Although South Africa’s economy is going through a rough patch, the country’s banking and finance industry is enjoying rude health. But the introduction of fintech, writes Mushtak Parker, is putting the country’s banking giants on notice to improve efficiency and customer service.
The news on the economic front may be disappointing, tempered with frustration. After all, the latest gross domestic product (GDP) growth results released by the National Treasury in Pretoria on 4 September showed that the South African economy contracted, by -0.7% in real terms in the Second Quarter (Q2) 2018, confirming that the country had ‘entered a technical recession’ for the first time since 2009. GDP of course measures the value of economic activity within a country and is the sum of the market values, or prices, of all final goods and services produced in the economy during a period of time. The main difference between nominal and real GDP is that the latter is adjusted for differences in prices levels and therefore inflation.
This is on the back of an even bigger contraction in Q1 2018, when the economy shrank by -2.6%, with the dubious redemption that at least the rate of contraction has slowed down. Not surprisingly, both credit extension by banks and GDP growth trajectory have taken a hammering. According to First National Bank (FNB), credit extension in July slowed to 5.4% from 5.7% a month earlier. The National Treasury earlier this year forecast a GDP growth rate of 1.5% for 2018 but nine months into the year, Finance Minister Nhlanhla Nene, to his credit, could not stop himself from issuing an official health warning for the South African economy.
“The outlook for the economy remains fragile,” he said. “The contraction in GDP growth in Q2 2018 and the downward revision to the first quarter data pose significant downside risks. Subdued business confidence, weak activity in the supply-side of the economy and various headwinds to household spending will hinder a robust recovery in growth. “South Africa’s growth trajectory is too low to meet the needs of our people, in particular youth unemployment, which remains too high at 55%. To make a significant dent on the unemployment rate, which currently stands slightly above 27%, our economy will have to grow at 5% or more.”
According to Moody’s Investors Service, one of the top three international credit rating agencies, amid weak consumer spending, and emerging market currencies’ volatility precipitated by the US tariff action against Turkey and hence the contagion effect of the depressed Turkish lira, and inflationary pressures, South African economic growth will remain weak. Moody’s forecast real GDP growth of just 0.7%-1% in 2018, rising to 1.5% in 2019, from 1.3% in 2017 – lower than the government’s budget growth forecast of 1.5% in 2018 and 1.7% in 2019. Yet the good Minister Nene may be pleasantly surprised that despite the statistics of doom and gloom, the outlook for the South African economy for the next year or two, especially the banking sector, is not as dire as the data suggests, of course with some caveats.
“We have changed our outlook for the South African banking system to stable from negative, reflecting our assessment that the banks’ financial metrics and creditworthiness will remain resilient over the next 12 to 18 months, despite weakening operating conditions. Slow economic growth will hold back the banks’ new business and revenues,” explained Nondas Nicolaides, Vice President & Senior Credit Officer at Moody’s, to African Banker. This resilience is borne out by the interim results of two of the largest banks in South Africa, Standard Bank and FNB, part of the Rand Merchant Bank (RMB) Group.
Against the backdrop of a tough economy including a recent increase in VAT, FNB’s balance sheet indicators for the first half of 2018 have all increased by healthy figures, in several instances by double digits. Profit before tax in the domestic franchise, for instance, grew 16%, with retail and commercial banking profits increasing by 18%. Customer deposits also increased with the bank now providing services to 8.15m customers.
This confidence even extended to providing unsecured facilities to the small-and-medium-sized enterprises (SMEs), which increased to R17bn ($1.19bn), up 13% at end June 2018 compared to the same period last year. Jacques Celliers, chief executive officer of FNB, in an official statement, attributed this resilience and ‘excellent results’ largely to the bank’s digital strategy. “Our digital journey, particularly FNB App usage, again showed excellent growth with financial transactions up 65%,” he said. “We were also delighted with progress in digital fulfillment where significant strides were made on both onboarding and leveraging cross-sell opportunities, and the bank will continue to invest in future technology projects.”
The scenario for Standard Bank was the same with Group earnings up by 5% to R12.7bn for FH 2018, led by personal and business banking and corporate and investment banking. Similarly, return on equity increased to 16.8%, well on course for the 2018 annual target of 18-20%. Not surprisingly, there was equally fighting talk from Sim Tshabalala, Standard Bank Group CEO, who is seeking to protect and grow the bank’s franchise both at home and in Africa per se.
“In South Africa, while consumer confidence has improved, delays in resolving key policy issues remain an obstacle to business confidence, fixed investment and growth. Inflation is expected to remain inside the 3% to 6% target range, supporting a flat interest rate outlook for the rest of the year,” he said. “The Group has the appetite to grow lending judiciously in South Africa. There is no doubt competitive pressures will continue to increase, however, we will fiercely protect our existing customer franchise and grow by partnering with third parties to build new, innovative offerings and revenue streams,” explained Tshabalala.
