The devil haunting banks

Banks might be showing profitability but the sector still grapples with a challenging accommodative monetary policy characterised by all-time low rates, slowdown in credit growth and heightened competition

The devil haunting banks

Overall, the banking sector has been displaying a solid performance and is in a healthy state as evidenced by numerous key metrics outlined by analysts. According to Donald Motsomi, Stockbrokers Botswana analyst, asset quality showed a slight improvement with the sector’s Non Performing Loan (NPL) ratio dipping marginally to 4.7 percent as at June 2019 compared to 4.8 percent in June 2018.

The liquidity ratio as at June 2019 declined slightly to 17.7 percent from 17.8 percent in December 2018. The ratio remains well above the regulatory minimum requirement of 10 percent. Motsomi has observed that the sector was well capitalised with a June 2019 capital adequacy ratio of 17.7 percent compared to 17.9 percent, which is above the 15 percent regulatory threshold. The 2018 Bank of Botswana (BoB) Banking Supervision Annual Report revealed that only one bank breached this threshold, reporting a capital adequacy ratio of 13.3 percent as at December 2018.

Banks’ profitability showed a strong improvement for the year ended December 2018 with the sector’s net profit increasing 41.8 percent to P1.7 billion. Return on Equity (ROE) ticked up to 16.1 percent compared to 12.6 percent in 2017 December, while Return on Assets (ROA) edged up to 1.9 percent (Dec 2017: 1.4 percent). In the first half of 2019, banks raked in P878.1 million as net profit after growing 2.1 percent from P860.3 million in June 2018.

But while profitability has been improving with banks seemingly having adjusted to record low interest rates, an important development for the sector was the Bank of Botswana’s decision to cut the bank rate by 25 bps to 4.75 percent in August 2019. This was after the central bank maintained the rate at 5 percent for nearly two years. The last cut of the interest rates had been in October 2017. Motsomi says the decision to cut was taken in the context of inflation printing persistently below the 3 – 6 percent objective range, the positive inflation outlook and accommodative monetary policy across major central banks with key trading partner countries having imposed cuts as well. FNBB economists argued that Botswana’s main trading partners are expected to cut rates by up to 50 basis points in the next 18 months. On a real policy differential perspective, experts said this provided room for BoB to cut rates without pushing real rates outside of historical averages. The monetary policy has been accommodative over the period, with the bank rate coming down from 9.5 percent in 2013 to the 4.75 percent.

Motsomi argues that the rate cut will result in a squeeze in banks’ net interest margins (NIMs) with no or little pass on effect to deposit rates, considering that these are already very low and the need for banks to remain competitive to attract funds. While interest rates have been coming down, banks have been trying to improve the performance of the non-interest income to negate the impact rate cuts.

Interest rates were further compounded by the fact that credit growth was growing at a snail’s pace. Statistics show that commercial bank credit growth for the 12 months to June 2019 eased to 6.5 percent (June 2018: 7.6 percent). The slowdown, as observed by Motsomi, was a result of sharply lower credit growth to the business sector at 1.7 percent (June 2018: 8.6 percent) due to decreased utilisation of existing credit facilities and loan repayments by some firms in select industries. In contrast, household credit rose to 9.7 percent (June 2018: 6.9 percent) on the back of increased demand for personal loans following the civil service salary increase effected in April.

Motsomi says household credit growth should continue to be robust going into 2020 underpinned by another civil service salary hike that is slated for April 2020. However, he fears that growth could be constrained by the structural issue of high unemployment. His worries are motivated by the Ministry of Finance and Economic Development’s 2020 Budget Strategy Pape, which speaks to rationalising the civil service, including freezing creation of new manpower positions in the 2020/21 financial year in the context of fiscal consolidation and competing spending needs. “In the absence of private sector job growth, unemployment will continue to constrain households’ income levels and borrowing capacity,” he says. “We expect the negative growth in business lending to reverse and tick up going into 2020 underpinned by improved business conditions and the evaporation of election uncertainty,” Motsomi says.

According to BoB’s September 2019 Business Expectations Survey, business conditions are perceived to improve in Q4 2019 and improve even further in the 12 months to September 2020. Firms were also cited to expect the volume of borrowing to increase in the 12 months to September 2020. There was also the general notion of election uncertainty and resultant delays in investment spending until after the elections.

Motsomi says conversations with the titans of banking have also led to analysts believing that they have not reached the bottom of the cycle as yet. “There is a general expectation of another 25 bps rate cut in the short term; which spells further pressure on industry NIMs and the increased need to diversify and grow non-interest income.”

Motsomi points out that the central bank has implemented numerous refinements to the monetary policy implementation framework with objectives of enhancing monetary policy transmission and liquidity management, access and flow in the commercial banking system. “The 7-day BOBC was introduced as a replacement for the 14-day BOBC in April 2019 and has improved liquidity management for BoB and commercial banks and acts as a base for the starting point of monetary policy transmission,” he says, adding that more recently, reserves averaging was introduced in October. This is also expected to improve liquidity management by the banks.

“The notional ceiling on the issuance of BOBCs has also been lifted so as to allow for more effective liquidity absorption by BoB,” Motsomi explains. “Consultations by BoB with stakeholders on the possible review of the anchor policy rate have reportedly been completed. The conclusions of these consultations are to be supplemented by lessons from other jurisdictions in informing the final decisions.”

The Stockbrokers analyst says the sector continues to increasingly embrace technology with the rollout of digital products and increased volumes of digital transactions as competition intensifies. Notwithstanding this, he notes, banks have been investing in refurbishment and rearrangement of their branch networks amidst this ‘bricks-to-clicks’ phenomenon. “However, going forth, it appears banks will be looking to consolidate their networks with agency banking outlets to be in lieu of branches, particularly in areas of low footfall,” says Motsomi.

“The traditional banking sector continues to face increasing competition from the mobile network operators’ (MNOs) mobile money services. MNOs trump banks geographically with their far wider access points while banks are more competitive with regards to their pricing. Some banks have managed to increase their financial inclusion reach with mobile wallet disbursement platforms while the increased adoption of agency banking will increase their access points.”