OREANDA-NEWS. South African banks are coping well with the difficult economic conditions but future profitability is likely to be lower, says Fitch Ratings. There is room for some profitability slackening because performance ratios at the country's leading commercial banks are good and compare favourably with those in other developing markets.

Growth opportunities for the country's large banks are likely to remain limited as our GDP growth forecast for South Africa of 2.1% in 2015 falls well below the long-term average for the country and rates achieved in some emerging markets. In this difficult environment, we believe bank earnings will decline and loan impairment charges will increase, leading to weaker bank performance.

The economic climate in South Africa has a strong influence on banks' ratings. Fitch has a Negative Outlook on the Long-Term Issuer Default Ratings (IDRs) of FirstRand Bank, Nedbank, Absa Bank and Standard Bank of South Africa and the respective group companies of the last three banks, reflecting the Negative Outlook on South Africa's rating of 'BBB'. This is because the banks' loans and government securities are highly concentrated in South Africa. Close correlations mean that if the sovereign rating were downgraded by one notch, so would the IDRs of the four major banks (and their rated group companies).

Investec Bank (and Investec Ltd) are rated a notch lower than the big four banks, at 'BBB-'. This reflects its niche franchise as a specialist bank and asset manager. The Outlook is Stable as the ratings are not capped by the operating environment.

Faced with these constraints, the country's four leading banks are expanding into other African countries. While geographic diversification can be positive, expansion into low-rated countries (mainly in single 'B' level rated countries) inevitably increases their risk appetite. We believe the South African banks, the region's most sophisticated, are well placed to develop pan-African business and take advantage of opportunities to expand into higher margin growth markets.

Domestic de-risking initiatives undertaken over the past three years are paying off and impaired loans are now manageable, representing 2%-4% of total loans. New impaired loans are emerging in unsecured consumer lending portfolios (representing 16% of sector lending) and in SME finance sectors. These sectors are particularly exposed to rising interest rates. Furthermore, the economic impact of continuing electricity supply shortages and possible labour unrest in certain key sectors affects all areas of the economy.

Funding and liquidity remain healthy, but reliance on institutional deposits from money markets, insurance companies and pension funds expose banks to structural funding risks. Wholesale funding reliance can widen asset-liability maturity mismatches, result in high deposit concentrations and hinder banks' ability to comply with Basel III's net stable funding ratio, effective in 2018. The liquidity coverage ratio is already being phased in from January 2015, with banks required to comply with a minimum ratio of 60%.

Return-on-average-equity figures for the large commercial banks have been above 20% over the past three years and capital ratios are strong, with core Tier 1 capital ratios around 10%. Regulatory ratios are improving and this is important if South African banks are to maintain their ratings at current levels.

Further details about South African banks can be found in "South African Banks: Peer Review" today and available by clicking on the link below.