South Africa starts again

South Africa stands at a point of inflection. After years of political dysfunction and economic stagnation, the country finally managed to shed its scandal-plagued former president, Jacob Zuma, in February 2018. Many people hope that renewal is in the offing.

However, there is a long road ahead for Mr Zuma’s successor, president Cyril Ramaphosa. Low growth, high unemployment, deep-seated inequality, corruption and a collapse in investor confidence are the surface manifestations of much deeper, structural problems – ones that will require difficult reforms and compromises to correct.

Surviving, not thriving

While South Africa’s economic malaise has seeped into all sectors of the economy, the country’s highly developed banking sector has managed to weather the storm if not unscathed, then at least not seriously damaged. “As far as South Africa is concerned, we have always said, and still have the opinion, that the banking sector is a supportive factor – it is the credit strength of South Africa,” says Konrad Reuss, managing director at rating agency Standard & Poor’s in Johannesburg, South Africa’s commercial capital. 

Even so, banks have not been unaffected by their surroundings. “South Africa was obviously a laggard... A downgrade and low consumer confidence subdued growth,” says Standard Bank CEO Sim Tshabalala.

South Africa’s economy may be sub-Saharan Africa’s most highly developed and industrialised, but it is also highly volatile. This came to a head in March 2017 when Mr Zuma fired respected finance minister Pravin Gordhan, triggering a round of sovereign downgrades. S&P and Fitch cut South Africa’s credit to junk.

Investor confidence – already shaken by the political infighting, low commodity prices and general unrest – sank still further. For banks, that meant a greater squeeze as customers transacted less and delayed investment decisions, all as the cost of capital went up. “It was clearly a difficult year in South Africa, both politically and economically. We saw the impact of that play out in our customer base, both wholesale and retail,” says Nedbank Group CEO Mike Brown.

Bankers hope that now the country’s political direction is better defined, the more unpredictable risks to their business will recede. “Economic risk you can predict [in] a certain manner, but political risk is more uncertain and can change overnight,” says Gerrie Fourie, CEO of Capitec, the country’s second largest retail bank.

Treading water

The performance of South Africa's major banks in 2017 reflected the country’s subdued environment while also capturing the industry’s resilience. At the height of South Africa’s political and economic crisis last year, a PwC analysis of the country’s top five banks showed annualised headline earnings grew at an average of 5.2% year on year. Income from interest also grew at a healthy 5.8% year on year against the second half of 2016.

A 10% decline in bad debts between the first and second half of the year helped. “We have had a remarkably clean bad debt experience over the past two years,” says Mr Brown at Nedbank.

However, once operating costs are factored in, the strain becomes more apparent: core earnings dropped to 3.6% on an annualised basis, according to PwC. Credit growth across the board also showed some strain, whether in corporate banking or retail and consumer finance. 

Standard Bank, one of the country’s largest banks with an established footprint across some 20 countries in sub-Saharan Africa alone, reported total revenue growth of 3%, and much of this was supported by its businesses outside South Africa. “The heart of strategy, if you think about it, is the fact that we are a South African-headquartered business growing very fast in the rest of Africa,” says Mr Tshabalala.

Capitec is also enjoying resilient results, having seen earnings grow 18% on customer base growth in 2017, as well as enjoying a 30% bump in transaction fees. “We have had very strong growth given the economy,” says Mr Fourie. “On the banking side [we’ve had] very strong growth in client numbers. We are seeing more than 100,000 clients a month joining us.”

Cautious optimism

Conditions in South Africa look set to improve for 2018. The country’s Bureau for Economic Research has revised gross domestic product (GDP) growth forecasts upwards to 1.9% for 2018 and 2% for 2019. The rand, South Africa’s notoriously volatile currency, rallied strongly following Mr Ramaphosa’s ascension and has continued to climb against a weakening dollar. 

However many warn that the boost provided by the political transition could be temporary. “There is a long to-do list for the next government and the next president,” says S&P’s Mr Reuss.

Bankers agree that they are not yet seeing a large-scale return of investment into the country. “Clearly, the political changes that started in December will help to rebuild confidence and we are seeing dramatically renewed optimism,” says James Formby, CEO of Rand Merchant Bank (RMB), the corporate and investment banking arm of First Rand Group. However, he believes it will be “a little bit of time before we see that sense of optimism translate into extensive investment”.

