PwC’s South Africa Major Bank Analyses survey reveals improvements in the banking sector

South Africa’s big four banks’ or major banks’ (Absa, FirstRand, Nedbank and Standard Bank) full-year results for the past year reinforce once again the collective strength and profitability of the South African banking system. Although there were differences in the performances of the individual banks, combined headline earnings increased by 12.9% to R33.9bn on an annualised basis. The average return on equity was 14.5%, compared to 13.3% in 2009.

The largest single contributing factor to profit growth was the reduction in bad debt expenses (down R10.9bn or 31.2%) as lower interest rates helped reduce the inflow of new non-performing loans and general economic conditions improved. Excluding this effect, core earnings decreased by 2.2% which put pressure on efficiency resulting in the average combined cost to income ratio to increase by 5%.

These are some of the highlights from PwC’s South Africa – Major Banks Analyses survey.

“The banks have all reported that the revenue growth outlook is less positive. This is testament to the difficult challenges facing banks as they grapple with the new post-global financial crisis (GFC) reality,” says Johannes Grosskopf, PwC’s Banking and Capital Markets leader.

Five separate sources of strain on the banks’ revenue include:

· Margin pressure as historically low interest rates are maintained.

· Low growth in demand of credit given the strength of economic activity in general.

· An increased cost of funding, as banks’ funding profiles are lengthened; with no reprieve on the cost of retail funding through deposits.

· Subdued trading income, driven by continuing low transaction volumes and limited risk taking.

· Pressure on fee income, partly due to less lending activity.

Although banks continue focussing on costs, the absolute expense number still increased 11.5% on 2010 and resulted in additional strain on cost to income ratios which increased to 58.6% from 55.8% in 2009.This will continue to be a major focus in 2011” continues Grosskopf.

The banks’ capital levels have remained strong with all banks well ahead of the regulatory minimum requirements. Given the unprecedented regulatory change and increasing levels of political scrutiny banks will likely retain these capital positions until the future landscape is clearer. This will continue to impact their ROE’s.

In addition to Basel III, banks also need to contend with the new “Twin Peaks” approach to financial regulation announced by the Minister of Finance in his recent budget speech. The revised regulatory framework will see the South African Reserve Bank (SARB) given lead responsibility for prudential regulation while the Financial Services Board (FSB) will deal with consumer protection.

In addition, a retail banking services market conduct regulator will be established within the FSB which will focus on structural market issues and banking fees while working closely with the National Credit Regulator to manage the extension of credit. The SARB’s mandate for financial stability will be underpinned by a new Financial Stability Oversight Committee, co-chaired by the SARB Governor and the Minister of Finance.

In a deleveraging world, and with new capital and funding restrictions, South African banks will need to be more selective in finding new ways to connect with customers to drive revenue and profitable growth. Large investments in technology to improve efficiency are clearly one vehicle for this. The banks are also pushing the mobile handset revolution for the same reasons as this is seen as a potentially high growth area that does not require significant infrastructure investment, given that a significant portion of the target market was previously unbanked. Furthermore, the big four banks are increasing their focus on the lower income sectors as the battle for market share intensifies, given the importance of growth in this sector.

In the pursuit of growth, offshore expansion into Africa remains very much in play, with each bank taking a different approach. Suffice to say, history has shown that this is an area where a precise understanding of the chosen market - in contrast to ubiquity of scope and reach - is fundamentally important.