South African banking outlook raised from ‘negative’ to ‘stable’

The outlook for the South African banking system has been changed to stable from negative, largely reflecting the improving macro-economic conditions that will likely have a positive impact on the sector's credit performance, Moody's Investors Service said in a new Banking System Outlook.
After going through its first recession in 17 years, the SA economy is recovering and expected to grow by around 3% in 2010. Reduced interest rates and benign inflation (3.5% in August 2010) are expected to help reduce debt-servicing costs and boost consumer affordability.
"Improved operating conditions are already having a positive impact on the banking sector's performance. The rate of early arrears has been decreasing and non-performing loans have flattened out since year-end 2009," explained Constantinos Kypreos, author of the report.
“Expected lower provisioning costs will likely improve net profits in the coming quarters, while credit growth, which was negative in 2009, turned moderately positive in H1 2010”.
The financial performance of SA banks is also supported by the sector's solid overall balance sheet: as of July 2010, the SA banking system maintained a combined Tier 1 ratio of 11.2% and equity-to-assets of 6.8%. Further, liquid assets above the minimum regulatory requirement increased to ZAR 99 bln (from ZAR 12.5 bln in January 2008), or 4% of deposits, providing a sizeable buffer to absorb liquidity pressures. As a result, the system did not require government-sponsored funding or capital support.
However, the rating agency notes that the banking system faces some challenges. The pace of economic recovery will remain subdued and asset quality and profitability indicators are not expected to return to pre-crisis levels in the near term. The sustained high, though reduced, credit risks faced by the banking system are exacerbated by high consumer indebtedness, challenges in the government-mandated "debt counselling" process, and by the banks' willingness to underwrite mortgage loans with high loan-to-value (LTV) ratios.
"The system is also faced with structural funding challenges, through its dependence on wholesale/professional deposits. This leads to high deposit concentrations, short-maturity liabilities leading to large mismatches in the maturity profile of assets and liabilities, and higher funding costs" added Kypreos.
Although its implementation is beyond the timing horizon of the report, Moody's expects that SA banks will find it difficult to meet the proposed new liquidity standards under Basel III in their current form. Existing exchange controls and restrictions, however, ensure that rand liquidity remains "trapped" within the domestic financial system, and has provided a level of protection during the recent financial crisis.