Forget that grey list, SA has bigger financial ‘fish’ to fry
As South Africans fret over whether or not the country is added to the global Financial Action Task Force (FATF) grey list, our regulatory authorities are hard at work to ensure the integrity of our financial system. The latest Financial Stability Review (FSR), published by the South African Reserve Bank (SARB) for the six months to end-October 2022, concludes that the domestic financial system [remains] resilient despite highly challenging global and domestic conditions. According to the SARB, “prudentially regulated domestic financial institutions remain resilient, partly owing to their ability to maintain adequate capital buffers to absorb the impact of shocks”. The central bank is confident that this outlook will remain unchanged for review’s 12-month forecast period, until end-November 2023.
Beware conflating the issues
The positive rhetoric contained in the FSR should not be conflated with the on-the-ground, lived experience of South African households as 2022 winds to a close and the New Year gets underway. Households are starting to feel the financial ‘pinch’ that follows from seven interest rate hikes over the last 12-months, with the prime lending rate up from 7% to 10.5% by December 2022. As this writer noted in a recent newsletter, this means mortgage holders are paying an extra ZAR2 200,00 per month per million rand of debt, assuming their loan was issued at prime over a 20-year repayment period. The FSR warned of worse to come, noting that “concerns over global stagflation and the consequent tightening of financial conditions have materialised, while fears of a global recession continue to grow”.
To further complicate matters, the ongoing Russia-Ukraine conflict and escalating geopolitical tensions around China-Taiwan and North Korea and its neighbours are sending uncertainty and volatility through the roof. Local financial and risk advisers, and their clients, should be aware that South Africa remains extremely vulnerable to spill-over effects from global events. Unfortunately, the financial impact following the latest round of domestic political shenanigans has overshadowed global concerns, with the South African rand suffering a massive ‘hit’ due to the unfolding Phala Phala farm-gate scandal and resulting uncertainty over the incumbent president’s fate. Check out ‘Farm-gate… Busting my opinion streak for some breaking news’ for some of the writer’s thoughts on the matter.
The FSR’s take on the domestic economy
The latest FSR, being the second edition for 2022, was published before the farm-gate scandal, when load shedding was top-of-mind among businesses, consumers, economic and financial analysts and even politicians. “Domestically, slow and inequitable domestic economic growth presents an unfavourable operating environment for the financial sector; this was exacerbated by increased load shedding during the review period, which had the dual impact of negatively influencing investor sentiment towards South Africa and detrimentally affecting business productivity,” they wrote. Yes, dear reader, the nightmare that is Eskom looks set to haunt and taunt the local economy, and your clients, for years to come.
The SARB summed up the impact quite succinctly, stating that “insufficient and unreliable electricity supply is likely to threaten the viability of some corporates, especially small and medium-sized enterprises (SMEs), for the foreseeable future, with losses potentially spilling over into the financial sector”. FAnews has spoken to a number of small businesses that are burning through thousands of rand worth of diesel each month, as they attempt to operate through load shedding. Just imagine a mid-size restaurant that has to keep a 32Kva generator running for 7.5 hours each day, seven days a week! If Stage II-IV becomes the new normal these costs will become permanent features on SME’s income statements, adding to the growing list of inflationary pressures.
Making the grey list will be very damaging
The FSR highlighted fiscal debt and the possibility of grey listing by the FATF as two major concerns going into the forecast period. “Should South Africa fail to demonstrate sufficient progress in remediating the deficiencies identified in the FATF Mutual Evaluation Report of South Africa, the consequences of the adverse findings could hold far-reaching implications for the domestic financial sector, particularly from a reputational risk perspective,” they wrote. Making the grey list means that the asset managers, life insurers and non-life insurers that you support, and whose products you advise your clients on, will face additional administrative and compliance pressures. The financial sector’s resilience and sustainability is also inextricably linked to the country’s fiscal outlook due to local financial institutions having high levels of exposure to government debt.
According to the FSR, this exposure to government debt “poses risks to domestic financial stability, particularly should there be a shock that leads to further volatility and a sharp repricing in the value of government debt”. An example of this type of ‘shock’ occurred mere days after the FSR report was published, as concerns over the country’s political leadership adversely affected the currency and government bonds. As reported on Fin24.com: “The nation’s currency tumbled toward its worst decline in six years and the government’s borrowing costs surged the most since 2015 as the president considered resigning over potential breaches of the constitution…” At its worst, the rand was down 4.4% [on 1 December 2022] while the 10-year sovereign rand bond yield jumped as much as 84 basis points, to 11.64%.
Fighting the good fight…
The SARB deserves praise for fulfilling its monetary policy and prudential functions despite global financial market uncertainty and unrelenting pressure from minority political parties domestically. Yes, it has hiked interest rates, but it has done so to fulfil its primary goal of combating inflation. In its ongoing fight for financial resilience and stability, the central bank has addressed key risks in collaboration with Financial Stability Oversight Committee members; identified risks that could result in potential systemic events in cross-sectoral collaboration with the Financial Sector Contingency Forum; maintained the so-called countercyclical capital buffer at 0%; and continued to work on the implementation of resolution and deposit insurance frameworks as enacted by the Financial Sector Laws Amendment Act, Act 23 of 2021.
In closing, we though it worth sharing some of the FSR comment on the domestic insurance sector. The SARB conceded that “profitability in the insurance sector came under some pressure between May and October 2022”. Life insurers saw a reduction in net premiums and lower unrealised gains on investment portfolios even as net claims paid were moderating post-pandemic. “By contrast, net claims in the non-life segment increased during the review period, predominantly due to an increase in claims related to motor vehicle and property insurance,” noted the FSR. “The increase in claims in the earlier part of 2022 was caused by floods in KwaZulu-Natal and higher levels of load shedding and power outages, while the rise in the number of claims for motor vehicle insurance reflected the normalisation of traffic volumes after the COVID-19 lockdowns”.
Solvency good, premium outlook less so
The good news is that despite the challenging macroeconomic environment, both the life and non-life insurance segments maintained adequate solvency capital requirement (SCR) ratios of 1.7 and 1.6 respectively, well above the minimum requirement. “In general, lower growth prospects and rising interest rates are expected to add pressure to premium growth over the medium term,” concluded the FSR. The biggest challenge to the life sector was offered as volatile financial market performance that could negatively impact investment income. For the non-life segment, concerns were raised over rising claims related to power surges; increasing climate-related risks; the soaring cost of vehicle repair and replacement; and higher reinsurance premium rates.
Writer’s thoughts:
Love them or hate them, interest rate hikes are a necessary weapon against inflation, with the caveat that overusing the weapon during periods of sluggish growth increases the risk of stagflation. This writer believes the South African Reserve Bank (SARB) has an exemplary long-term track record in keeping inflation in check. Do you agree or disagree? And how would you say they have performed in the financial system resilience and sustainability stakes between 2019 and 2022? Please comment below, interact with us on Twitter at @fanews_online or email us your thoughts [email protected].
