Squeezed consumer income causes lower retail bank confidence

Ernst & Young Financial Services Index Q2 2008

The latest Ernst & Young Bank index, released today, indicates that banks, particularly retail banks, are feeling the strain of slowing business fundamentals.

The index results show that banking confidence fell once again, from 79 points in the first quarter, to 68 points in the second quarter of 2008. The survey is conducted by the Bureau for Economic Research in Stellenbosch. The fall in bank confidence was entirely attributable to the retail banking sector, with retail bank confidence declining even more sharply than it did in the first quarter, from 78 index points to 57.

Bank Confidence Levels

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Says Emilio Pera, lead Banking director at Ernst & Young; ‘ For two consecutive quarters we have seen a noticeable decline in overall banking confidence levels. However, unlike the previous quarter, where both retail and investment banks reported sharply lower confidence levels, we observe that in the 2nd quarter of 2008, the decline in confidence was solely due to declining retail banking confidence. Investment bank confidence remained stable at 79 index points.’

Continues Pera, ‘It is not surprising that retail banking confidence levels continue to drop, whilst that of investment banks is holding steady. The retail banks are being particularly impacted by rising interest rates and rising inflation. High and rising interest rates have reduced the demand for credit, whilst simultaneously causing bad debts and provisions to increase. Rising inflation leaves lower levels of discretionary income with which to service existing debt. This double knock results in revenue growth pressures, at the same time that expenses are generally pressured upwards through increasing bad debt costs.

In the corporate market, on the other hand, strong demand for corporate credit remains the pattern. Companies with a strong resource focus are growing capacity, although they are often cash-flush due to strong commodity prices. Their demand for advisory services remains strong. At the same time, the country’s general infrastructure thrust is only in its initial stages, and more projects are likely to come on line, as Transnet’s and Eskom’s capacity building initiatives take off.’

Says Pera, ‘ Whilst there are lower levels of activity in certain key areas, such as private equity and corporate finance, other areas of activity remain buoyant. For instance, Treasury & specialised finance volumes remain strong, and there is moderate growth in project finance. Lower business volumes in private equity and corporate finance are very likely a response to lower levels of global liquidity, a consequence of the US sub-prime crisis. There are certainly lower levels of funding available for investment in private equity, whilst corporate finance activity has slowed on the back of considerably lower appetite for mergers and acquisitions.’

Other findings from the survey indicate that:
-banks continue to grow employee numbers despite slowing revenues. However, the rate of employee hiring is slowing, particularly in the retail banking sector, and has slowed from the high levels of hiring observed through 2006 and 2007.
-Bad debt provisions growth in retail banks hit an all-time high, with all banks indicating that their provisions have increased in the last year. To some extent the provisions are leading actual bad debt increases, indicating that banks are anticipating bad debts will continue to rise in the face of rising interest rates.
-Both provisions and doubtful debts growth is more moderate in the case of investment banks, in line with stronger business prospects.

Regarding costs, all categories of cost expenditure has seen a noticeable fall-off in the 2nd quarter. Marketing, IT and capital expenditure have all slowed. Says Emilio Pera, ‘ Banks need to adjust their cost base in line with slowing revenue streams and the retail banks have been especially aggressive in containing costs. Most of the banks are cutting back projects which are not considered essential, and the rate of extending the branch network has also slowed considerably.’

With regards longer term prospects, retail banks are optimistic that their revenue streams will be positive one year forward. Concludes Pera, ‘Whilst the environment for banking is undoubtedly tougher, we have not seen a situation of contracting profits, rather there is an adjustment in the rate of growth of income and bottom-line profits to lower levels than has been the case in the recent past. The lower confidence is thus a reflection of a much slower market, rather than a market contraction.’

Furthermore, continues Pera, ‘not the whole banking industry is feeling the pressures of a slower market. Eight out of ten investment banks are still satisfied with current business conditions. Whilst this may be low when compared with the situation in 2006 and 2007, it is by no means a weak level of confidence. Even six out of ten retail banks are not saying that the business environment is unbearable. We must recall that we are coming out of a very bullish two year cycle, and that the end of that cycle is about slower revenues and profits than the banks had become accustomed to. However, on the whole, banks seem to be managing the slower growth environment, cutting cost growth accordingly, and slowing the pace at which new employees are taken on board.’