Johannesburg - A hefty hike in interest rates or inflation that exceeded the Reserve Bank’s upper target of 6 percent in the current economic climate could have a detrimental effect on South Africa’s banks, Standard & Poor’s (S&P) warned yesterday.
The ratings agency said the inflation breach would pose a bigger threat to the banks’ unsecured or instalment finance books, since they were often at fixed rates and borrowers tended to be inflation sensitive.
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The inflation print to be released tomorrow is expected to have touched 6 percent last month, driven mainly by domestic food prices as a result of the current drought. It rose to 5.2 percent in December from 4.8 percent in November.
S&P said in a report: “A ratio of debt service to disposable income greater than 10 percent to 11 percent could cause credit losses across the sector to increase markedly.”
It said a sudden interest rate increase of between 150 basis points and 200 basis points, depending on its timing, could result in asset quality problems.
“Moreover, slower economic growth, the increasing threat of higher inflation, drought and the weaker South African rand are heightening the risk that households’ real income will not stay in step with their debt-servicing capacity.”
Corporate sector
S&P said, however, the banks’ dependence on external debt remained limited, protecting them from the effect of the rand’s depreciation and risks to changes in the Federal Reserve’s monetary policy.
It said overall banks’ performance had been fairly resilient. “Profitability has increased moderately, and we expect this will continue in 2016. In our view, a latent risk for banks stems from the residential mortgage loans, which are exposed to a spike in interest rates.”
S&P said the performance of South Africa’s corporate sector was largely sound last year, which should support banks’ asset quality.
“This is although business confidence reached its lowest level in 10 years, due to weak economic growth prospects, uncertain political leadership, unreliable electricity supply, drought, and economic slowdown in China, the country’s major trading partner.”
The agency said the banking sector continued to evolve due to regulation.
It said compliance with Basel III funding ratios remained a challenge, given the banking system’s reliance on short-term wholesale funding from financial corporations, and the lack of retail savings.
But, S&P said, system-wide capitalisation remained largely sound. “The implementation of a resolution framework, which already has led to changes in the amounts, characteristics, and hierarchy of debt instruments that banks and their holding companies issue in future.”
Fitch downgraded four of South Africa’s biggest banks in December. The ratings agency downgraded First Rand, the owner of First National Bank and Rand Merchant Bank; Nedbank and Standard Bank from triple B status to triple B-minus status.
Reserve Bank
Fitch said its rating actions were driven mainly by banks’ concentration in South Africa, large holdings of government securities, high exposure to state-owned firms, and the weakening economic and operating environment as indicated by South Africa’s downgrade to BBB, one notch above junk status. Fitch downgraded Absa and Barclays Africa to BBB and BBB+ as a result of South Africa’s downgrading.
The Reserve Bank hiked the repo rate by 50 basis points to 6.75 percent last month on the back of a deteriorating inflation outlook and a worsening growth outlook.
It said inflation was expected to breach the upper end of the 3 percent to 6 percent target in the first quarter of this year.
Finance union Sasbo said after the latest rate hike the biggest banks were expected to consider reducing staff this year to control costs as rising interest rates, a slowing economy and weakening rand weighed on earnings.
The four largest banks employed more than 165 000 people by June, according to data by PwC, with Standard Bank the biggest employer and Nedbank the smallest.
BUSINESS REPORT