Warning about South Africa’s big banks

South African banks are at risk of destabilising the financial system as they become increasingly interconnected with the government by holding increasing amounts of its debt. 

The government’s financial health has steadily deteriorated over the past decade, with the trend accelerating in recent years as it takes on more debt to cover its spending. 

South Africa last posted a full budget surplus in the 2007/2008 financial year, after which it has run a deficit for 16 consecutive years. 

This has led to the country’s debt burden surging and its debt-servicing costs skyrocketing, crowding out spending on other areas of the economy. 

In the 2008/2009 financial year, government debt amounted to R627 billion, or 26% of GDP. After 16 years of deficits, it now stands at R5.21 trillion, or 73.9% of GDP. 

The government spends R1 billion a day to service this debt, and interest payments on its loans are one of the largest expenditure items in the budget. 

“The domestic financial sector has increasingly absorbed these bonds amid the steady decline in non-resident investors’ holdings in recent years,” the Reserve Bank said. 

While this is not problematic in itself, the sheer scale at which the government has issued debt and the amount local financial institutions have taken on poses a significant risk. 

In effect, South Africa’s financial system is increasingly exposed to a single common risk – the government. 

A higher concentration of government bonds on domestic financial institutions’ balance sheets also inhibits the capacity of the domestic financial system to absorb financial shocks. 

It may also lead to increased high volatility and low-liquidity episodes in the domestic bond market, impairing price discovery and deteriorating trading conditions in the rest of the financial market. 

In turn, this would reduce the overall resilience of the domestic financial system.

The graph below shows the rise in government bonds as a share of total bonds, crowding out funding for local companies and posing a risk to the financial system. 

The Prudential Authority echoed this warning in its annual report and said that it may be contained in the interconnectedness with the South African government and with states across Africa. 

It said South Africa’s credit rating had been downgraded to its lowest level since 1994 due to the deterioration of the government’s finances. 

As a result, the interconnectedness between the financial sector and the sovereign has become a “credible concern” for the banking regulator. 

Similarly, debt sustainability risks across Africa pose an ongoing issue for governments and major financial institutions. 

“High sovereign debt levels, along with reduced debt and interest servicing capacity, increase the possibility of sovereign restructures or downgrades and defaults,” the regulator said. 

“Contagion risks across regions in Africa are being monitored by regulated financial institutions.

The PA continues to apply moral suasion on banks to limit their risk appetite and tighten the lending criteria on high-risk regions until the risk of sovereign debt ameliorates.” 

This risk is compounded by growing pressure on businesses and consumers in South Africa, the annual report read. 

Banks increasingly have to raise provisions to cover a rise in bad debt, impacting their profitability and balance sheets. 

While South Africa’s banks are adequately capitalised well above regulatory requirements, a sharp uptick in non-performing loans will adversely affect their financial buffers. 

More importantly, this will reduce the ability of banks to spread their risk across sectors of the economy. 

In response to these emerging risks, banks have proactively worked with customers to restructure their loans and ensure that consumers remain resilient by implementing rigorous risk containment efforts.