Financial stress testing indicates that the largest South African banks are expected to remain resilient through the current period affected by the Covid-19 outbreak, even under severe stress scenarios. Financial stress testing involves the assessment of modelled outcomes under a range of adverse economic scenarios (called “stress scenarios”) – typically mild, medium and severe stress scenarios.
The high-level stress testing was done as part of postgraduate research by Corné Conradie, actuary and PwC partner (within the PwC Actuarial, Risk and Quantitative team). The research is done in collaboration with Prof. Conrad Beyers, Absa Chair in Actuarial Science at the University of Pretoria.
The largest full-service banks, that include Absa, FirstRand, Standard Bank, Nedbank and Investec, were assessed. These banks account for 91% of all bank deposits and 94% of all loans granted by South African banks. According to Conradie, the resilience of these banks is key to ensure the resilience of the South African banking system as a whole.
Prof Beyers said that it currently appears unrealistic to make reliable forecasts around the exact spread of the virus based on biological and epidemiological models. It is however possible, to use financial modelling to form a view on the impact on the banking sector, which forms the backbone of the current financial system. “It is clear that banks will experience significant strain, although the financial system appears to be stable for the foreseeable future”. Beyers said that deep changes in the financial system could be necessary to be more robust to future possible shocks.
The research shows that banks are expected to experience significant credit losses. These losses will be driven by defaults on residential home loans, company loans and retail unsecured loans. The likely causes of such losses is a loss of income of borrowers instead of affordability driven by increased prices and loan installments. Based on the nature of the stress, it is expected that unsecured loans will be the harder hit by the economic fallout of the Covid-19 pandemic. Residential mortgages are expected to be affected less compared to the 2008 crisis while companies may experience similar strain compared to the 2008 crisis.
It is expected that bank deposits will drop. Deposits by financial institutions are expected to be affected most, followed by public sector, company and retail deposits. This would be driven by lower interest rates, lower economic growth, lower stock market returns and lower household disposable income.
Despite these stresses, banks are currently sufficiently capitalised to withstand the shocks.
Conradie noted that the current financial situation is often compared to previous stress events such as the 2008 global financial crisis. The two scenarios are however different in various respects. The 2008 crisis was concentrated in the financial sector and was characterised by high interest rates and inflation with prime lending rates that peaked at 15.5% from June to November 2008 and inflation that peaked at 8.7% in May 2009. The South African equity market dropped by 34% between June and October 2008. Over 2009 the South African economy shrunk by 1.5%. In contrast, the Covid-19 financial stress is much more widespread with nearly all sectors experiencing strain. Energy, construction, hospitality, transport and financial sectors are expected to be severely impacted. The underlying macroeconomic conditions are also very different. The prime lending rate is very low - at a level last seen in 1973 and inflation is within the South African Reserve Bank target range. The equity market showed a similar drop of 33% between the end of December 2019 and 23 March 2020. The impact on GDP and subsequent job losses are however, expected to far exceed the levels seen during the 2008 crisis. Initial estimates indicate a record GDP drop of more than 10% and a large increase in unemployment.
A number of positive developments and downside risks, together with other critical risk factors were identified.
Critical risk factors:
“The exact effects of the Covid-19 pandemic will, however, become more apparent over the next year and is very dependent on the degree to which the pandemic is contained without causing large scale economic damage. A quick progression through the lockdown stages will reduce the negative effects while a resurgence of infections and further or prolonged lockdown will exacerbate the large negative impact that is expected. Therefore, only time will reveal the exact impact of this pandemic on the South African banking system”, Conradie added.
Senior Manager, Media Relations, PwC South Africa
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