EDITORIAL: Rapidly rising rates a mixed blessing for banks

Latest trading updates from three of SA’s largest banks demonstrate their resilience in an economy that is taking strain. But they also hint at the extent to which rapidly rising interest rates are a mixed blessing for the banks.

Absa, Nedbank and Standard Bank will report their full-year 2022 results in March next year but their trading updates give a flavour of how their operations have done in the first 10 months of the year, which is broadly expected to be the trend for the full year.

The domestic economy has had a roller-coaster year with a better-than-expected first quarter, a contraction in the second quarter and another better-than-expected third quarter. Despite floods, load-shedding and a rapidly deteriorating global picture, the rebound from Covid-19 has continued, tourism and agriculture are doing well for SA, and economists now expect the economy could grow at 2% or better for 2022.

Amid all this SA’s private sector still has an appetite to take on more credit, with the Reserve Bank reporting the private sector was up more than 9% for the 12 months to October. That represents growth in real terms given inflation, which is expected to average about 6.5% for this year. And the three banks’ trading statements confirm there has been robust loan growth.

However, with global inflation and interest rates soaring, local interest rates have been hiked by 350 basis points for the year to date to a level now higher than it was before the Covid-19 pandemic. Inevitably, higher interest rates must take their toll on household finances, as well as on the financial positions of businesses. That will translate into higher bad debt ratios in the coming months. The banks’ updates suggest bad debts are already rising, but evidently the distress and the defaults are not looking too bad at this stage. Absa and Standard reported credit impairments had increased, though credit losses remained within their target ranges. Nedbank revealed only that its credit loss ratio was within the guidance it provided for this year.

But banks are much more fortunate than the rest of us when it comes to high interest rates. They earn higher rates on big chunks of their loan books, specifically those loans that are mostly at variable rates — such as home loans and vehicle finance — and so reprice immediately when the Bank hikes interest rates. That helps to counter the higher rates they have to pay on their wholesale and retail deposits.

In addition banks have to hold large quantities of capital to meet regulatory requirements and some is in interest-earning securities, which may also earn more when rates rise. Bankers talk about this positive “endowment” effect, which drives up net interest income when the Bank raises interest rates. How much each bank stands to benefit depends on its mix of loans and its mix of deposits, including how much of each book is fixed, and how fast the one side of its balance sheet reprices relative to the other. It also depends crucially on the particular mix of capital it holds to meet regulatory requirements.

Sanlam Private Wealth investment analyst Gary Davids estimates Standard Bank and Nedbank are the most positively positioned to benefit from this high interest rate “endowment effect”, in terms of how much of their net interest income will increase when interest rates rise, though Absa and First Rand benefit, too. But those high interest rates have to hit banks’ income eventually as bad debts rise. That’s especially so given the other pressures weighing on households and businesses, including record levels of load-shedding and high food and fuel costs. Davids argues in a recent note that SA’s banks are in a profitability “sweet spot” as they are benefiting from rising interest rates but not yet taking the pain on the bad debt line.

Of concern too is that with interest rates rising and the economy slowing into 2023, it’s unlikely banks will continue to see robust growth in their loan books, particularly from stressed households. In the end, banks cannot rely on playing the interest rate cycle to sustain their profitability. They need a growing economy, and the consumer and business confidence that will support higher investment and sustainable lending growth.