It is astounding how many countries settle on a banking system of four top banks. The UK, Kenya, Australia, the US, India and Spain are among the many examples. Indeed, it is hard to think of exceptions — Switzerland is down to a big two after UBS’s takeover of Credit Suisse. Japan has a big three. France has a big six. But these are a far less common pattern.

SA might have become a “big three” country had then-finance minister Trevor Manuel allowed Nedbank’s takeover attempt of larger rival Standard Bank in 2000. His decision locked SA into the “big four” model we now have. Why is it that the world over, four seems a stable equilibrium in banking?

I pondered this pattern in reviewing Capitec’s financial results, which were released last week. Given its continued outperformance in profitability, it could one day break the model.

Capitec for now seems the only bank with a prospect of doing so. Investec remains a serious competitor in niches at the top end of the market and some areas of investment banking, but growth in SA has been sluggish for some time. We have recently had several new entrants including Discovery Bank and TymeBank that may one day be contenders, but not yet.

The global preponderance of the “big four” model suggests it is some form of stable equilibrium. More banks should make for a more competitive industry and arguably better customer service. Fewer banks make for economies of scale, and a generally safer sector with more diversified portfolios and capable of larger single exposures. A four-pillar system is also easier to regulate, allowing authorities to focus their attention. It seems to be the Goldilocks bank market structure — just enough competition but just enough stability.

So how could a newcomer break into this club? Capitec remains small — while its growth in its 22 years of existence has been impressive, it still commands only 2.6% of deposits in the market. Investec has had a banking licence for 43 years and has 7.8%. Discovery Bank, the biggest of the recent new entrants, has 0.2%. But the big four command 84.5% between them.

Small, however, can be beautiful. Capitec’s results last week showed return on equity (ROE) of 26%, beating FirstRand’s 22.5% in 2022 and the other bigger banks in the mid-teens. We will be getting Investec’s results in May, but its target ROE is also in the mid-teens. ROE is the main driver of bank growth because it creates the capital that allows it to expand balance sheets. So, if a bank is sustainably more profitable than the rest of the market, it is inevitable that it will gain market share. Either Capitec will be one of the big four (or big five) one day, or it will be less profitable. Those are the only two options.

Growth ambitions

Capitec clearly intends to continue growing. Its history provides a textbook model of how to break into an oligopoly. It got its foothold by being the only bank to understand what the National Credit Act meant for credit markets when it was introduced in 2005. It moved into the unsecured lending space that was opened while the other banks were caught napping. That gave it profits which it used to invest in diversification. As it gained traction it improved its funding mix, shifting out of wholesale towards deposits. It diversified revenue, shifting from interest earnings to transaction fee income. Now, of its 20.1-million active clients, just 1.3-million are credit clients. The focus of its growth ambitions has more recently shifted to business banking and insurance — another big step towards becoming a full-service bank.

There are obviously big gaps that distinguish Capitec from larger rivals. It does nothing in corporate and investment banking, which account for about 40% of bigger rivals’ businesses. It has big gaps in the retail market too, with no vehicle finance (though it offers personal loans for this) and no home loans (though it offers them through a partnership with SA Home Loans). These home loans could be shifted onto Capitec’s balance sheet in future, as it is now doing with its credit life business that was previously done with a partner. It is also purely an SA operation, while its rivals all have operations elsewhere to varying degrees.

Its business banking model is focused on SMEs, which it believes are underserviced, with a serious digital offering. But I suspect the big opportunity for Capitec will depend on regulatory change — shifting the regulations that now make it impossible to lend to informal businesses and start-ups under the National Credit Act. That legislation is under the purview of the department of trade, industry & competition, and that department has historically shown indifference to how it could improve conditions for SME finance. Were it to one day change though, Capitec could repeat what it did in unsecured retail lending in the small business sector.

The challenge for Capitec is to grow while maintaining its profitability. It sits at a price-to-book ratio of twice its bigger rivals, which roughly means shareholders expect it to grow at roughly twice their rate. That is a hard expectation to meet forever, and Capitec faced a bruising response from shareholders when it disappointed the market with earnings guidance earlier in 2023.

As it gets closer to the big four’s turf, it has to face up to their economies of scale, while navigating regulators who prefer to keep the peace. It will be a hard slog to challenge the long-running equilibrium.

Dr Theobald is chair of research-led consultancy Intellidex. This article first appeared in Business Day.