This is the first time that the Reserve Bank included the financial distress of households and SMEs in its financial stability review.
The South African Reserve Bank (Sarb) says South Africa’s financial stability outlook has improved, but a number of key risks to domestic financial stability remain and an economist is worried about the sovereign debt and geopolitical risks the country will face in the future.
According to the latest Financial Stability Review by the Sarb, the country’s financial system demonstrated notable resilience over the past few years, despite various global and idiosyncratic shocks.
The Sarb points out that after the start of the Covid-19 pandemic in 2020 several other global shocks materialised, such as Russia’s invasion of Ukraine, disruptions to supply chains and transport routes, sharp increases in inflation and interest rates and more recently, escalating conflicts in the Middle East.
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How resilience of SA financial system was tested
In addition, the Sarb says domestic developments further tested the resilience of the South African financial system in recent years. These include South Africa’s sovereign credit rating downgrade, the subsequent exclusion from the World Government Bond Index (WGBI), greylisting by the Financial Action Task Force (FATF), unprecedented levels of load-shedding, extreme weather events such as floods and violent incidents of social unrest.
The Sarb says the outlook for financial stability improved since the release of the previous review in June, largely thanks to an orderly election and the formation of the Government of National Unity (GNU), which contributed notably to stabilising the political landscape.
Other factors, such as an improvement in the availability and supply of electricity, evidence of fiscal consolidation and an improved sovereign credit rating outlook, also supported positive investor sentiment towards South Africa.
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Key risks to domestic financial stability
However, the Sarb says, despite the improved financial stability outlook, a number of key risks to domestic financial stability remain, including:
- escalating global conflicts
- deteriorating public sector debt ratios
- rapid capital outflows amid declining financial market depth
- increased financial distress in households and small, medium and micro enterprises (SMMEs)
- critical infrastructure failure and
- remaining on the FATF greylist over the medium term.
The Sarb says the risks are assessed against the backdrop of perpetual or structural risks, such as South Africa’s low and inequitable economic growth, the implications of climate change for the financial sector and the ever-present vulnerabilities associated with cyber incidents with systemic impact.
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Impact of heightened geopolitical tensions
Sanisha Packirisamy, chief economist at Momentum Investments Group, says she is worried about heightened geopolitical tensions that could affect the financial system through:
- increasing volatility and uncertainty in financial markets leading to a risk-off environment
- supply chain disruptions which introduce inflationary pressures and could derail the ongoing monetary policy easing cycle
- limiting access to a wider variety of markets which could lead to higher costs and reduced availability of funding, hedging and diversification options and
- increased risk of cyber-attacks.
She says South Africa has made progress with addressing the outstanding action items on the FATF’s greylist, with only six of the 22 items left to address by February 2025. Three items relate to prosecutions and the other three to access to beneficial ownership information for companies and trusts.
“If South Africa is not successful in being removed from the greylist by June 2025, the adverse impacts will escalate. These impacts include increased compliance costs, restrictions to the global financial system, higher funding costs, less and more expensive hedging opportunities and loss of regulatory equivalence status.”
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Several risks remain – economist
Packirisamy says while the fiscal outlook improved since June, “several risks” to the fiscal outlook remain. “As usual, the biggest concern in this category is the financial sector’s high exposure to sovereign debt which is reported to have increased since the June 2024 FSR.
“The remaining three risks, critical infrastructure failure (new), increased financial distress in households and SMMEs (new) and rapid capital outflows amid declining financial market depth are deemed to pose similar residual vulnerabilities to the financial system.”
She points out that the Sarb only featured the electricity crisis before. “In the new review, the Sarb expanded its assessment to all the network industries (electricity, logistics and water).”
Packirisamy says the deterioration in these industries could affect the financial system directly by disrupting operations and indirectly by:
- adversely affecting the financial health of municipalities, making it challenging for them to meet their debt obligations to financial institutions,
- deteriorating municipal service delivery which could spark social unrest with resulting losses absorbed by the financial system and
- high municipal rates threaten the viability and sustainability of commercial property.
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Importance of resilient financial system
“The Sarb and the Financial Sector Contingency Forum are developing contingency plans to ensure the domestic financial system remains operationally resilient in the event of critical national infrastructure failures.
“A current priority initiative is to establish direct connectivity among key nodes in the financial sector in a scenario where existing telecommunication networks are unable to function so that a certain level of payment, clearing and settlement activity can continue.”
She says despite increasing financial distress in households and SMEs, the aggregate banking sector appears resilient against credit risk although the Sarb flags that individual banks may be more exposed and therefore require close monitoring.
Packirisamy agrees with the Sarb that the financial system’s vulnerability to the risk of declining market depth has reduced somewhat since the release of the June review. “This is supported by the increase in the allocation to domestic assets from 58.5% in the first quarter of 2024 to 62% in the third quarter according to J.P. Morgan’s estimates.
“The higher domestic weighting (lower offshore weighting) may be attributed to investor optimism on the back of the formation of the GNU, a stronger Rand against the US dollar and improving structural constraints.”
She says a resilient financial sector is important to support economic activity, particularly with increasing momentum on structural reforms and improving business and consumer sentiment.
