Picture: 123RF/Kevin George
Picture: 123RF/Kevin George

The banks' sizeable exposure to government debt is one of the key risks to financial stability which the Reserve Bank is watching as it counts the cost of the pandemic — and it is one of the reasons for the Bank's intervention to stabilise the bond market over the past few months.

In its twice yearly Financial Stability Review, released this week, the Bank listed Covid-19, further deterioration in SA's economy and a tightening of global financial conditions as key risks — though it emphasised that SA's financial system was resilient and its banking sector sound, and that both banks and insurers had strong capital buffers.

The government is now the banking sector's biggest debtor and, said the review: “The banking sector-sovereign nexus is presently a threat to financial stability due to government's large and increasing financing requirements.”

Banks have to hold “high-quality assets” — mainly government bonds — as part of their regulatory liquidity requirements, and the tightening of regulatory requirements since the global financial crisis has seen their holdings of government bonds double over the past 12 years to 15% of their total assets.

But the quality of those assets has deteriorated as SA's public finances have deteriorated and its sovereign ratings have been downgraded, and that in turn affects investor and ratings agency perceptions of the banks themselves.

The Bank's deputy governor, Kuben Naidoo, said banks were likely to make losses but their stability was not at risk. SA's banks had R509bn of capital and would have to see about 10% of their loan book default for this to be wiped out — but over the past 80 years the highest level that non-performing loans had ever reached was 3%-4% of loan books. The Bank was tracking non-performing loans daily but had not yet seen a significant increase, though, Naidoo said, “I am sure they will come”.

The International Monetary Fund now sees the government's deficit reaching 13.3% this year, with government debt rising to 85.6% of GDP in 2021, while ratings agency S&P said in a report on SA this week that it projects that the interest bill on government debt will increase to consume 22% of government revenue by 2023, from 14% last year.

The sharp rise in yields on government bonds, especially long-dated bonds, also affects the cost of borrowing across the economy, with the Bank's review noting that many private sector debt instruments are priced relative to sovereign bonds.

SA's economy was already in recession and had average growth of just 1% over the past five years, and even though much of the economy will reopen as the country shifts to level 3 tomorrow, the shock to growth is expected to be profound.

The Bank forecasts the economy will contract by 7% this year. Its lead economist on financial stability, Alex Smith, said the Covid-19 shock could result in nearly half a decade of lost output for SA. Even with a growth recovery, the level of GDP in 2022 would still be lower than in 2019 and even 2018.

S&P banking analyst Samira Mensah said in a webcast this week she expects private sector credit to shrink by 5% this year and expects about a 60% uptake of the R200bn new loan guarantee scheme.

The government-backed scheme was launched this month to assist small and medium businesses through the crisis, though the banks have already granted requests for debt relief in their own right to hundreds of thousands of individual and business clients who are in financial distress because of the crisis.

In an update this week, Banking Association SA reported that commercial banks had by May 23 provided R14.5bn of debt relief to individuals with 2.15-million loan agreements, and a further R10.2bn of relief to 132,000 businesses of the 140,000 that had applied.

This was before the introduction of the R100bn loan guarantee scheme in terms of which the government and the Bank will guarantee new lending by banks to distressed small and medium businesses.

The banking association said figures on the uptake of the new scheme were not yet available.

Naidoo said it was too early to tell as there had been only two weekly drawdowns by the banks on the new scheme.

The banking association pointed out that the Bank's interest rate cuts, which had brought the prime lending rate down to 7.25%, were also a significant source of debt and cash flow relief for businesses and individuals.