Small businesses and households continue to be under significant financial strain, with above-average bad debt levels, but banks are holding significant bad debt provisions against this, mitigating the risk to financial stability, the Reserve Bank says.
The Bank identified “increased financial distress in households and SMMEs” as a new risk in its latest Financial Stability Review on Thursday, alongside other risks such as escalating global conflicts, deteriorating public sector debt ratios, capital outflows and critical infrastructure.
But the head of the Bank’s financial stability division, Nicola Brink, emphasised that the risks to financial stability identified in the biannual reviews were “what if” assessments, not forecasts. The review found that the outlook for financial stability had improved since its June edition.
“This is largely attributable to an orderly election and the formation of the government of national unity, which contributed notably to stabilising the political landscape,” it said.
Borrowers started showing signs of distress from mid-2022 after interest rates started to increase in November 2021, and the nonperforming loan ratio climbed from 4.7% to 5.7% of total loans.
Brink said the worst-performing portfolios were credit to small, medium, and micro-sized enterprises, with a non-performing loan ratio of 8.7%, and unsecured credit to households, at 15.6%. Mitigating this, however, was that banks had managed their credit risk well with the non-performing loans covered by provisions that were well above the long-term average. “But it is a trend the Bank and the Prudential Authority are monitoring closely,” she said.
Debt service costs
The review noted that households’ debt service costs seemed to have passed their peak as a ratio of disposable income, with slowing household debt growth also mitigating some of the risk.
Financial results from SA’s big banks for the latest period showed bad debt ratios had peaked for the most part, though this depended on the mix of the various banks’ loan books, and with interest rates coming down most expect customers’ finances to start turning around.
One area where companies are taking increasing strain is commercial real estate, which was the subject of a special section in Thursday’s review. It found that the sector’s woes were a risk for investors in the sector, but did not have big implications for financial stability. That is especially so given that banks’ exposure to commercial real estate has declined, which has itself added to the sector’s vulnerability.
“The assessment found that financial imbalances within the SA CRE (commercial real estate) sector have significantly increased since the Covid-19 pandemic, with vulnerabilities exacerbated by climate change. Meanwhile the banking sector’s exposure to CRE has also declined, indicating tighter lending standards,” the review said.
This was positive for financial stability but contributed to growing financing challenges for the sector. Investors could incur large financial losses in the event of market shocks, but systemic risks appeared limited because of the financial system’s relatively low exposure to the sector, the review said.
The sector was under cost pressure because of the need for investment in electricity supply, as well as municipal rates and taxes increasing faster than rental income. Water supply risks and climate change risks also affected property values and insurance costs, the review found. At the same time, the shift to e-commerce and working from home had put pressure on rental income. Though the shift was triggered by the Covid-19 pandemic, rental demand remained subdued, it found.
The Bank also again flagged financial stability vulnerabilities if SA remained on the Financial Action Task Force greylist over the medium term, saying SA’s access to the global financial system could become increasingly restricted if it did not get off the greylist in June next year.
SA has addressed all but six of the 22 items in its action plan but the Bank’s governor, Lesetja Kganyago, cautioned that the last stretch could be the hardest, comparing this to people (himself included) who manage to lose much of the weight they need to drop, but struggle to lose the last couple of kilos to get to their target weight.
Deputy governor Fundi Tshazibana said the remaining items were largely about prosecution. SA needed to show it could sustain progress on the action items, but since the outcome of the prosecutions it was undertaking could not be predicted this was a vulnerability.
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