Dangers of increased lending to entities in terms of creating problems for the economy and the banking system trigger decrease in loans
This column was first published in Business Day
Governments globally lean on the banking system when they need cash. SA is no exception. During the latter half of the Zuma presidency, as the financial position of state-owned enterprises (SOEs) deteriorated, banks sharply increased their lending to them. That creates problems for the economy and the banking system.
My analysis of banks’ statutory returns shows that the amount they lent to SOEs increased sharply from 2013 to 2018, when it reached a record high of R56.4bn, up 2.6 times from R21.6bn five years earlier. While the figures don’t break out just which SOEs received this cash, it is safe to assume that by far the biggest of these borrowers was Eskom.
Several issues arise when the banking system is being tapped in this way. The first is the overall risk of the system. Such lending is often driven more by political considerations than the usual balance of risk and return within an overall balance sheet context. Any bank has to be sensitive to being seen to support the government, especially on socially sensitive issues as serious as keeping the lights on.
The growth in lending increased banks’ exposure to SOEs from about 0.6% of total assets to 1.1%, almost doubling. Such loans can be a mix of short and long term, but as has been made clear by several recent examples (SAA most prominently), banks are often forced to roll over their SOE loans, so even short-term ones on paper are long-term in practice.
By directing their funds to SOEs, banks are often lengthening their balance sheets, meaning they can’t do as much other long-term lending, such as for mortgages.
Our scarce savings should be directed to the most productive uses
And even though much of the more recent bank lending to SOEs has been guaranteed by the state, there is still clearly credit risk. In the effort to save Eskom, the possibility of a restructuring of its borrowing is clear, with banks being forced into some form of rescheduling. So the increased exposure to SOEs really represents an increase in risk to their balance sheets.
The next problem is that it represents poor use of savings. As is often lamented, SA has a very low savings rate, with Statistics SA figures showing it to have been negative (we were spending more than we were saving) for almost all of the last 10 years. Our scarce savings should be directed to the most productive uses.
According to the Treasury, SOEs averaged a return on equity of negative 0.3% in the 2017-18 financial year. While profitability is not all that matters regarding SOEs, the fact that they are making bottom-line losses means that they are poor users of funding.
Bank funds should be directed to productive users of that money, such as profitable businesses who can use it to fund investment and drive economic growth (people often miss that profits are the fundamental source of growth. It is out of profits that investment is made and investment is the only way to increase the potential output of the economy).
So both because it is bad for the risk-return profile of banks’ balance sheets, and because it is bad for economic growth, the major increase in bank lending to SOEs is not a good thing. That seems well appreciated, with banks having cut back a lot so far in 2019, with total exposure down to R51.6bn or 0.91% of assets.
You might also be wondering which of the banks were most aggressive in the lending. The big four — Absa, Standard Bank, Nedbank and FirstRand — are obviously all there and steadily increased their exposure to SOEs during the period with no clear market share trends between them. Investec did not lend to SOEs during the period.
The most interesting movement was among foreign-owned banks, which collectively had about R7bn lent to SOEs at the peak and the largest exposures relative to their balance sheets. Citi, Deutsche Bank and JP Morgan all had more than R1bn lent to SOEs in 2017, with Deutsche’s R1.7bn the largest proportion of assets at 14.2%.
Of course, for foreign banks the concentration risks are less of an issue given the diversification of their parent balance sheets. But they have also been sharply reducing their exposures, which is down to R3.4bn in latest figures, though Deutsche has maintained its exposure despite scaling back in SA, which is up to 17.6% of its assets. The biggest reduction has been by Citi.
As the Ramaphosa administration works on sorting out the mess left from the Zuma years, banks will have to play their part. Eskom is most urgent and it looks like some plans are solidifying among the different task teams working on the problem, ranging from accessing global climate change funding to rescheduling Eskom’s mammoth R500bn in total debt.
For banks, the task of working out what role to play has to carefully balance political issues with risk management. Supporting the Ramaphosa presidency is close to the hearts of many bankers, but the Zuma years should have left them gun shy about putting more funding into SOEs.
The need to stimulate broader private sector activity is furthermore urgent and would be a better use of bank funds. Working out the perfect role to play will be a challenge for bank leaderships.
• Theobald is chairman of Intellidex.