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SA Banks gets boost from Fitch ratings despite Omicron surge

Published Dec 28, 2021


CAPE TOWN - The IMF may have reservations about South Africa’s lack of progress in the implementation of economic reforms and continued weaknesses in state-owned enterprises (SOEs) as highlighted in its latest Article IV Consultation earlier this month. But at least the South African banking sector is holding its own despite the resurgent Omicron variant of Covid-19.

In New Year cheer, the banking sector got a boost from Fitch Ratings on December 21, when the agency revised its outlook on the Long-Term Issuer Default Ratings (IDRs) of the country’s top five banks including Absa Bank, FirstRand Bank, Investec, Nedbank and Standard Bank to stable from negative and affirmed the IDRs at “BB-”.

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The rating action was necessitated following a similar revision of the outlook on sovereign South Africa's Long-Term IDRs to stable from negative and affirmation of its IDRs at “BB-” a week earlier.

“All things being equal,” says Mahin Dissanayake, senior director and primary rating analyst at Fitch Ratings.

“We believe 2022 will be a continuation of 2021. The recent outlook revision (to stable) on the banks’ ratings reflects our view that downside risks from the sovereign and the South African operating environment have receded, which in turn takes pressure of the banks’ ratings.”

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Despite continuing operating environment challenges like slow GDP growth, low interest rates, the fallout from the pandemic (and Omicron) and political/policy uncertainty, Dissanayake says: “Banks will generate sufficient earnings and profitability which should entail good loss absorption capacity. We also believe asset quality will continue to deteriorate, albeit slowly, and within tolerance levels of the ratings.

“We also gain comfort from the banks’ solid capitalisation and our expectation that downside risks to capital have eased. Funding and liquidity continue to be solid.”

However, the bane of the South African banking sector is that its ratings will always be beholden to their sovereign’s rating. The South African banks, according to Fitch, are constrained by the sovereign because their business activities are concentrated in South Africa and they hold significant exposure to the South African government, mainly through their holdings of government securities.

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The good news is that excluding the sovereign constraint, South African banks have notable fundamental credit strengths.

International gatekeepers such as the IMF, World Bank and the major rating agencies always refer to the fundamental soundness of the South African financial sector and the robust regulatory regime of SARB (South African Reserve Bank). This is despite some questions over the central bank’s future operational independence away from political interference that seek to align SARB’s policies with that of the redistributive economic objectives of the ruling ANC coalition.

To what extent have the banks held their own in the Covid-19 (and Omicron) impacted 2020/21 era?

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“Our belief remains justified,” says Fitch’s Dissanayake.

“The SARB is among the best regulators in emerging markets globally. The SARB was quick to respond to the pandemic and will remain supportive of the banking sector. Rules and regulations follow international best practice. Importantly the SARB is independent. All these factors have ensured the soundness of the banking sector.”

The IMF in its Article IV Consultation concurred that the South African financial sector has weathered the pandemic well. “Robust prudential regulation – closely aligned with international standards – and a commitment to independent supervision has helped moderate risk,” it said.

However, the financial system’s resilience, stressed the IMF, needed to be strengthened further amid the weak macroeconomic outlook and the government’s large borrowing needs. This would allow banks to increase their role as intermediaries of funds for productive investments, including for small and medium-sized enterprises.

The fund has other concerns and recommendations. These include the ongoing expansion of the payment system to non-bank financial institutions should help deepen financial access and inclusion.

Close monitoring of the deepening nexus between the financial sector and the sovereign is also warranted, together with enhanced supervision, swift completion of the bank resolution and deposit insurance schemes, and improved implementation of anti-money laundering/combating the financing of terrorism measures.

The IMF also urged reforms to the pension system, which it said “needs to be carefully designed to prevent undermining old-age security savings of the population and weakening one of the key pillars of the strong financial system.”

The fact that the South African banks are of “systemic importance” to the economy is not in doubt, given their exposure to holdings of government securities. But it does raise the issue of changing government support dynamics. Fitch also updated its Government Support Rating (GSR) to all banks to B+ but “No Support” to four Bank Holding Companies (BHCs), namely Absa Group Limited, Investec Limited, Nedbank Group and Standard Bank Group.

“The GSR of ‘B+’,reflects a limited probability of support from the government for South African banks – this reflects a high willingness but at the same time, a limited ability to provide support given the significant size of the banking sector and, in that context, the government’s limited financial flexibility.

“Once resolution legislation is enacted we will downgrade the GSR to ‘no support’ to reflect the view that government support is uncertain. This follows the approach taken in developed markets as in our view the SARB, as an advanced regulator, will follow/implement resolution legislation as intended by global developed market regulators,” says Dissanayake.

To him, the priority for the South African banking sector in 2022 will be to contain credit costs. At the same time, the banks will look to resume growth. Banks with regional operations will see faster growth, particularly on the lending side.

South Africa also faces significant climate challenges, reflecting its high vulnerability to extreme weather events and the carbon intensity of the economy. Banks here are also expected to play their role in climate adaptation finance.

Parker is a writer and economist based in London.