Stabilisation of the rand will help. Once “idiosyncratic rand issues” linked to political uncertainty are taken out of the equation, the landscape becomes much easier to navigate, according to Mr Formby. “I actually think it [becomes] less relevant to us as banks because we have operated in a market of relatively high rand volatility for a long time – we can manage that volatility,” he adds.

From a regulatory standpoint, South Africa’s banking sector also has strong foundations. The country’s banks are already fully compliant with Basel III global reform guidelines, including liquidity coverage ratios. “It does feels like the big regulatory change that everybody has endured since the global financial crisis is largely behind us,” says Mr Brown.

South Africa has a long track record of strong oversight and regulation. Anti-terror and money-laundering legislation is in place and robustly enforced, as are credit requirements. The central bank’s past handling of bank failures, such as the collapse of African Bank Investments Limited in 2014, were “textbook” and avoided creating systemic risks, according to S&P.

The central bank, for its part, has no quibbles about poking its nose into the affairs of the banks it regulates. “Our regulation is not just robust with respect to the banking sector, it's actually pretty intrusive,” says Lesetja Kganyago, the governor of the South African Reserve Bank (SARB). Its latest move to make the headlines was to place VBS Mutual Bank under curatorship in late March – an initial audit found evidence the bank had been “severely mismanaged” and that there had been fraudulent reporting of and manipulation of financial information. According to SARB deputy governor Kuben Naidoo, nearly R1bn ($81.6m) deposited in VBS Mutual could not be accounted for. 

Deeper issues

Now South Africa's political scene has shifted, the question remains whether the new administration has the political will to carry out the deep reforms needed to get the economy back on track and for banks to boost their business. “Businesses look for clarity from government. If they can get clarity then they can operate,” says Mr Fourie at Capitec. “I believe South Africa still has a positive story to tell.”

One bellwether will be getting the sovereign’s credit rating back up, and there are some positive signs already. In a closely watched decision at the end of March, Moody’s – the only one of the big three not to have cut South Africa to junk status in 2017 – held its sovereign rating at investment grade. It also changed the outlook to 'stable'. The decision reflected Moody’s view that “the previous weakening of South Africa’s institutions will gradually reverse” – an early endorsement of Mr Ramaphosa’s actions.

A third downgrade would have kicked South Africa out of international bond indices, further increasing the burden of government debt that ballooned during the Zuma era. Indeed, two downgrades had already been difficult to navigate. “There is a very real cost to the business because the return requirements go up across the economy and the capital requirements go up for banks at the same time,” says Mr Formby at RMB.

South Africa’s stubbornly high household debt levels have also started to go down – partly due to tighter regulation but also as a result of banks’ conscious decision to reduce their exposure as the market deteriorated. “The key area where we reduced loan appetite was personal loans and unsecured lending. We actually shrunk our book,” says Mr Brown at Nedbank.

The country’s addiction to credit reflects its high level of unemployment – currently about 28%. In a 2014 report, the World Bank called South Africans "the world’s biggest borrowers”, and warned that credit use was outpacing job creation. Official statistics say two out of every five South African consumers are credit stressed but this does not account for rampant informal lending through loan sharks. The real numbers are likely much higher.

For Capitec, meanwhile, this meant pulling back from lending to small businesses. “We saw the smaller companies closing given the economy so we cut back quite a lot on smaller companies,” says Mr Fourie.

The Eskom bomb

Across the board, the greatest fear expressed by bankers, regulators and analysts is a crisis at one of South Africa’s state-owned companies. Many of these were severely mismanaged during the Zuma years, and are now burdened with debt and glaring holes in their accounting books.

“We cannot afford for an accident to happen in that space,” says Mr Reuss. If that were to happen “it would have a systematic implications and risks for the South African financial system”, he adds.

The state power company Eskom is one that causes concern. Bank executives describe it as “too big to fail” in the South African financial system, given its size and its total monopoly over supply and distribution of power for the entire economy. Indeed, when Eskom went through a period of shortages and load shedding in 2015, it knocked an estimated 2% off the country’s GDP.

A clean-up now looks to be in the offing. Eskom’s finances are in a parlous state, with S&P warning the company was in “clear and present” danger of default in January 2018. That was papered over, at least for the time being, by a controversial R5bn loan from government-owned asset manager, the Public Investment Corporation.

