South African banks will struggle with rising non-performing loans this year as consumers suffer from narrowing savings and elevated interest rates, although the Moody’s ratings agency has maintained a stable outlook for the country’s financial services sector.
It said South Africa would have to balance out macroeconomic and asset risks through issuance of loss-absorbing instruments.
Moody’s expects South Africa’s gross domestic product (GDP) to grow by 1.5% this year and sees an uptick in the banks’ non-performing loans ratio to between 6% and 7% of gross loans from 5.5% in October 2023.
“High interest rates, subdued growth and narrowing savings buffers will weaken borrowers' repayment capacity. Unsecured consumers loans are particularly exposed,” Moody’s said in a Banking System Outlook report for South Africa yesterday.
Further worsening the situation was an increase in the debt-service cost to household income ratio, which rose from 7.1% in June 2022 to 8.9% as at September 2023. South Africa’s overall debt to disposable income currently stands at 62%.
Although the corporate sector has remained solid, Moody’s is expecting some pressure on the category in the months ahead, citing commercial real estate, state-owned enterprises and banks’ exposure to government securities as precarious.
The lowly 1.5% growth projection for South Africa by Moody’s is on account of operational constraints the economy and companies are facing.
“Energy and logistic constraints, restrictive monetary policy and high government debt limit the country's growth potential. All these factors will curb business growth opportunities and pressure the loan repayment capacity of borrowers,” Moody’s said.
Nevertheless, South African banks are expected to lean on their “prudent financial and risk management” capacities “to weather the tough” economic conditions currently in the country.
Moody’s is thus expecting the banks to record “stable profitability” with a return on assets of around 1.1% owing to improved digitalisation and high net interest margins which are expected to “compensate for higher loan-loss provisioning needs” and the resultant subdued credit growth.
Two banking sector executives who spoke to Business Report yesterday agreed with the findings by Moody’s, saying South African banks had already started to buffer against a tapering out credit market that was still suffering from elevated interest rates.
However, according to Moody’s, the higher rates will allow South African banks to maintain robust net interest margins and pressure borrowers' repayment capacity. The banks' commitment to cost-cutting, in addition to their digital transformation was likely to keep operating cost growth “broadly in line with inflation” which is estimated at 4.6% for 2024.
“We assign a stable outlook for the South African banking sector, which balances high macroeconomic and asset risk against banks' sound financial metrics and prudent risk management.
“Robust capital generation will also allow banks' Common Equity Tier 1 capital ratio to remain above 13%, while existing liquidity buffers and historically stable funding will continue to support financial stability,” said Moody’s.
This year, South African banks are expected to start issuing Flac instruments, which according to the World Bank, are tranches of funding instruments that are subordinated to other unsecured liabilities, but senior to regulatory capital instruments.
Described as a new class of subordinated, loss-absorbing instruments pivoted mainly on converting maturing senior notes, the Flac instruments are seen as one way of buffering the South African banking sector for stability and profitability.
Analysts at S&P Global said recently that growth in South African banks’ credit to the private sector will be subdued at 5% this year although these finance institutions are seen advancing funding into the renewable energy sector because of electricity shortages.
According to the S&P Global Ratings analysts, South Africa’s private sector credit to GDP will remain stable, at about 70%.
“We expect that the banking sector's credit loss ratio will remain slightly higher than the historical low of 0.75%, averaging 1.4% of total loans through 2024,” they said.
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