Moody’s Nondas Nicolaides expects South African banks’ credit risk profile and problem loans to remain broadly stable to the end of 2019. Impaired loans stood at 3.5% of gross loans system-wide in June 2018. The news on the capital adequacy front is also good. According to him, “South African banks report solid capital metrics, well above regulatory minima, and our central scenario is that capital buffers will remain resilient and protected by profits. The average common equity Tier 1 ratio was 12.8% as of June 2018, with a Basel III leverage ratio of 6.6%.
“Funding and liquidity conditions will be stable. Institutional short-term deposits are an important source of funding for South African banks, and this will make meeting Basel III’s net stable funding ratio (NSFR) next year a challenge. However, banks have built good liquidity buffers in recent years, while limited use of foreign-currency funding also supports their funding profiles,” he added. However, profitability will be strained by slow business growth and higher costs. Banks’ revenues will be pressured by subdued business opportunities and increased operating expenses.
Net interest income, according to Moody’s, is likely to come under modest pressure because of lower loan growth, while increased staff and digitalisation costs will create a drag on net profitability. The rating agency expects banks’ return on assets in 2018-19 to be marginally lower than the 1.4% reported in June 2018. The country’s and bank’s fortunes will also be affected by the ability of South Africa to attract inward foreign direct investment (FDI), albeit China’s planned massive investment in Africa of up to $6bn over the next few years, especially in South Africa, should be an exception given the special partnership Chinese state-owned ICBC, the world’s largest bank in terms of assets, has with Standard Bank through its 20% acquisition in the latter.
$100bn FDI drive
With an alarming decline in the total inward FDI, the country has embarked on an ambitious global roadshow to whip up support for a record $100bn FDI drive (see following story). But investor concerns over the potential impact of the government’s proposed expropriation without compensation (EWC) initiative are hindering progress. “Uncertainty with regards to the EWC,” stressed Moody’s Nicolaides, “is something that undermines investor confidence and defers any new investments, especially in the agricultural sector.
“In addition, it depresses asset valuations and accordingly increases potential losses for banks in case a borrower defaults. We believe that this will be managed in a way that it will not compromise banks’ exposure to the agricultural sector and will not create any black holes on banks’ balance sheets.” He is not duly concerned by the bank’s exposure to state-owned enterprises (SOEs) and other sectors, including infrastructure financing, when during the Zuma presidency banks went on “a financing strike” because of the perceived effects of the government’s economic management. “Banks in South Africa at the moment are still quite cautious in their lending to SOEs, still usually requiring a government guarantee against any new exposure. This will likely continue to be the case until these SOEs are fully revamped operationally and become self-sufficient and viable entities,” he added.
The introduction of the Twin Peaks regulatory regime together with the reputation of the South African Reserve Bank (SARB) provides a welcome overhaul of the regulatory framework, which the general consensus maintains will contribute to financial stability and effective management of any troubled banks. Digitisation through fintech, however, could prove to be a greater game changer in the coming years. The widening application of digital innovations in financial services, according to Moody’s, is placing a premium on efficiency and opening up banking services to competition from financial technology firms (fintechs). This is driving disruption in the South African banking sector and in banking globally.
“In South Africa, digital innovation will drive disintermediation, with technological advances also threatening banks in the payments space,” explains Nicolaides. “Incumbent South African banks will also face competition from digital-only (internet & mobile) challenger banks and fintech firms intent on capturing an ever-increasing share of customers’ online activity, online spending and internet data. These include Discovery Bank, Bank Zero and Tyme Digital,” he adds.
The large South African banks have an advantage over their smaller peers because of their scale and resources, as well as the attractiveness of their nationwide footprint for fintech and big tech partnerships. Banks that have the resources and strategic vision to develop or acquire innovative products and processes and integrate new technology into their business models will be most successful in defending their customer relationships. According to Nicolaides, many South African banks are focusing on achieving this through partnerships with fintechs to enhance their mobile banking capabilities, enhance online account-opening functionality and automate credit decisions for online consumer loan applications.
New technology, to him, can also increase efficiency through the reduction of large branch networks and call centres, the upgrading of legacy IT systems and automation of internal processes, although this requires high initial investment and ongoing maintenance costs. In February 2018, SARB launched a fintech programme, a starting point for the central bank to experiment with digital technologies, establish a regulatory framework for virtual currencies and assess the appropriateness of innovation facilitators.
“The adoption of fintech infrastructure and regulation following these assessments, which are scheduled to conclude in 2018, will improve efficiency, strengthen anti-money laundering practices and increase South African technologies’ competitiveness globally,” says Moody’s. Of the three primary objectives outlined by the SARB, the most pioneering is the experimentation with distributed ledger technologies, whose adoption can improve efficiencies in back- and middle-office functions. The cost-to-income ratio of South African banks is higher than that of BRICS peers, with the improvements in the ratio in recent years also trailing peers. Consequently, adoption of more efficient and less costly processes will help bridge the growing efficiency gap.