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AfricaSeptember 30 2022

FATF threat hangs over South Africa’s banking sector

The country’s lenders are in rude health, even as the threat of a greylisting by the FATF looms. John Everington reports.
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FATF threat hangs over South Africa’s banking sector Image: Getty Images

South Africa’s banking sector — arguably the most developed on the African continent — remains resilient even as the economic challenges in the country mount. While the economy has shown tentative recovery after a series of stringent lockdown measures during the Covid-19 pandemic, flooding in the KwaZulu-Natal region, extensive blackouts and high levels of corruption have acted as a brake on economic activity.

Despite such challenges, the banking sector as a whole has proved robust. The country’s five largest lenders returned to profit growth in 2021, in a trend that has further accelerated in 2022.

“The sector has emerged in good shape and still has double-digit growth prospects ahead, notwithstanding the weak economic environment,” says Mike Brown, CEO of Nedbank, the country’s fourth-largest lender by assets.

“The numbers for the first half of the year demonstrate very strong resilience, with surplus capital and liquidity across the sector, meaning it’s well-placed to deal with any economic challenges that may come our way.”

While banks’ retail loan books have benefited in the recent past from an uptick in mortgages in a low-interest rate environment, corporate lending has remained sluggish as a result of South Africa’s many macroeconomic challenges. Nevertheless, lenders have been encouraged by the financing opportunities by the government’s infrastructure investment plans, not least in the renewable energy sector, even as the possibility of a greylisting by the Paris-based Financial Action Task Force (FATF) looms large.

Sector stable

The country’s banking sector is made up of 31 banks, together with three mutual banks and 28 foreign bank representatives. The five largest lenders — Standard Bank, FirstRand, Absa, Nedbank and Investec — account for around 90% of the sector’s total asset base.

Even as the economy contracted in 2020, banks’ capital levels remained high as growth in loans and risk weighted assets remained muted. While common equity Tier 1 capital levels for the sector dipped early during the pandemic (see chart) they remain comfortably above the South African Reserve Bank’s (SARB’s) required level of 4.5%. The sector’s liquidity coverage ratio increased to 144.8% at end-2021, slightly above pre-pandemic levels.

“Capital levels should remain elevated into 2023, but then we should see a gradual normalisation to target levels, as there’s a reluctance among the bigger players to hold excess capital,” says Vinay Nagar, a senior analyst for financial institutions at GCR Ratings.

“The dividend payments for the first half of the year have been quite strong and we think this will continue.”

Analysis from EY suggests dividend payment ratios are likely to be at about the 45–60% level in the short term.

The one casualty of the sector since the start of the pandemic is Ubank, a smaller lender with around 4.7 million customers that provides services to South Africa’s mineworker community. The minister of finance placed the bank under curatorship in May, after its capital adequacy ratio fell from 23% in 2020 to just 3% in 2022.

“Ubank is not systemically significant, and its curatorship does not pose any systemic risk to the rest of the financial sector,” the SARB said in its most recent financial stability review.

African Bank, the country’s seventh-largest lender, announced a R80m ($4.53m) deal in late-August to acquire Ubank’s disclosed assets and liabilities.

The announcement of the deal came weeks after TymeBank, a digital lender that launched in early 2019, acquired small business lender Retail Capital for an undisclosed sum, in a bid to boost its business banking proposition.

“Our 150,000 business-banking customer base is by far our most profitable segment. What Retail Capital provides is a working capital solution that fits very nicely with the transactional banking and acquiring proposition that we already have in the bank,” says TymeBank’s CEO Coen Jonker.

While TymeBank’s increased focus on the business segment will bring it increasingly into competition with the country’s largest lenders, Mr Jonker is confident it can tap hitherto unserved market segments.

“We see a bit of a blind spot in the banking system, which is sole proprietors and owner-managed businesses where personal and business financial positions are deeply intertwined, and the business is typically not formalised,” he adds. “None of our competitors are set up to actually focus on that segment.”

Profitability on the rise

After an across the board drop in profits in 2020, the sector rebounded last year as easing lockdowns led to increased transactional activity alongside lower provisions and increased cost control. Return on equity (ROE) for the sector rebounded from 6.96% in 2020 to 13.79% in 2021, according to SARB data, although this figure remains below the pre-pandemic level of 16.09% for 2019.

The upward trend has increased thus far into 2022; ROE rose to 16.9% for the country’s four largest banks at end-June, compared with 15.4% for the same period last year, with headline earnings increasing by 19% over the same period, according to data compiled by PwC. Pre-provision operating profits rose by 15.8%.

Non-performing loan levels across the sector are forecast to continue to decrease throughout the year, while still remaining at about pre-pandemic levels (see chart).

“The industry is in rude health,” says Sim Tshabalala, group CEO of Standard Bank Group, the country and continent’s largest lender by assets. “The results of the group [for the first half of the year] were characterised by very strong revenues, with [revenue] growth of 14% and net interest income (NII) up 15%.”

NII is set to increase further in the short term for the sector as a whole as interest rates continue to rise. After slashing interest rates to an all-time low of 3.5% at the start of the pandemic, the SARB has resumed its tightening cycle, with six interest rate rises between November and September, including two 75 basis point (bps) rate rises — the largest rate rises in 20 years — in July and September.

Yet, Mr Tshabalala cautioned that although inflation is forecast to peak during the second half of this year, interest rate rises may impact confidence and demand negatively and constrain economic growth.

Such pressures are unlikely to adversely impact the performance of the sector.

“The big five are focusing on high-quality corporates and higher income households, so higher interest rates and even inflationary pressures are not going to put their client bases under too much pressure,” says GCR’s Mr Nagar.

