Against the backdrop of a relatively supportive global economic environment over the first half of 2018, offset by a weak South African economy in technical recession during the same period and a modest recovery over the second half, the major banks delivered resilient earnings growth and progressed many key strategic initiatives in 2018.

However, banking conditions and the broader operating environment remained challenging amidst a benign local economy and a range of strategic and regulatory imperatives confronting the banks and their management teams over the period, according to PwC’s Major Banks Analysis.

The study examines the combined local currency results of Absa, FirstRand, Nedbank and Standard Bank. The analysis identifies common trends shaping the banking industry, building on previous PwC analyses that has now been for a period of over a decade.

Unpacking this further, global economic growth in 2018 was driven by robust business and consumer activity in the US, supported by fiscal stimulus in that market, while the pace of growth elsewhere in the developed world generally slowed.

As geopolitical concerns, protectionism fears and trade tensions escalated in 2018, global risk sentiment and trade volumes deteriorated.

At the same time, China experienced a slowdown in growth from historical levels, which triggered adverse consequences for certain commodity prices and placed added export pressure on commodity-producing territories. The implications of this included, among others, reduced credit demand from already challenged mining and construction sectors.

Domestically, the second half of 2018 saw the South African economy recover some of the weaknesses experienced in the first half, with modest annualised GDP growth of 0,8% recorded for the year off a low base. Despite modestly increased consumer spending in the second half, household income growth remained subdued, while business and consumer confidence continued to be depressed as a consequence of, among other factors, higher fuel inflation, increased electricity and water tariffs and the effects of a higher VAT rate.

The 25 basis point interest rate cut in March was reversed in November as US fiscal tightening, the foreign exchange rate and oil price outlook threatened the SARB’s inflation target.

From a currency perspective, the rand reversed its strong position against major currencies in the first half of 2018, lessening the impact of FX movements upon conversion to local currency results.

Capital expenditure on the part of corporate South Africa state-owned enterprises (SOEs) and government slowed over the second half, reflecting continued policy uncertainty over a number of key issues which remain unresolved. This uncertainty was amplified as a result of significant strategic, operational and financial pressures within some SOEs, which weighed on wholesale credit appetite in key sectors.

While the sovereign credit rating was maintained at investment grade by Moody’s in 2018, the outlook and any ratings activity by the agency remains uncertain and will be closely followed by stakeholders.

Positively, an increasingly relevant theme that we continue to observe in the major banks’ results is the significant earnings contribution from their operations in the wider African continent.

2018 economic growth in sub-Saharan Africa came in at a resilient 2.9%, with recoveries experienced in key West African territories, including Nigeria and Cote d’Ivoire. Meanwhile, Uganda, Tanzania and Kenya recorded robust growth upwards of 5%, driven by a recovery in foreign investment and strong infrastructure spend.

While inflation and currency devaluations stabilised in Angola towards the end of 2018, severe currency shortages and inflationary pressure in Zimbabwe heightened as 2018 drew to a close.

Against this context, reflecting on the major banks results for the period to 31 December 2018, Johannes Grosskopf, PwC Africa’s financial services leader, notes:, “The major banks continued to deliver growth in spite of a challenging environment. They’ve benefitted from their broader African strategies which they have focused on and set in motion in prior periods.

“Another contribution is their ability to leverage enabling technologies and the execution of their digital strategies which now clearly support increased transaction volumes on digital platforms. This continued digital and customer-centric focus will make competition with more nimble new entrants into the local banking market especially interesting, with the customer as beneficiary through potentially richer service offerings and more competitive pricing.”

Highlights from the major banks results include:

* Although there were unique performances between the individual banks, on a combined basis the four major banks posted full-year headline earnings of R82.75bn, which grew 8.7% year on year (against FY17) and 5.1% against 1H18.

* Transactional volume growth supported by a sharp focus on digital strategies and richer mobile capabilities led to non-interest revenue growth of 4.6% against 1H18 (6.3% against FY17).

* From a capital adequacy perspective, the major banks remain robustly capitalised, comfortably above regulatory minima across all capital tiers, while generating commendable returns. During the current period, combined ROE grew 10bps to 18.9% against 1H18 (18.6% at FY17).

* The aggregate loan book registered growth of 5.1% against 1H18 (and 13.4% against FY17). Interestingly, the theme we had previously observed of corporate credit demand outpacing retail reversed in the current period for some banks, with retail outpacing corporate lending for the first time in many reporting periods.

* Some banks noted continuing challenges by corporate borrowers in the mining, construction and cement industries. On a positive note, the major banks noted improvements in the health of corporates in the oil and gas sectors – on the back of stable and more elevated oil prices compared to a few periods prior.

