loss of R2.8bn ($241.9m), down from a loss of R5.9bn ($509.7m) a year earlier.
Consumers in the country also have a significant amount of debt, and this could weigh on the banking market beyond just the failure of one institution. According to World Bank research, 86% of South Africans had taken out loans during the 2013/14 year, much higher than the global average of 40% for the same period. Research also indicates that South Africans are borrowing to cover living costs and would not be able to survive a surprise bill without credit. Unsecured lending in particular has boomed in recent years, jumping from R40bn ($3.5bn) in 2008 to R172bn ($14.8bn) in 2014, and the cost of servicing these claims has reached crisis proportions. According to local press, South Africans commit an average of 76% of their monthly earnings to servicing their debts, while the South Africa Human Rights Commission (SAHRC) said that over half of the country’s active credit users – 11m out of 19m – are more than three months in arrears.
The collapse of the African Bank raised serious questions about lending practices and how best to regulate them. According to the press, sales tactics may have contributed to the high levels of consumer debt, especially among the poor. The SAHRC blames the lack of financial literacy and predatory lending, but the weakening economy is also seen as leading to difficulties in paying back loans. Others blame low interest rates and a 2014 credit amnesty, which wiped credit ratings rather than the debt itself, making it difficult for lenders to assess borrowers.
However, the sector is well regulated, and the laws on the books should prevent the offending practices, which may have been the result of sales tactics. The National Credit Act, which has recently been amended, stipulates that institutions should only make loans that have a good chance of being paid back and that an assessment should be conducted.
South African banks are strong and well regulated, and their domestic market is solid. The issue is not one of survival but of growth. Opportunity is limited at home as the pace of expansion slows and tighter supervision weighs on the sector. While the country has a large unbanked population, it will be tough to develop business within that sub-market. The pivot to Africa also increases risk profiles, which will be important to manage. South African banks should be able to eventually increase growth over the medium term and in the long term will be better off for having made the investments in compliance, in systems and in regional economies.