Recession presents sustainable growth opportunity for finance industry

The largest industry in South Africa is financial, real estate and business services (hereafter the finance industry). In 2010 this industry accounted for 19.2% of GDP. Among the important functions it plays are providing payment systems for economic transactions, mobilizing savings, channelling these resources to productive investment opportunities, disbursing credit to households and providing employment to about 1.6 million workers. Given its key role in the economy, it is important to assess the effect the recent recession has had on this industry.

Impact on growth, share of GDP and confidence levels

Prior to the recession the finance industry was growing much faster than the economy as a whole. For instance, in the third quarter of 2007 the finance industry grew by 11.1% while the economy grew by 5.1%. This was mainly a result of the credit boom that took place during this period. Rising disposable income, low interest rates, loose credit conditions, and the resultant high growth rates in the property market contributed to the strong performance of the industry.

During the post-recession period, the industry has experienced a significant slow-down in growth. This is because households are struggling to reduce their debt, banks are hesitant to lend and more people are without jobs. However, a repeat of the negative growth registered by the finance industry in the first and second quarters of 2009 is not expected under prevailing conditions. The economy is expected to grow in excess of 3.5% in 2011 and 2012, which should ensure that the finance industry also remains in positive territory.

Before the recession the share of the finance industry in GDP expanded quite rapidly. However, its low growth rate during the post-recession period has led to a decline in its share of GDP. Between the last quarter of 2009 and the last quarter of 2010 the finance industry shed 218, 000 jobs, which is equivalent to a 12.1% reduction in employment. This was far more than any other industry. The sharply contrasting pre and post recession performance of the finance industry suggests that its growth prior to the economic downturn was somewhat separate from economic fundamentals.

Due to cost pressures and declining income, confidence in the retail banking industry dropped to a level of 20 in the first quarter of 2011 from 38 in the final quarter of 2010. This is the lowest level since Ernst & Young started measuring financial sector confidence levels in 2002. Operating costs increased mainly due to bad debts, demonstrating that although the economy is recovering, households are still in difficult financial circumstances.

Other industries within the broader financial industry covered by the Ernst & Young survey – investment banking, life insurance and asset management – have significantly higher levels of confidence levels at 55, 90 and 83 respectively. These industries are less affected by household debt than retail banking. Furthermore, they are less reliant on interest income, which has contracted as a result of historically low interest rates and subdued levels of credit extension.

Positive effects of the slow-down

There is some concern among economists about the relatively weaker performance of the finance industry. In particular, low levels of credit extension dampen consumption and investment, which negatively affects economic growth. While these concerns are valid, there are also positive aspects to the slower growth experienced by the finance industry.

First, the financial industry and the economy as a whole could move towards a more sustainable growth path. The global financial and economic crisis demonstrated that growth led by excessive credit is harmful to the economy in the medium to long term.

Second, the subdued credit conditions mean that households are under pressure to strengthen their balance sheets. While a tightening of lending criteria may impede spending in the short term, it can have a positive long term impact by motivating households to improve their financial positions.

Third, banks will have to strengthen and/or explore other income streams. These could include un-banked lower income households and Small and Medium Scale Enterprises (SMEs). An increase in access to financial services would benefit not only the recipients of such efforts but the economy as a whole. Clearly, innovation to develop new business models is required if this potential is to be realised.

Fourth, non-bank institutions may have greater opportunities if the current environment shifts the demand for financial products in their favour. This could result in a more diversified finance industry with greater capacity to respond to the needs of consumers.

Conclusion

The recent recession had a disproportionate negative impact on the finance industry. Despite this, it remains the largest industry in South Africa and plays a number of important economic functions. It is unlikely that the finance industry will experience the rapid expansion it attained prior to the recession in the foreseeable future. This is not necessarily a bad thing because it may be more conducive to sustainable economic growth in the long run.