Category Investments

Banks are bullet proof

20 May 2004 Angelo Coppola

Lower inflation and interest rates will not hurt South African bank’s profit margins in the long term.

That’s according to a study by global business advisory and auditing firm Ernst released today, which investigated the impact of a long-term decline in inflation rates on the South African banking industry’s profit growth path.

Commenting on the research, Rakesh Garach, partner in Ernst & Young Financial Services, says the 550 basis points fall in interest rates through the course of 2003, will likely lead to banks facing a margin squeeze in the short term.

“This should, however, be reversed once interest rates stabilise at current levels,” he says.

Garach says real disposable income gains have been made in the last few years and this should favour banks to grow their advances books in a lower interest rate environment.

“This in turn, implies that consumers have more cash at hand, which will likely lead to an increased appetite for debt throughout 2004,” he adds.

According to the study, although lower inflation and interest rates should boost bank earnings due to higher volumes, it will only be an initial spurt.

Garach explains that the consumer psyche will adjust to lower interest rates and the need for debt will decrease.

Garach points out that lower inflation is synonymous with more restrictive monetary policy, which in turn means that interest rates will rise should consumer spending and debt levels increase too rapidly.

“In a more restrictive monetary environment it can be anticipated that authorities will be forced to raise interest rates, to enforce lower spending and underlying inflation, should bank advances rise too steeply,” he says.

The survey indicates that the UK underwent a similar cycle during the 1990s, when structural inflation fell from double to single digits averaging between two and three percent in the late 1990s.

“In large part, UK banks responded by focusing more intensely on non-interest revenue. British banks started charging for services that, prior to that, had been offered free of charge,” says Garach.

“This tied the banking industry over through periods of low advances growth.”

But Garach says from the mid nineties, the industry experienced buoyant demand for debt on the back of a housing market boom, as well as growing equity values.

“The wealth effect this created supported strong growth in credit demand without resulting in revived inflation,” he adds.

Garach says South African banks are not likely to react similarly as it appears that there is a limited ability to grow fees and charges in excess of general inflation levels in the years ahead.

“Over the last decade, the local banking industry has increased fee charges in excess of general inflation levels, which has led to banking charges becoming considerably more expensive relative to other goods and services.”

He says there will undoubtedly be a consumer backlash to future attempts to increase costs.

In line with international banking trends to counter lower revenue growth, Garach says South African banks will have to look at diversifying earnings streams into other markets, both locally and internationally.

“The introduction of the Financial Services Charter requires banks to expand their service offering to currently unbanked individuals and the critical success factor will be in implementing lowest cost technology to ensure that feasible solutions are found to service this market,” he says.

According to the study, there has also been a thrust into Africa by the local banking industry, largely to support the move of many local corporate companies into the continent.

“Although it is an expensive exercise in terms of the expertise required to get it right, it has thus far proved to be successful,” Garach says.

Quick Polls


There are countless articles written about South Africa’s poor retirement outcomes. Which of the following would you single out as the biggest contributor to local savers not accumulating enough to buy an adequate and sustainable pension?


Lack of personal accountability
Poor participation in formal retirement funds
Reluctance to seek financial advice early on
SA’s high unemployment rate
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