Mr Ramaphosa also fired Eskom’s board and, on April 6, ordered an investigation into allegations of mismanagement at Eskom and Transnet, the state rail and port company. “It is absolutely essential that these organisations have the type of governance that inspires the confidence of banks and capital markets. Without that, there is no doubt that South Africa could be put at risk,” says Mr Formby.

Beyond the borders

South Africa’s large banks have long had an international presence. As uncertainty mounted at home, however, these parts of the business acquired even greater importance. “Rand Merchant Bank’s performance was boosted by growth in the rest of Africa,” says Mr Formby.

Standard Bank had a similar experience. Whereas its South African business grew 16% in 2017, its west Africa holdings were up 40%. 

Standard Bank also received a boost from southern African neighbours Mozambique, Zambia and Zimbabwe, despite the fact that all three are facing severe economic problems. But while Mr Tshabalala admits he has some concerns there, his holistic outlook on the maturation of Standard Bank’s 'rest of Africa' businesses is positive. “I take comfort in the fact that the portfolio is starting to behave as you would expect a portfolio to. The countries are not correlated to one another,” he says.

In 2018, both Rand Merchant Bank and Nedbank also intend to focus on growing their pan-Africa operations. “Our market shares are low relative to South Africa in most markets except for Botswana and Namibia. So there is quite a lot of runway for us to grow,” says Mr Formby.

Nedbank’s wider Africa experience is complicated due to its decision to invest in west Africa-focused Ecobank in 2015. When oil prices dropped, the economy of Nigeria (the regional hegemon) went into a tailspin, resulting in a number of problems throughout 2016. That has left a hangover. However, Nedbank remains confident that this move will pay off in the long term. “We still believe that our 20% investment in Ecobank Transnational Group is a good investment. We made it at an unfortunate time in the Nigerian cycle but over time it will still prove to be a good investment,” says Mr Brown.

Digital growth

Like other industries across the globe, South Africa’s banks are contending with the transition to digital – a process that executives ranked as a top priority for 2018.

For retail, this is driven by customer expectations for a more seamless, user-friendly online and mobile banking experience, as well as competition with new digital upstarts for clients. “People expect as good an experience from their bank as they do from using their phone... or [an] app. It is imperative for us to successfully deal with the challenges coming from fintech and new entrants,” says Mr Tshabalala at Standard Bank.

South Africa’s banks are also putting robots to work to reduce dull, repetitive back-end work and cut costs. Rand Merchant Bank, for example, has about a dozen robots now ‘on staff’. The first of these, Mr Robert Bot, joined in November 2017. He has an employee number and signs on and off of the bank’s systems.

In addition, Rand Merchant Bank is working on upgrading its digital customer interface despite the fact that the bank does not deal with retail. “[Clients] can see how retail banking has become so much more web enabled and channel driven, and there is a growing expectation to see the same when they are in their work environment,” says Mr Formby.

But though the digital revolution has well and truly arrived, bankers concur that bricks-and-mortar branches are unlikely to disappear any time soon. “A big proportion of South Africa is financially illiterate,” says Mr Fourie. “In our rural areas, people want that personal interaction. They want to see who is behind the screens.”

From transactions to sales

But while branches are still an important part of a bank's business in South Africa, what happens inside them is shifting. At Capitec, branches are transitioning from focusing 70% of their work on transactions to 70% selling. At Nedbank, a similar transition is under way. “The size of our branches and what activities go on inside bricks-and-mortar banks is changing,” says Mr Brown.

Financial inclusion is another motive for keeping branches, as they are more likely to attract first-time banking customers. South Africa’s banking penetration remains high compared with most of the rest of the continent, but there is still room to grow its customer base – in the rest of Africa, even more so.

According to a study by consultancy McKinsey, the number of Africans with formal bank accounts grew from 170 million in 2012 to almost 300 million in 2017. That will rise to 450 million by 2022.

For Nedbank, financial inclusion is important for its wider socioeconomic benefits. However, it is also smart business sense. “To grow our business, we need to grow across all of the customer buckets, because quite simply your entry level accounts of today are the middle market accounts of tomorrow,” says Mr Brown.