The impact of covid-19 on South Africa’s financial sector

Despite inherent obstacles and the additional burden of the global pandemic, South Africa harbours the ambition, and the advantages to become the continent’s financial hub. However, worrying indicators and difficult numbers will need to be overcome before it can achieve this goal.

By Mushtak Parker

It is no surprise that the Money Smart Week South Africa held in March 2021 reflected the changing mood music of a global financial sector under siege over the past year thanks to the economic and health impact of the COVID-19 pandemic. Under normal circumstances, the event, which is aligned to Global Money Week, promotes financial literacy “aimed at motivating and empowering South Africans to become better educated about their finances.” This year’s theme was building financial resilience and staying healthy in the context of the pandemic. The vagaries of the pandemic including lockdowns and social distancing, fast-tracked changes in the banking sector especially digitisation, but the current watch words include business and personal finance resilience, proliferation of scams and fraud, credit responsibility, importance of retirement and funeral planning, and the necessity of a will.

Sub Head: The Financial Sector

So how is the South African financial sector coping under COVID-19? Finance Minister Tito Mboweni in his 2021 Budget in February put a moral burden on South African banks, insurance companies and pension funds, reminding them of their role in helping to build the post-pandemic recovery, especially in financing the country’s huge infrastructure ask. The government has committed to a R791.2bn infrastructure investment drive including a blended finance Infrastructure Fund in collaboration with the private sector. The carrot dangling in front of the financial sector is Mboweni’s reiteration of his ambition to turn the country into the financial hub for the continent thus opening up new expansion and investment opportunities for its banking majors. “The government and the South African Reserve Bank,” maintains Mahin Dissanayake, Senior Director, Fitch Ratings’ African banks team, “will certainly encourage banks to step-up lending to stimulate the economy. What measures or incentives the authorities will introduce remains unclear. The budget refers to an ambitious, yet vital, infrastructure roll-out which presents significant lending opportunities for banks, but this will play out over the medium term. State-owned enterprises (SOEs) will be at the forefront of the roll-out and it is important that these entities are financially sustainable.”

In the past especially during the Zuma presidency, banks were holding back because of the dire macroeconomic situation and allegations of corruption and state capture. Fitch maintains that South African banks “will initially remain cautious on infrastructure financing given elevated sovereign risks. It also exposes them to a whole range of new risks such as the viability of new projects, repayment risk, political risk and operations risk. These could be mitigated by solid transaction structures and the banks certainly do have this expertise.” Mboweni confirmed that the Treasury will soon publish draft amendments to Regulation 28 for public comment. The amendments to Regulation 28 seek to make it easier for pension funds to increase investment in infrastructure.

South African banks are expected to remain focused on traditional retail and corporate lending, partly based on projected low customer loan growth in 2021 (less than 5%) reflecting the macroeconomic backdrop, the weak operating environment and the impact of the pandemic on borrowers. The ‘Big 3’ rating agencies, Fitch, Moody’s and S&P, were all caught on the backfoot over Mboweni’s stronger fiscal trajectory in Budget 21, “mostly driven by exogenous developments from a faster recovery in domestic demand, as well as the rebound in international prices for mining commodities which has supported activity in extractive industries.”

The dire economic indicators too present a mixed outlook for 2021. GDP growth, according to Mboweni “is expected to rebound by 3.3% in 2021, following a 7.2% contraction in 2020, and will average 1.9% in the outer two years.” For Pretoria to deliver on the manifold needs of the economy in uplifting the population out of poverty on a sustained basis, a minimum GDP growth of 5% is required. Gross government debt increased from 65.6% to 80.3% of GDP for 2020/21. Mboweni says this will stabilise at 88.9% of GDP in 2025/26. “Our borrowing requirement will remain well above R500bn in each year of the medium term despite the modest improvements in our fiscal position. Consequently, gross loan debt will increase from R3.95 trillion in the current fiscal year to R5.2 trillion in 2023/24,” he reminded. But at what cost? The country’s debt-service burden is projected to grow progressively from R232.9bn in 2020/21 to R338.6bn in 2023/24.

Sub Head: The Outlook

So, how does this impact on the outlook for the South African financial sector? Fitch’s Dissanayake believes that the drag on bank earnings and prospects due to the pandemic will last for at least another two years. “Profitability weakened significantly in 2020, with the sector’s operating return on risk-weighted assets declining to 1.2% from 2.8% in 2019. Banks’ business and revenue prospects will remain subdued in 2021,” he adds.

The rebound in the domestic economy to him will not translate to a rebound in banks’ profitability because of low interest rates, muted loan growth and still high credit losses. “We believe asset quality will continue to deteriorate with the expiry of debt relief measures, rising unemployment and the hardest hit SMEs struggling to recover from the crisis. Around 20% of sector loans have been restructured due to the pandemic and some of these will inevitably become impaired. We guide a sector impaired loan ratio of 6.5% by end-2021 (end-2020: 5.2%) – albeit still low by global emerging markets standards.”

Structural challenges however remain. The low take-up of the Treasury’s loan guarantee scheme by SMEs but extended by the banks, for instance, could mean the winding down of the facility. Relaxed liquidity and capital rules as well as state-guaranteed loans were important measures introduced by the Ramaphosa government last year. This ensured banks continued to lend through the crisis. The low take-up could result in the National Treasury making further revisions to the scheme. One of the main reasons for the limited success of the loan guarantee scheme was that the banks extended debt relief directly to customers. But these measures will eventually wind down. Fitch sees a continuing rise in impaired loans in 2021 and this may also discourage banks from expanding their loan books.

Sub Head: The Hub

How realistic also is Mboweni’s financial hub ambitions? In his Budget speech he confirmed that the “National Treasury continues to work with industry bodies to implement reforms promoting South Africa as a financial hub for the continent in light of the African Continental Free Trade Agreement (AcFTA).” The other potential ‘rivals’ are Nairobi in Kenya and Casablanca in Morocco. The latter, despite minimal post-Arab Spring reforms, remains a Francophone absolute monarchy with a lack of financial market depth and critical mass. The former is dogged by political instability, a tortuous bureaucracy, a lack of financial market depth and critical mass, entrenched corruption and a spill over terrorism threat from neighbouring Somalia. Bankers maintain that if South Africa can capitalise on its financial sector strengths comprising a world class architecture including the Johannesburg Stock Exchange (JSE) with its cross listing to the London Stock Exchange and others in Africa, then this can offset its geographic remoteness and socio-economic structural issues.

Fitch’s Dissanayake maintains that the “South African financial services and markets are among the most developed and best regulated in global emerging markets. South Africa has a significant lead over other African markets.” His colleague in the Sovereign Ratings team, Mahmoud Harb, concurs that “strong international investor interest in South Africa’s financial markets reflect its fully floating exchange rate regime, the deep rand markets and a strong institutional framework and regulatory environment.”

Indeed, to them, the silver lining for the financial sector is the comfort South African banks give through their “solid capitalization, funding and liquidity.”

NATIONAL TREASURY CONTINUES TO WORK WITH INDUSTRY BODIES TO IMPLEMENT REFORMS PROMOTING SOUTH AFRICA AS A FINANCIAL HUB FOR THE CONTINENT.