RMB Morgan Stanley has named Standard Bank as the lender most at risk for potential negative effects that could flow from SA being greylisted by the Financial Action Task Force (FATF).
The Paris-based FATF, an intergovernmental body that assesses countries’ ability to combat illicit financial activity, gave SA 18 months to tackle shortcomings in its ability to prevent financial crimes outlined in an evaluation report in October 2021. The one-year observation period for SA ends in October 2022, a deadline at which point the country must demonstrate progress in addressing its anti-money-laundering and terrorist financing shortcomings or risk being added to the greylist when FATF holds its follow-up review meeting in February 2023.
Though RMB Morgan Stanley says SA will be somewhat insulated from the negative effect of greylisting due to its deep capital markets, well-developed financial system and orthodox monetary and fiscal policies, it does expect some bank-level risks to portfolio flows as well as trade-related bank revenues. That’s likely to affect Standard Bank’s global markets business, which is engaged in financial markets trading, as well as the trade finance revenue it earns from funding large corporate activity across Africa.
Nedbank is heavily reliant on the trading activity of its corporate and investment banking (CIB) unit, which accounts for about half its earnings. Absa is also at some risk due to the rest of Africa operations it inherited after its separation from Barclays.
“In terms of potential impact, our illustrative analysis suggests a reduction in capital flows would affect Standard Bank and Nedbank’s earnings the most, given their larger proportional trading revenues,” equity analyst James Starke and economist Andrea Masia wrote in a RMB Morgan Stanley report on Tuesday.
“Standard Bank and Absa have the largest reliance on trade finance, which is sensitive to import/export disruption but also incremental compliance costs given the cross-border nature, which carries inherently higher money laundering/terrorism financing risk.”
Standard Bank CEO Sim Tshabalala said in July that the consequences of being greylisted would be worse than a sovereign credit downgrade as it would cause the rand to weaken while interest rates and inflation would spike. However, not all analysts have been as apocalyptic in their analysis, with Old Mutual economist Johann Els saying earlier this week that while SA’s greylisting was virtually inevitable, that had largely been priced in by financial markets.
Nevertheless, the Reserve Bank has said greylisting could result in higher transactional and funding costs for SA banks; restricted cross-border transactional ability that would hurt imports and exports; reputational damage to the local financial system; and a deterioration in relationships with offshore financial institutions. A July report by the Prudential Authority (PA), a division of the Bank that regulates financial firms, found that SA’s large banks on average had 24,786 clients considered to be high risk while one had 8,388 clients with unknown citizenship.
“This points to existing KYC [know your customer] deficiencies that will need to be addressed and may potentially attract regulatory penalties,” Starke and Masia wrote in their report.
RMB Morgan Stanley pointed out that historically it had taken between two and three years for countries to get themselves removed from FATF’s grey list, though Mauritius managed to exit the list in just 20 months.
While RMB Morgan Stanley said Standard Bank had the highest revenue reliance on capital flows via income earned on financial markets trading, it added a caveat to its analysis by saying the lender’s reliance on SA may be overstated as the rest of Africa contributed a substantial portion to those trading revenues, though the quantum was not disclosed in its results.
Starke and Masia also provided what they termed “illustrative” effects on the various banks, saying a 10% reduction in financial flow (i.e. markets trading) revenues would reduce Standard Bank’s overall earnings 3% and Nedbank’s 2%.
By contrast Absa and FirstRand’s earnings would drop by only about 1% in response to a 10% reduction in financial trading revenues while Capitec's would be “barely affected.” RMB Morgan Stanley highlighted Nedbank and Absa as having the largest reliance on rand-denominated government bonds in their asset mix, suggesting a decline in the value of these debt instruments in response to grey listing could negatively impact their equity base as fair value losses filter through to the income statement, assuming the securities were unhedged and not held to maturity.
Though Capitec was assessed as having the largest exposure to Treasury bills the relatively short duration of these instruments meant this posed “limited valuation risk”, RMB Morgan Stanley said. Even so, RMB Morgan Stanley pointed out its analysis of bank bond holdings was based on Reserve Bank data and that it could not determine the degree to which the debt securities were hedged or held on behalf of clients.
To quantify the overall capital flow effect of greylisting inclusion on SA’s entire economy, RMB Morgan Stanley highlighted an International Monetary Fund working paper, which found that it caused portfolio inflows to decline by an average of about 2.9% of GDP. Foreign direct investment (FDI) typically fell by an average of 3% of GDP in response to FATF grey listing while other investment flows declined by 3.6% of GDP on average.
Would you like to comment on this article?
Sign up (it's quick and free) or sign in now.
Please read our Comment Policy before commenting.