Banking

South African banks riding high

South African banks’ profitability is set to remain strong despite expected interest rate cuts, as reforms in the country are projected to benefit the financial sector.

Rating agency S&P Global recently released its South Africa Banking Outlook 2025, which predicts another strong year for the country’s banks.

South Africa’s biggest banks generally experienced a strong year in 2024, with increased profits and earnings.

This came despite economic headwinds like high interest rates, a high cost of living, and subdued economic growth.

Many of the country’s biggest banks experienced elevated bad debt charges directly linked to these tough economic conditions.

These conditions increased difficulties for consumers and businesses in repaying their debts, which affected the banks.

Despite these circumstances, the country’s so-called ‘Big Five’ banks achieved positive growth in 2024.

Many expected the banks to experience a tough 2025, as the South African Reserve Bank (SARB) started cutting interest rates in September last year.

The bank cut rates by a cumulative 50 basis points in 2024, with more cuts expected this year.

Lower interest rates can severely affect a bank’s profitability by compressing its net interest margin (NIM), the difference between the interest income earned on loans and the interest paid on deposits.

Lower interest rates reduce loan yields, compressing a bank’s NIM. Since interest income is a significant revenue source for banks, this can decrease profitability.

However, S&P said it expects banks’ profitability to remain strong, supported by higher credit growth, non-interest income, and lower provisioning. 

“We expect a 20-basis point net interest margin compression by the end of 2025 relative to 2024 because of the anticipated interest rate cuts,” the firm said.

However, it said South African banks’ diversified revenue bases, with 41% of their operating revenue stemming from non-interest revenue in 2024, will support their performance in a decreasing interest rate environment.

“We anticipate that the sector will maintain an adequate return on equity of 16% and 1.4% of return on assets on average in 2025. This compares well in the broader emerging market context,” it said.

The firm explained that, although improving, banks’ asset quality metrics remained under pressure in 2024, mainly driven by their retail portfolios. 

In 2024, South Africans’ disposable incomes and ability to repay debt were constrained by high interest rates and relatively high food prices.

However, S&P predicts that improving macroeconomic conditions in South Africa will ease pressure on households’ capacity to service debt, benefitting local banks.

The firm said households being able to access part of their retirement savings through the recent two-pot retirement system will also contribute to their ability to repay debt.

“We expect that the banking sector’s credit loss ratio will normalize, averaging 90 basis points in 2025, from an estimated 100 basis points in 2024,” the firm said.

“Similarly, nonperforming loans will improve toward 4.4% of total loans at year-end 2025 from an estimated 4.7% in 2024.”

South African banks already started to see an uptick in credit extension in the latter half of 2024.

In recent years, South African banks have maintained strict controls on loan growth due to rising interest rates, which led to a sharp rise in bad debt. 

While higher interest rates typically improve margins and boost revenue for banks, prolonged high rates can pressure consumers, leading to increased credit losses and a need for higher provisions, which reduce profitability.

To counter this, some banks tightened lending criteria over the past year, while others faced declining loan affordability among consumers who failed to meet lending standards. 

As a result, credit extension to households and small businesses slowed significantly.

Data from the Reserve Bank highlights this slowdown, with year-on-year growth in credit extension dropping from 9.9% in February 2023 to just 3.2% in April 2024 – the lowest rate since October 2021, when the country was emerging from pandemic-related lockdowns.

Credit growth averaged 4.2% during the first ten months of 2024, far below the 7.5% and 7.4% averages recorded in 2022 and 2023, respectively. 

However, growth began to recover in September and October 2024, with rates of 4.4% and 4.5%, respectively.

The Reserve Bank noted that corporate credit extension is driving this recovery, as banks remain cautious about extending loans to financially strained consumers. 

Real loans and advances grew by 0.6% in September and 1.5% in October, marking a shift from contraction to modest expansion. 

This was due to nominal loan growth slightly outpacing consumer price inflation.

Several factors suggest that the recovery in credit extension may continue. The Reserve Bank said high government borrowing could push banks to allocate domestic savings to the private sector instead of government debt. 

In addition, sustained improvements in foreign investor sentiment could reduce reliance on the domestic financial system to fund the fiscal deficit.

Declining interest rates and an improved economic growth outlook are also expected to lower credit risk, encouraging banks to extend more credit to the private sector. 

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