Global accountancy firm PwC said on Tuesday, 2 June that financial stress testing shows South Africa’s banks will survive Covid-19. The sector will face pressures but is sufficiently capitalised to withstand the shocks. It would be easy to be glib about fat-cat bankers surviving while so many businesses go under and the spectre of hunger spreads. But if the banks go down the whole economy will go down the drain with them.

PwC said in a statement that “high-level stress testing” was conducted by Corné Conradie, an actuary and PwC partner, in collaboration with Professor Conrad Beyers, Absa Chair in Actuarial Science at the University of Pretoria.

Financial stress testing involves the assessment of modelled outcomes under a range of adverse economic scenarios (called “stress scenarios”) – typically mild, medium and severe stress scenarios. 

“The largest full-service banks, that include Absa, FirstRand, Standard Bank, Nedbank and Investec, were assessed. These banks account for 91% of all bank deposits and 94% of all loans granted by South African banks,” PwC said.

The banks may survive, but they are hardly going to thrive. 

“The research shows that banks are expected to experience significant credit losses. These losses will be driven by defaults on residential home loans, company loans and retail unsecured loans. The likely causes of such losses is a loss of income of borrowers instead of affordability driven by increased prices and loan instalments.

“Based on the nature of the stress, it is expected that unsecured loans will be the harder hit by the economic fallout of the Covid-19 pandemic. Residential mortgages are expected to be affected less compared to the 2008 crisis while companies may experience similar strain compared to the 2008 crisis,” PwC said.

It went on to note that “bank deposits will drop. Deposits by financial institutions are expected to be affected most, followed by the public sector, company and retail deposits. This would be driven by lower interest rates, lower economic growth, lower stock market returns and lower household disposable income. Despite these stresses, banks are currently sufficiently capitalised to withstand the shocks.”

The economic fallout from Covid-19 is often compared to the 2008 financial crisis, but PwC said the two had significant differences.

“The 2008 crisis was concentrated in the financial sector and was characterised by high interest rates and inflation with prime lending rates that peaked at 15.5% from June to November 2008 and inflation that peaked at 8.7% in May 2009. The South African equity market dropped by 34% between June and October 2008. Over 2009 the South African economy shrunk by 1.5%. In contrast, the Covid-19 financial stress is much more widespread with nearly all sectors experiencing strain,” it said.

South Africa’s banks, in part, because measures put in place because of the last global financial crisis, at least have adequate capital reserves to absorb much of the expected shock – that is why they are there in the first place.

It also noted positive contrasts with that crisis, such as lower interest rates – the SARB has cut its key repo rate by an astonishing 275 basis points in the year to date – and stable inflation and increased risk aversion, which “will mitigate the negative effects of reduced disposable income. Loan repayments should generally become more affordable.”

PwC also said that “The largest South African banks increased credit loss provisions by about 38% due to the move to the new IFRS9 accounting standard, making them more resilient to credit losses.”

Still, there are risks galore.

“Over the last 12 years, unsecured lending increased on average by 9.6% per year. This loan category is likely to be severely impacted by the current crisis,” PwC said. Unsecured loans have always been an area of vulnerability to the banking system.

Intriguingly, it noted that companies have become more exposed than homeowners with debt.

“Company loans grew by 7.6% per year to a total of 49% of all loans. These loans are highly sensitive to company profitability and business interruption. In comparison, home loans (which are affected less) grew by only 3.9% per year.”

And then there is this kicker:

“Banks face significant liquidity risk if there is a large-scale withdrawal of deposits. If this happens in conjunction with increases in loan defaults, further strain could be put on banks. Confidence in the financial system and economy guards against vast depositor withdrawals while stringent regulation and capital requirements mitigate the risk of credit losses and day to day movements in liquidity.”

On top of that, there are “critical risk factors”, including government policy, health outcomes, the expected surge in poverty and a contracting economy.

There is a lot of food for thought here. South Africa’s banks, in part, because measures put in place because of the last global financial crisis, at least have adequate capital reserves to absorb much of the expected shock – that is why they are there in the first place. But in the age of Covid-19, one of the few things that is certain is uncertainty. That may well apply to the balance sheets of banks as well. BM/DM