South African Banks Face Asset Quality Risks from Load Shedding

South African banks face near-term asset quality pressures due to record load shedding on economic activity, Fitch Ratings says. Load shedding or power blackouts has caused significant disruption and reduced business confidence, currently at a two-year low, as well as raising labour market uncertainty.

This adds to existing asset quality and profitability pressures from persistently slow economic growth, high inflation and rising interest rates. The financial health of South Africa’s electricity sector particularly that of the state-owned power utility Eskom, has continued to deteriorate.

Eskom supplies more than 85% of South Africa’s electricity. The South African Reserve Bank (SARB) recently updated its GDP growth figure for 4Q22 to a 1.3% contraction.

This follows a downward revision in its 2023 GDP growth forecast to 0.3%, from 1.1% previously. The lower forecast is partly due to SARB’s revised estimate of load-shedding days in 2023, exerting a 2pp drag on GDP growth during the year due to lost working days.

According to SARB, the sectors most affected by load shedding are agriculture, mining and manufacturing. Load shedding will also add to inflationary pressures given disruptions to supply chains and decreased output.

Increased reliance on diesel generators during power outages has caused the commercial property industry’s cost of operations to surge. Pressure on all businesses is compounded by the recent sharp increase (18.7%) in electricity prices, well above the rate of inflation (annual inflation was 6.9% in January 2023).

South African banks have started reporting their 2022 financial results and are highlighting the impact of load shedding as a key operating environment risk for this year.

However, Fitch analysts expect load shedding to have a delayed effect on the banks’ earnings and asset quality, which will become more pronounced in 2023.

As a consequence, analysts said they expect banks to adopt more cautious views on credit growth. South Africa’s ‘BB-’/Stable rating has some headroom to absorb a temporary impact on economic metrics from load shedding, but a failure to address the problem over the medium term could put downward pressure on the rating.

The South African banks rated by Fitch have an asset quality score commensurate with the sector’s non-performing loans ratio (end-2022: 4.7%), but the ratio could increase to the pandemic high of 5.2% if the load shedding crisis is prolonged. However, this alone should not lead to rating downgrades as other key rating drivers remain relatively solid.

South African banks’ ratings are constrained by the sovereign rating. Any negative rating action on the sovereign rating driven by macroeconomic deterioration amid the country’s ongoing electricity crisis would be mirrored in the banks’ ratings.