South Africa’s possible grey-listing will have a “muted” impact on the country’s banking sector, although local banks might suffer some reputational risk and could face higher compliance costs, according to S&P Global Ratings.
The credit rating agency said it did not expect that South Africa’s banks would lose their correspondent banking relationships if the country was grey-listed in February next year by the Financial Action Task Force (FATF).
However, the prevalence of cash transactions because of the country’s large informal sector and indirect exposure to other sectors with less rigorous anti-money laundering and counter-terrorism financing (AML/CFT) management than the banking sector could pose some risks to the banks.
“While banks’ digital transformation has contributed to embedding AML/CFT requirements into their risk management, the financial sector is indirectly exposed to gaps from the private sector, which might have weaker understanding and management of these risks,” S&P said.
“Based on our observations in neighbouring countries where they have operations, we expect South African banks will likely maintain their correspondent banking relationships. Large South African banks might also leverage their presence in Mauritius to raise and deploy foreign exchange funding.”
It expects the impact on portfolio flows emanating from the risk of grey-listing to be low.
“South Africa benefits from deep domestic capital markets, and a ‘risk-off’ sentiment because of a grey-listing could be mitigated by liquidity stemming from non-bank financial institutions and the SARB’s intervention,” it says.
S&P said South Africa’s failure to prosecute cases tied to state capture and efforts to cover up illicit cross-border payments were behind the country’s poor AML/CFT score in the FATF’s initial assessment.
The weakened capacity of the South African Revenue Service, the National Prosecuting Authority and governance gaps at state-owned enterprises (SOEs) had further undermined the country’s AML/CFT framework.
‘More severe’ implications for SOEs
S&P said it expected the impact of grey-listing on private sector corporates to be “largely benign”.
Entities with mainly South African operations were typically funded by domestic banks and non-bank financial institutions, it said.
However, grey-listing could have “more severe” implications for public sector entities.
“Grey-listing could raise investor concerns that concerted efforts to improve governance and oversight may prove ineffective against rooting out corrupt practices within the largest SOEs.
“South Africa’s domestic markets are not large enough to cater to the funding needs of the country’s largest SOEs, which also rely on financing from international banks and debt capital markets, as well as South African development finance institutions.”
Government’s borrowing costs
S&P said grey-listing could weigh on the government’s borrowing costs and trade flows to some extent, but this was unlikely to affect South Africa’s creditworthiness significantly.
“Interest payments are already high, at about 17% of government revenue, and foreign participation in government securities makes up about 28% of total bonds. Sharp portfolio outflows could result in a steeper domestic yield curve [higher interest rates] and tightening domestic credit conditions.
“However, we believe the deep domestic capital markets, including large pension and other non-bank financial institutions, mitigate these risks somewhat,” it said.
South Africa was less exposed to external borrowings risk than many other jurisdictions because most government debt was rand-denominated.
South Africa’s net external asset position was only 3% of GDP, while foreign direct investment flows, which might be affected, were also low, averaging only 1% of GDP from 2011 to 2020.
