SA’s financial stability outlook is improving as the economy recovers and profitability of financial institutions improves though risks to the financial system remain, the SA Reserve Bank said on Wednesday
A flare-up of Covid-19 and its potential to derail SA recovery, a sudden tightening of global financial conditions and the financial system’s interconnectedness with SA’s sovereign through its holdings of government debt were among risks highlighted in the Bank’s latest Financial Stability Review.
The Bank also flagged rising loan defaults, particularly among retail customers, which it believes may not yet have peaked.
“Global growth concerns alongside domestic structural challenges such as electricity constraints and high unemployment levels are expected to negatively affect the domestic economic recovery,” said Reserve Bank governor Lesetja Kganyago.
As temporary support measures put in place to help the economy and financial sector through the pandemic are gradually being unwound the effects of Covid-19 will continue to be felt, he said.
The government’s financial position has improved thanks to the economic recovery and a surge in commodities that has temporarily boosted taxes, reduced debt levels, as well as a recent revision of GDP numbers that has helped improve financial ratios.
Nevertheless debt is expected to reach 77.8% of GDP by 2024/2025. The most recent figures published by the Treasury suggest that banks hold just less than 20% of all government debt.
“The nexus between the financial sector and the sovereign is also likely to remain a key risk to financial stability over the medium term,” Kganyago said. “Exposure of financial intermediaries to government debt remains elevated while debt is expected to grow further.”
According to the review “very little capital is held against sovereign exposures in the banking sector and there is a high degree of exposure concentration relative to other asset classes, particularly among smaller banks”.
This could leave banks vulnerable if SA’s fiscal metrics deteriorate further, the review said. The high yield offered by government bonds and their favourable regulatory treatment may be supporting the rising exposure of banks to the sovereign over time.
The Bank’s financial stability committee is assessing policy options to address the bank-sovereign nexus, along with work being done through the Basel committee on banking supervision, according to Kganyago.
The review warned that a gradual reduction of monetary stimulus is expected to take place in both the US and the eurozone, beginning with a tapering of large-scale asset purchase programmes, followed by rising interest rates.
“If this occurs rapidly or in a fashion which surprises markets, there is a risk of a sharp tightening in global financial conditions,” it said. Improved communication from key central banks could mitigate this vulnerability.
These risks notwithstanding, SA’s financial system “has displayed a relatively high level of resilience under very challenging conditions”, said Kganyago.
The review revealed the results of the Bank’s latest stress tests on the country’s six largest domestic banks, which account for 92% of total sector assets.
The findings showed that even if the pandemic worsens and SA experiences a “double-dip recession” with the economy shrinking a further 4.9%, these systemically significant banks are expected to maintain adequate capitalisation and liquidity levels above minimum regulatory requirements.
The Bank implemented a range of interventions to mitigate financial stability risks in the wake of Covid-19.
While some of these policies were or are being removed certain interventions remain in place, namely eased liquidity coverage rules for banks as well as the differentiated regulatory treatment of loans restructured due to Covid-19.
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