With the economy blighted by load-shedding, some may be surprised to see banks reporting record profits for 2022. How are they doing it? In short: higher interest rates and lower bad debts. But there are clear reasons why shareholders will be cautious about popping champagne.

FirstRand was the first to report last week, in its case for the second half of last year, showing profits of R18bn, 15% more than 2021’s matching period and much higher than before Covid-19. We will see even bigger records from the other major banks when they report over the next two weeks (Standard Bank has guided the market to expect growth of 30%-35%, Nedbank 24%-29%, Absa 10%-15%).

This growth is not thanks to the general economy; that has been dismal. While Covid-19 disruptions make it difficult to analyse GDP trends, the first three quarters of 2022 showed nominal GDP 18% higher than in 2019. Once inflation is factored in, the economy is barely bigger than three years ago. However, FirstRand’s nominal profits were 29% higher in the second half of 2022 compared with 2019. Nominal GDP growth in the first three quarters of 2022 averaged 7.1% (and we’ll get the full picture for the year on Tuesday when Stats SA announces the fourth quarter). Employment is similarly leaning against the banks, with the numbers employed in the formal sector still lower than in 2019 (10-million vs 10.2-million in 2019).

The banks have been able to overcome these headwinds thanks to a few factors. They benefit from rising rates because they have two sources of interest-free funding: shareholder’s capital, and “lazy deposits” on which they pay no interest. In FirstRand’s case, however, margins were only marginally higher, and that thanks entirely to its UK business. Margins in SA were negatively affected by a shift in its portfolio to more corporate lending, which earns less interest. I expect the other banks will see much higher margin growth thanks to a better balance of retail lending. Corporate and Investment Bank (CIB) lending was helped by one area of strong volumes for all the banks: helping companies finance off-grid electricity and funding new electricity projects.

Bad debts

Geographic diversity also helps — the big four banks have exposure to the rest of Africa to varying degrees and FirstRand owns a UK bank. These can be volatile sources of earnings, for example Ghana’s sovereign debt default has hurt most banks’ numbers for 2022, but overall African exposures helped earnings last year.

The other major source of profits has been a fall in bad debts. Banks have been cautious post the Covid-19 crisis. When the crisis first struck, all the banks rapidly set aside money to pay for a sharp increase in customer defaults. But one of the surprises of the Covid-19 period was how well customers were able to continue paying for their debts. This has allowed the banks to release provisions, which is treated as a source of income on the income statements.

This was not particularly helpful in FirstRand’s case, as it released provisions in the comparable period, creating a base effect that held back earnings growth this period, but underlying customer performance is continuing to improve. This was clear in the drop in non-performing loans, with FirstRand’s defaulting loans falling from 3.9% to 3.6% of its loan book. Credit performance is improving as clients that struggled during lockdowns are now largely worked out of the books. What’s left, particularly in FirstRand’s case, is a more creditworthy book.

The problem is how to sustain this growth. Earnings this period are being delivered by cyclical factors: an improving credit performance and the higher interest rate cycle. We are not seeing growth in top line — the kind of growth driven by real improvements in economic activity. FirstRand’s overall book grew 11%, a lot of this due to corporate credit demand to finance electricity generation.

Colossal effort

What banks want to see is businesses investing to expand output, not to merely protect existing output, which is what much of the electricity investment is doing. We have not seen a sustained increase in investment levels in SA since 2008 and it is difficult to see any trigger for improvements on the horizon, given load-shedding is at least a few years away from being resolved.

FirstRand declared that a “colossal effort” will be required to rebuild economic capacity, calling for increased private sector involvement in structural reform of the economy to shift potential growth upwards.

There are obvious opportunities: the mining industry could be exporting much more if we could just get the rail and port capacity right. There is more that could be done to enable the expansion of private electricity generation. Somehow, we need to trigger confidence in the future, the kind that will get shareholders to put their capital at risk to invest for payoffs that are years down the line. That remains the missing ingredient that fundamentally constrains the banks’ performance.

• Theobald is chair of research-led consulting firm Intellidex. This article first appeared in Business Day.