* Having been fully implemented in 2018, IFRS 9 was used by all banks in the classification, measurement and disclosure of financial assets at 31 December 2018. The implementation of IFRS 9 had a few noticeable impacts on the profit or loss measures (interest income and impairment charge) and the statement of financial position (non-performing loan balances) in the financial statements and key bank ratios at 31 December (interest margin ratio, non-performing loan ratio, impairment coverage ratio). These impacts are discussed at a high-level below. We note that previously reported impairment ratios in respect of performing and non-performing portfolios are not directly comparable under IFRS 9, and we will unpack the effects of IFRS 9 in more detail in a separate analysis.

* Total non-performing loans comprised 3.8% of gross advances (3.6% and 3% at 1H18 and FY17 respectively), with the increase attributable mainly to changes brought about by the application of the IFRS 9.

* The implementation of IFRS 9 also impacted the impairment charge and had other disclosure effects.

* A relentless focus on credit quality is another theme that continued in the current period, with the major banks reporting a resilient combined credit loss ratio of 0.65% and a total impairment coverage ratio of 73.5% (compared to 0.72% and 65.8% respectively at 1H18).

* Cost management and a focus on optimisation initiatives remained top of the agenda of almost all bank management teams as they balanced investment with growth in 2018. In spite of this, the current period continued the theme of “negative jaws” (as total costs grew faster than operating income) which we observed at both June 2018 and December 2017. At 2H18, the combined cost-to-income ratio was 56.8% (compared to 55.1% and 55.7% at 1H18 and FY17 respectively).
* Consistent with our previous observations, staff costs comprise the majority of overall group costs, reflecting both the inflationary environment that persisted in 2018 as well as the demand for critical talent in response to increasing specialisation in the areas of risk, compliance and IT. At the same time, we continue to see increases in IT costs as the banks invest in their applications and systems infrastructure towards further digitising their platforms.

Costa Natsas, banking and capital markets leader for PwC Africa, says: “Overall, as we expected in prior periods, the major banks diversification strategies across franchises, regions and portfolios has been central to their ability to achieve growth against difficult trading conditions. At the same time we expect the banks to be acutely focused on the continued evolution of their strategies in the context of heightened competition and the exciting digital journeys they are on – all of which focus on putting the customer at the heart of their business models.”

The deep and rapid impact that technological progress is set to have on the global banking industry cannot be understated. Globally and domestically, banks are becoming more strategically focused and technologically advanced to respond to customer expectations while deploying defensive strategies to protect market share against traditional competitors and new entrants. As such, the importance of product and channel innovation and developing new solutions that take advantage of this progress – in data, advanced analytics, digital and new delivery platforms – has never been more important.

Key trends that PwC expects to see the major banks continue to focus on in 2019 include:

* While most banks have initiatives aimed at targeting demographic-based or LSM clusters, we expect to see trends going beyond segment targeting, to developing highly customised experiences for more granular sub-sets of customers based on common characteristics that leverage data-driven insights (for example common spend characteristics).

* A greater number of global regulators are embracing efforts towards “Open Banking” – which implies the ability to securely share data with third parties based on customer consent – through democratising account and payment data through secure application programming interfaces (APIs). As this happens, customers stand to have greater freedom and control in how they interact with their financial service providers, leading to even greater innovation from non-traditional players and increased personalisation. This is arguably one of the most compelling prospects on the horizon as banks seek to leverage their skills, resources and trusted social status to strategically respond to this new competitive environment.

* These changes are not limited in their impact to retail banking. For corporate clients, it might be using bank data to provide proactive insights to support strategic planning, or cash flow analysis that feeds into working capital and broader treasury management solutions.

* Beyond cost discipline, PwC expects to see relentless focus on optimising operational efficiencies within banks, as they continue to rationalise their IT architectures, standardise and simplify core banking operations and reduce operational complexity. Advancements in robotic process automation will have an increasing role to play on the process optimisation imperative.

* Meanwhile, a strong focus on further strengthening cyber risk monitoring and mitigation capabilities are likely to persist in 2019, as banks face a growing volume and sophistication of cyber threats against their systems and data.

Each of these represent exciting prospects for the industry as banks further incorporate the mindset and characteristics that may once have been the preserve of fintech startups. Naturally, with this bold new world of opportunity comes an evolving risk landscape, and banks will continue to focus on ensuring that their risk management capabilities and core risk disciplines keep pace. In this respect, we expect to see banks more keenly exploring the digitisation of risk functions and deploying technological change to improve, enhance and make risk management smarter, more resilient and responsive. Ultimately, leading banks will be those who harness technological and digital change to better anticipate and manage emerging risks within a rapidly evolving risk landscape.