Credit concerns dominate local banking environment

Credit concerns dominate local banking environment

The Centre for the Study of Financial Innovation (CSFI) in association with PriceWaterhouseCoopers (PwC) released its 2008 Banking Banana Skins report at a media function in Johannesburg yesterday. The survey, already in its ninth year, focuses on the main concerns facing global financial systems over the next two to three years. It also ranks a list of potential stumbling blocks in the banking industry.

In 2008 the survey was based on 376 responses from bankers, regulators and observers from 38 countries. The majority of respondents were in the UK (190) with Russia (25), the US (19) and Australia (15) also well represented. There were four submissions from South Africa. Most submissions came from banks (59%) with observers (35%) and regulators (6%) accounting for the balance.

Credit is a top concern at domestic banks

For obvious reasons the major concerns identified by participants differed significantly by geographic region. FAnews Online is most interested in what the four South African respondents had to say. The survey results confirm the fears we’ve been picking up in the domestic economy.

Top of the list of SA Banking Banana Skins is the ‘credit spread’ risk. In layman’s terms a credit spread arises due to “variations in the cost of credit to different classes of borrower.” Banks can make profit by trading one class of borrower against another… The sub-prime bubble resulted because “banks ignored the extra risk in low class assets.” Today there are huge levels of mistrust around spreads which also indirectly contribute to liquidity concerns. Incidentally liquidity concerns dominate the international Banking Banana Skins survey, identified as the major concern by Europe and placing second in the US and Asia.

South Africa ’s second concern is credit risk. Credit risk links back to the affordability issues faced by domestic consumers. A series of nine interest rate hikes in the last 22 months has left many South African consumers on the back foot. Tom Winterboer of PwC SA Banking and Capital Markets notes that while South Africa’s household debt to annual income (at 77%) was low compared to the US (110%) and UK (125%) it remains a major worry. Position three on the SA Banking Banana Skins list is occupied by derivatives. The “potential for derivatives to cause trouble, particularly in the credit default market, remains high.” Major concerns in this category include bank exposure to derivatives, the potential for non-performance of weakened counterparties, turmoil in back offices and the sheer complexity of unresolved deals based on derivatives.

Currencies and equities also worry local players

Position four and five on the SA Banking Banana Skins report are occupied by currencies and equities respectively. Currencies appear higher up on the SA list due to the relatively big impact of a volatile and unpredictable rand on South Africa’s current account. Obviously local miners and exporters benefit from a weaker currency while importers and capital intensive manufacturing companies struggle. … Equities remain a concern due to the volatility introduced to global markets subsequent to the sub-prime crisis. It seems the JSE has shrugged off most of the negative sentiment with resources in particular carrying the All Share Index to new highs. Weakness in the domestic financial, banking and retail sectors have more to do with credit concerns and spiralling interest rates than the global crisis. But we cannot discount further market volatility.

The biggest mover on the SA Banking Banana Skins ranking from 2007 to 2008 is the regulatory interference category. Too much regulation ranked only 13^th on South Africa’s concerns compared with first position last year. It seems respondents either believe that regulators have completed the bulk of regulatory interventions, or that the regulatory process is less intrusive than originally feared.

Liquidity is the top concern for international banks

Winterboer notes that liquidity and credit spreads are two issues which have not previously appeared in the Banking Banana Skins report. He says that the risk environment has changed dramatically, evidenced in that “the only non-financial risk in the [global] top ten is the prospect of regulatory over-reaction as politicians and regulators prepare to fix the problem.” He also pointed out that liquidity concerns carry a much higher weighting than the top concern in the preceding three years. The global obsession with sub-prime has been exacerbated by the failure of Bear Stearns in the US and the bailout of Northern Rock in the UK.

In the aftermath of the credit crisis the 2008 Banking Banana Skins report is the ‘darkest’ in some time. A mere 24% of global respondents felt banks were well prepared to meet all the risks identified compared to 64% in 2007. This underpins the uncertainty lingering in global financial markets where as much as $945bn will have to be written off due to questionable lending practices and the rapid spread of complicated (and risky) securitised debt instruments in the US and other Western countries

Editor’s thoughts: Credit, credit and more credit. We can confirm that credit concerns dominate the local financial services industry. The big four local banks have all upped their ‘bad debt’ provisions in anticipation of a bloodbath in the mortgage, hire purchase and personal loans arenas. Do you anticipate a huge surge in credit defaults this year? Send your comments to [email protected] or add them below.

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