Revenue growth remains banks’ most pressing issue whilst Basel III has been identified as the most important driver of change

Participants to the survey identified Basel III as the most important driver of change in the banking sector and it is expected to significantly impact on banks’ funding models. Basel III’s proposed liquidity rules, coupled with more stringent capital requirements on trading positions and securitisations, mean that banks will have to be even more efficient in their use of capital if they want to avoid lower future returns on equity.

These are some of the key findings in the 12th PwC survey on banking in South Africa, highlighting strategic and emerging issues in the sector says Tom Winterboer, PwC Financial Services Leader for Southern Africa and Africa.

“Banks have been dealing successfully with regulatory changes for several years, and this is set to continue for some time” added Johannes Grosskopf, Banking and Capital Markets Leader, PwC Southern Africa. “In addition to Basel III, banks also have to implement changes to comply with numerous other pieces of new legislation, ranging from the new Companies Act to the imminent Protection of Personal Information Bill to the US Foreign Account Tax Compliance Act (“FATCA”) , a US based legislation aimed at identifying US citizens with income in foreign jurisdictions. Regulatory developments have also compelled banks to change their remuneration structures, with many revisiting cash components of bonuses, and introducing more stringent bonus deferral conditions.”

The PwC survey is based on research conducted in February and March 2011, and the 20 respondents cover domestic and foreign banks, ranging from the ‘Big Four’ to local niche players and branches of global banks. ‘Unlocking opportunities - Strategic and emerging issues in South African banking 2011’ has been developed by PwC and Dr Brian Metcalfe, associate professor in the Business School at Brock University, Ontario, Canada.

Although long term projections for South African banking revenue growth and profitability are bullish, revenue growth and returns in the current environment are sluggish and the most pressing issue for banks according to the CEOs surveyed. “Banks are currently focussed on driving revenue growth on the one hand and profitability through further trimming of the cost of delivering services on the other hand. Banks identified staff costs and increasing efficiencies by eliminating duplication as two of the most important components of reducing costs” says Grosskopf. “However, for those who are expanding, cost reductions, if any, may be limited.”

Many respondents expect their Return on Equity to increase to above 19% in the next three to five years, with a few expecting more conservative RoEs of 13% to 18%. Profit after tax growth is predicted by participants to be in the range of 11% to 20%, over both the next 12 months, and for the coming three to five years.

Competition in the sector is expected to increase, coming from the entry of Postbank, and growth in the lower end of the market, served by banks such as Capitec, African Bank and associations with retail stores. Corporate & investment banking and trading, which saw a drop in the levels of perceived competition in 2009, have rebounded strongly, and are now being viewed as intensively competitive.

Mobile banking and electronic channels are also gaining momentum, with two participants noting a doubling of activity in 2010. “Innovation in these areas will be critical for future success” says Grosskopf. “However, weaknesses in information technology are a hindrance. Respondents indicated that South Africa must increase its internet bandwidth and international connectivity. Furthermore, there are ongoing challenges relating to legacy systems, integrated business process management and card fraud. Given these challenges, the Big Four banks indicated that they are expecting to spend over R30 billion in the next three years on upgrading or replacing their IT infrastructure and related processes.”

The survey indicates the decline in importance of home loans in banking retail operations - possibly due to increased funding costs, heavy losses suffered during the economic downturn, and the administrative burden placed on banks to collect overdue accounts following the introduction of the National Credit Act (NCA). Respondents also noted the potential impact of Basel III on home loans if they have to match-fund their home loans portfolio with similar long dated liabilities, which is currently not available.

Interest in Africa, particularly in the SADC countries (rather than broader Sub-Saharan Africa) remains strong. The move into Africa is partly driven by the banks’ need to follow and service their corporate clients as they expand in these markets. “Participants suggested that many banking assets in Africa are for sale” says Grosskopf “but it is not easy to find targets with good quality management and staff at the right price.” Outside of Africa, participants weighted interest in Asia, Middle East and South America equally.

The “return of foreign banks” was highlighted by several participants, reversing their sentiment of two years ago. Respondents believe foreign banks still have an appetite for major investments in South African banks, despite the HSBC/Nedbank deal not materialising.

Banks responded that they believe the South African banking sector has robust risk management systems, being rated in sixth place in the World Economic Forum’s 2010 global ranking of bank ‘soundness’. “However, the skills shortage is problematic and impacts on how staff understand risk management – this is echoed by several domestic banks who expressed a concern over the quantitative aptitudes of new staff entrants to the sector” notes Grosskopf.

The removal (in the new Companies Act) of the annual audit requirements for certain companies was not welcomed by participants to the survey. This relaxation impacts negatively on their credit risk evaluation and management, and loan covenant monitoring. Banks indicated they would prefer all but the smallest SME entities to be subject to a statutory audit. Another concern raised was how the new business rescue provisions will impact lenders.

Based on responses in the 2011 South African Banking Survey and our in-house research it is clear that “South African banks will have to contend with a number of new realities if they wish to remain relevant in the post-crisis environment”. Winterboer concludes that the likely winners should be those that can respond to these challenges, while at the same time making the most of their competitive strengths.”