Rising risk of government debt harms creditworthiness of banks
SA’s banks have experienced a sharp increase in exposure to government debt. In 2008, government bonds made up 3.3% of banks’ total assets, but in December last year, the most recent data available, that had ballooned to 9.3%. In nominal terms, that is a tenfold increase to R607bn, from R64bn six years ago.
The steepest acceleration occurred during the Covid-19 crisis. From March to end2020, there was a 32% increase in banks’ holdings of government debt. Much more of SA’s deposits are being used to fund the government.
There are several reasons for this growth. Banks have too much cash relative to demand for debt in the economy. Since the Covid crisis began, banks have seen their liquidity balloon as businesses and individuals have put cash in the bank rather than invest or spend it.
There has also been a sharp reduction in borrowing by companies and individuals because of wider economic uncertainty. When there’s noone to lend money to at a higher rate, banks do the next best thing, which is to park it in government paper. Another reason is that government paper is paying relatively high yields, even though short-term interest rates have been slashed. Longdated government paper will give you more than 10% while the prime interest rate is 7%.
The problem is that while the banks’ exposure to the sovereign has been increasing, the credit quality of the government balance sheet has been worsening. SA lost its last investment grade credit rating in March last year, as the pandemic was breaking. Things have worsened since.
Unlike what you expect a bank to do, instead of a reduction in exposure to deteriorating credit risk, there has been an increase. This means that the overall risk facing the banking sector is increasing faster than the risk represented by government paper, damaging the creditworthiness of SA banks.
This “sovereign-bank nexus” ties the fortunes of the banking industry to the government. It can create problems both ways: if governments rely overly on the banking sector, and the industry hits problems, it quickly becomes an issue for the government’s ability to fund itself. But the other direction is perhaps the bigger worry: if government finances hit trouble and doubts rise about the ability of government to meet its obligations, it quickly becomes a banking crisis. In the budget two weeks ago, the National Treasury forecast that gross debt will reach a peak of 89% of GDP in 2025/2026. The budget deficit will average 7.7% of GDP in the next three years. These are the worst figures SA has seen in recent memory yet it is precisely when banks are landing up with the biggest exposures.
In its Financial Stability Review in November last year, the Reserve Bank signalled concern about the growth in the sovereign bank nexus, declaring that the “interconnectedness between the financial sector and the sovereign has emerged as a major threat to financial stability in SA”. The European Central Bank, for instance, in which the average bank exposure to domestic government paper for the zone is less than 4% is concerned about Italy’s 11.9% and Spain’s 7.2%. SA’s 9.3% is clearly comparable. Banks have limited options in dealing with their exposures. They could shift more assets towards private sector lending, reducing government exposure. But given the economic outlook this may not be an effective risk reduction strategy overall. The problem is that the regulatory architecture makes it hard to do this; government paper is treated as risk-free in bank regulation. Capital requirements are lower the more government paper banks hold.
Things would get interesting if the economic outlook improves. Then interest rates may be forced upward quickly as the government and private sector compete for the liquidity available, with government paper crowding out lending to the private sector. For now, banks’ only option may be to reduce funding by lowering the rates they pay for deposits so they don’t have excess liquidity to park in government paper.
Banks have cut public exposures in some areas, particularly loans to stateowned entities which have fallen from more than 1% of bank assets in 2018 to less than 0.6% last year. The credit quality of Eskom particularly, but also Transnet and others, has deteriorated faster than the core government balance sheet.
But there’s no getting away from the government balance sheet in the end. The alarm bells have been flashing about government finances for some time. The budget was able to show a small improvement compared to what was presented in the medium-term budget policy statement in October last year, thanks largely to unexpectedly strong tax receipts thanks to high commodity prices. But we are still in trouble. Navigating through the fiscal crisis is key to the outlook for the country. What people might not be as conscious of, is that it is becoming even more critical for the banking sector.
Patrick Foley
BARCZA – KERES, TALLINN 1957
White is to play and win in this might-havebeen position
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To get the best out of a bubbleweary squad in a Covid-19 world is never easy, but India combined empathy with a “kick in the backside” approach to get the job done in the justconcluded home Test series against England.
Virat Kohli and most of his teammates have been hopping from one biosecure bubble to another since the 2020 Indian Premier League in the United Arab Emirates.
Soon after the Twenty20 competition, they headed to Australia where they won the Test series 2-1 before rushing home to host England.
“From when the season started, our main aim was to show empathy,” India head coach Ravi Shastri told Star Sports on Saturday after India’s 3-1 series victory against England. “Empathy, because these are tough times — you’ve not seen these times since World War 2,” he said.
“For professional players, when they’re under the hammer, it is really tough to get your best and deliver for your country.”
As in Australia, India lost the series opener against England, prompting the team management to take the other approach.
“The first Test in Chennai would have been different if we had a few more days off,” Shastri said. “It’s no excuse — England outplayed us there, but the boys were like zombies, they were tired. “But then a kick in the backside to reignite the pride in the system can make a lot of difference. And it showed in the last three Tests.”
Stumper-batsman Rishabh Pant was probably its biggest beneficiary. The 23-year-old appears to have worked on his fitness, overcome his tendency to gift his wicket and fine-tuned his keeping skills.
“He was told in no uncertain terms that he’s got to respect the game a little more,” Shastri said.
Player of the series Ravichandran Ashwin spoke of the monotony in “claustrophobic” hotel rooms and the craving for “fresh air” but felt bubble life may have helped the team gel better.
● India breezed into the final of the World Test Championship (WTC) following their 3-1 series victory but Shastri is still bitter how the qualifying rules were changed last year.
The nine top test teams were originally scheduled to play six series each over two years in the WTC, with the top two making the showcase final in London. But after the Covid-19 pandemic halted the game in 2020, the governing International Cricket Council decided to rank teams based on percentage of points earned from completed matches, instead of total points, to determine the finalists.
India, leading the table with 360 points, slipped behind Australia under the new rankings unveiled in November with Kohli questioning the logic behind the rule change.
Kohli’s team went into the home series against England as part of a three-horse race, also including Australia, to join New Zealand in the WTC final.
“Please don’t shift the goal post,” Shastri told a video conference on Sunday when asked if he found any aspect of the inaugural WTC cycle problematic.
“You have got more points than any other team in the world, 360 at that time, and suddenly there’s a percentage system where you go from No 1 to No 3 in a week,” Shastri said.