DAAN STEENKAMP: What the shifting payments landscape means for banks’ profits

SA’s major banks stand out globally among large banks for their extraordinary profitability. A common measure of profitability is return on equity, and the SA banking sector’s return on equity is high by international standards, having averaged about 15% since 2011, more than in other concentrated banking systems such as Australia or New Zealand (both about 12%).

Why are SA banks so profitable? Our modelling suggests the best explanatory factors over the long term have been developments in credit impairments, costs relative to income and the credit cycle. Over recent years banking return on equity has been buoyed by improved capital positions and elevated real interest rates.

An interesting feature of the SA banking system is that local banks are highly dependent on deposits as a form of bank funding and the relative cost of raising deposit funding compared with other forms of funding has historically been low. Banks’ interest income rises when policy rates rise, while deposit rates in SA have been sluggish to adjust to higher interest rates. This has helped to raise banks’ net interest income during periods of higher policy rates.

Bank profitability is a function of interest income, non-interest income and a bank’s cost structure. Shifts in the payment landscape are putting banks’ non-interest income under pressure. The use of cash has not been growing to the same extent as other forms of payment. Since the Covid-19 pandemic, cash in circulation has not kept up with growth in consumer prices. Banks’ average fees from transactions have also been declining. Again, relative to inflation, average revenue from payments for the industry is down 50% since 2016. There is increasing regulatory and market pressure on banks to reduce interchange fees, led by innovations such as real-time payments clearing and PayShap.

Grow revenue

However, the displacement of cash by other digital streams also presents an opportunity for SA banks. SA’s GDP is becoming more bank transaction intensive, with the number of banking transactions rising strongly even though the value of transactions has not increased to the same extent. SA ranks above countries such as Turkey, Mexico and India in terms of the intensity of cashless payments in GDP, according to the latest Bank of International Settlements estimates.

There is therefore an opportunity for banks to grow their revenue streams despite lower average payment fees. Growing their client bases would also present an opportunity for banks to leverage their client data to better understand what developments in the economy mean for specific market segments and how they could better serve their clients. 

The prospect of interest rate cuts by the SA Reserve Bank will put pressure on banks’ net interest income. Reforms to the Basel regulatory framework that bear on banks have also increased their funding costs by increasing the relative cost of deposit funding and the duration of bank borrowing.

Banks have an opportunity to reduce their cost structures and sweat their capital harder. SA’s large banks have a strong capital position for new investment. But SA banks generally lag on investment in new technologies. For example, automation offers banks an opportunity to reduce their costs through streamlining aspects such as their compliance and reporting processes. Over recent years banks have faced significant cost pressures from staff expenses, which represent more than 50% of operating expenses, and technology costs, with computer processing representing 15% more.

Broaden base

Embracing automation and digitally efficient architecture will be crucial to reducing bank operating expenses and enhancing the efficiency of service provision in SA banking. Real-time payments and modernisation of the payment system promises to reduce system overheads and reduce the amount of time bank cash is tied up, speeding up the deployment of funds to investments and loans.

This also offers banks the opportunity to partner with fintech companies to offer value-added services to their customers, such as digital wallets or mobile payment platforms, to broaden their customer base. Predictive analytics can help banks better understand emerging market trends, and inform asset allocation decisions and liquidity management.

Banks can also do much more to harness their data to better tailor their offerings to customers and use customer insights to target their value-added services to clients. Such services are already growing rapidly. Electrum’s estimates and other sources suggest that banking value-added services market volumes have grown 40% in SA since 2021.

Regulations and shifts in the payments landscape are changing the drivers of bank profitability in SA. While the ongoing decline in interchange fees will be a boon for consumers, bank revenues will be under increasing pressure. By adopting modern payment systems and investing in automation, banks can scale their payment systems and develop new revenue streams, realise cost efficiencies, and exploit data analytics to improve their asset utilisation and raise the return on their investments.

• Dr Steenkamp is CEO of Codera Analytics and a research fellow with the economics department at Stellenbosch University.