“The stress is going to be felt by lower income households that are typically served more by smaller banks, whose asset quality ratios are way higher than those of the big five.”

Despite this, rising inflation is likely to weigh on banks’ costs, given the country’s highly unionised workforce.

“We expect a bank’s proportion of overheads to total costs and staff unionisation to be key determinants of how fast operating costs rise as inflation climbs upward,” said Moody’s Investor Service in a September briefing note. “Banks with extensive low-cost digital services will be better placed to manage costs, although those that outsource these services may not fare as well.”

Credit increases

Credit growth recovered from 3.2% in 2020 to 4.6% in 2021, according to GCR data. Gross loans and advances rose by 9.8% for the country’s four largest banks in the year to June, according to PwC.

While retail credit growth has held up since the start of the pandemic, with banks benefiting from an uptick in mortgage lending on the back of low interest rates, macroeconomic concerns have thus far put a damper on corporate lending.

“We’ve seen good momentum in retail credit growth in 2021 and 2022, averaging around 5–6%, and we expect this to continue,” says Nedbank’s Mr Brown.

“Where we’re hoping for an improvement would be on the corporate or wholesale side of our book, where we still saw relatively low core growth in the first half of the year.”

One of the key areas of potential growth identified by banks is the country’s overhaul of the country’s ageing infrastructure, particularly its struggling electricity sector.

In July, president Cyril Ramaphosa unveiled his energy crisis plan in a bid to solve the problem of the country’s unreliable electricity supply. The plan includes measures to improve the performance of existing power plants run by local electricity provider Eskom, accelerate the procurement of new capacity, increase private sector investment in energy generation and further enable the take up of rooftop solar power generation by businesses and households.

Included in the early measures was the decision to increase the total capacity of Bid Window 6 — the latest round of the country’s renewable energy independent power producer programme, from 3.6 gigawatts (GW) to 4.2GW.

“We are very encouraged by recent developments in the energy sector, which we think will unlock significant investment in the medium term,” says Mr Tshabalala.

Such opportunities in the renewable energy sector provide clear opportunities for banks to increase lending in an environmental, social and governance (ESG)-friendly manner.

“From the provision of sustainability financing, arranging corporate debt placements of ‘green’ bonds to their own sustainability-linked issuances, we expect the major banks will play a key role in facilitating an orderly energy transition as economies, markets and companies adapt to evolving climate policy,” PwC said in a September briefing note.

“The policy measures and actions set out in the presidential energy crisis plan in July are likely to trigger growing focus in this area.”

Yet the participation in such projects poses several challenges for lenders and businesses, adds Mr Tshabalala, with investment in renewable energy set against concerns over jobs in the coal industry, which continues to supply the vast majority of the country’s energy.

“It’s a matter of strategic importance for us to get it right, in terms of having appropriate policies and strategies and risk mitigants for [the] E, S and G [in ESG],” he says.

“There’s a real potential conflict between our environmental commitments on thermal coal versus job losses in mines and the treatment of workers. For us it’s a lived contradiction.”

FATF chance

One of the most immediate challenges facing South Africa’s banking sector is the threat of being put on the Financial Action Task Force’s (FATF) greylist of jurisdictions under increased monitoring in 2023, in response to the deterioration of effective financial regulation under the presidency of Jacob Zuma between 2009 and 2018.

In a damning report published in October 2021, the FATF noted that significant money laundering risks “remain to be addressed”, and that law enforcement agencies lacked the skills and resources to proactively investigate money laundering, as a result of a systematic programme of “state capture” by Mr Zuma and his allies.

South Africa’s country risk premium already includes assumptions around the country's risk management framework

Sim Tshabalala

In May 2022, the Zondo Commission, the country’s largest ever judicial inquiry, accused Mr Zuma of overseeing endemic and systemic corruption, involving the systematic weakening of anti-money laundering mechanisms.

The country has until October to show progress in addressing the shortcomings identified by FATF, if it hopes to avoid being put on the organisation’s jurisdictions under increased monitoring list. Other countries currently on the list include Turkey, Senegal, South Sudan and Myanmar.

Deputy finance minister David Masondo told The Banker that the government was “painfully aware of the need to act quickly to avoid falling foul of international norms and standards aimed at preventing financial crimes”.

The cabinet subsequently approved the tabling of the General Laws (Anti-Money Laundering and Combating Terrorism Financing) Amendment Bill in parliament, in an attempt to address the deficiencies identified by the FATF report.

“The bill demonstrates the authorities’ commitment to fighting corruption, money laundering and terrorist financing, and is a massive step towards addressing the deficiencies that were identified by the FATF,” says Mr Tshabalala. “The chances of being greylisted are high, but are reducing every day because the South African authorities are addressing the concerns that were raised.”

While local banks’ reputational risks may be adversely affected and compliance costs may rise, the overall impact on the sector is likely to be muted, according to guidance published by S&P Global Ratings in mid-September.

“[South Africa’s] country risk premium already includes assumptions around the country's risk management framework, regarding money laundering, terrorist and proliferation finance,” adds Mr Tshabalala. “If we can prevent [the greylisting], it just improves our ability to regain and claw back that country risk premium.”

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John Everington is the Middle East and Africa editor. Prior to joining The Banker, John was the deputy business editor of The National in the UAE, and has also worked for Dealreporter, Arab News and The Telegraph. He has also covered the telecom sector in Africa and the Middle East, living and working in Qatar and the UK. John has a BA in Arabic and History and an MA in Middle Eastern Studies from the School of Oriental and African Studies (SOAS) in London.
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