South African Banks Can Withstand Rand Weakness, says Fitch

South African banks are resilient enough to withstand pressure on the rand (ZAR), which has fallen 17% against the US dollar (USD) over the past 12 months, said Fitch Ratings.

Depreciation is, however, likely to hurt South African banks’ asset quality to the extent that it leads to higher interest rates or inflation and lower real wages, which impair the debt service capacity of borrowers, the credit ratings agency (CRA) added.

The banking sector has limited exposure to foreign-currency loans and funding. Currency depreciation on its own is therefore unlikely to lead to rating downgrades. Banks’ exposures are predominantly domestic and in rand, despite four of the five major banks pursuing a broader African strategy. Standard Bank Group and Barclays Africa Group have greater geographical reach at the moment, but even so, Fitch estimates non-domestic and foreign currency loans are moderate at between 15% and 20%.

Foreign funding in the sector is low at the domestic bank level. Regulatory filings show that the proportion of foreign-currency funding was below 10% of total liabilities at end-2013 at the five largest banks – Standard Bank, Absa, FirstRand, Nedbank and Investec. Banks are mostly funded by customer deposits, which make up around 70% of total funding. Although there is reliance on deposits from financial corporates, including money market and pension funds, this funding is in turn underpinned by a retail deposit base. Refinancing risks are manageable especially because the closed rand system mitigates potential outflows so there is a deep local bond market and banks hold solid cushions of liquid assets.

Significant direct foreign exchange (FX) losses are unlikely as a result of ZAR devaluation because of generally small open positions. By local regulation, banks cannot hold net foreign-currency positions greater than 25% of equity, and banks are typically well below this limit.

However, policy interest rates rose by 50 basis points (bp) in January. Higher interest rates and weaker capital inflows could reduce economic growth; while higher inflation from a weaker ZAR not matched by wage increases will reduce the affordability of debt repayments which could weaken banks’ asset quality.

This could reverse the trends in bad debt, which have improved steadily since 2010. That said, a fall in real wages could improve competiveness and profitability, potentially supporting growth.

If the secondary effects of a weaker ZAR leads to a material weakening of asset quality and long-term earnings, this could put pressure on the standalone credit profiles of major South African banks, especially if capital levels appropriate for the operating environment are not maintained.

Fitch concludes that this week’s budget highlights the South African government’s aims of steering a course between fiscal consolidation and supporting the subdued economy. While sluggish growth remains a challenge – the National Treasury revised its 2014 gross domestic product (GDP) growth forecast in the budget to 2.7% from 3% – the CRA still expects non-performing loan ratios to remain between 3.5% and 5% in the longer term.

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