Tighter Capital Adequacy Requirement Positive for South Africa’s Banks

Tighter Capital Adequacy Requirement Positive for South Africa’s Banks

Tighter capital adequacy requirements are credit positive for South Africa’s banks, says Moody’s in a new credit report on the industry. The credit rating firm said the South African Reserve Bank (SARB) published a directive reinstating the systemic risk (Pillar 2A) capital requirement of 1% at the total capital level in 2022, of which 0.5% must be Common Equity Tier 1 (CET1) capital.

It also requires the first 1% of banks’ specified domestic systemically important bank (D-SIB) capital requirement to be met with CET1 capital. Moody’s said the Pillar 2A requirement was temporarily reduced to zero in April last year to help banks tackle the coronavirus crisis, while banks were also allowed to temporarily draw down their capital conservation buffer if needed.

“The reinstatement of the more stringent requirements is credit positive for South African banks. We expect banks with lower capital ratios to take measures to enhance their capital buffers, and that banks with higher ratios will seek to keep their capital ratios stable”, it added.

At the CET1 level, the changes mean that the minimum CET1 requirement will be 7.5% as of 1 January 20221 (see Exhibit 1), plus the first 1% of the D-SIB requirement 2 – which can be up to 2.5% but currently ranges from 1.0% to 2.0% for the big four South African banks – and 50% of the bank-specific individual capital (Pillar 2B) requirement, which is confidential.

In addition, if a countercyclical capital buffer is imposed, it also has to be met at the CET1 level.

Currently, the CET1 requirement does not include the 0.5% Pillar 2A requirement, and only 50% of the D-SIB requirement, up to a maximum of 1%, has to be met in CET1. South African banks entered the pandemic in much better shape than the global financial crisis.

The system wide CET1 ratio was 12.7% as of December 2019 and the Tier 1 capital ratio was 13.6%, compared with a Tier 1 ratio of 10.2% as of December 2008.

However, the banks have not been immune to the pandemic’s impact, which has exacerbated already difficult operating conditions in the country. The weak economy is straining borrowers’ cash flow and making it more difficult for them to meet their loan obligations, while also weakening banks’ credit metrics.

The capital ratios of the country’s four largest banks all fell in 2020, reflecting lower earnings, increased risk-weighted assets driven by the migration of Stage 1 and 2 loans to Stages 2 and 3, and in some cases a dividend payment from 2019 profit.

FirstRand Bank Limited (FRB, Ba2/Ba2 negative, ba23) had the highest reported CET 1 ratio of 13.5%4 as of December 2020, followed by The Standard Bank of South Africa Limited (SBSA, Ba2/(P)Ba2 negative, ba2) at 12.1%.

Nedbank Limited (Ba2/(P)Ba2 negative, ba2), with a CET1 ratio of 10.4%, and Absa Bank Limited (Ba2/Ba2 negative, ba2), with a ratio of 10.6%, had the lowest CET1 ratios. However, both banks have halted dividend payouts and we expect them to report higher ratios this year. We expect the banks’ capital metrics to increase in the current year.

Banks are targeting internal capital ratios above minimum requirements and we expect some to raise their CET1 targets with the new directive.5 Retained earnings will support their capital metrics as profitability recovers amid lower but still elevated provisions and banks take a more conservative stance on dividends, maintaining lower payouts than their pre-pandemic levels in the next 12-18 months.

However, this improvement will be partly offset by a potential deterioration in loan quality, reflecting weaker corporate profits and lower household incomes. Banks with lower capital buffers, such as Nedbank and Absa, appear committed to rebuilding their capital metrics by maintaining a more conservative dividend policy.

Management can take further capital-boosting measures where needed, such as issuing capital instruments –as an example, additional Tier 1 capital bonds or selling specific loan portfolios and investments that would reduce their risk-weighted assets.

Tighter Capital Adequacy Requirement Positive for South Africa’s Banks