The Impact of Basel III and IFRS 9 on Bank Lending
Much has been written about Basel III and IFRS 9 and their impact on bank lending. It is important to remember that, especially outside South Africa, banks are large lenders to non-bank financial institutions and other financial intermediaries. We estimate that around one-quarter of borrowings by non-bank lenders in Africa, outside South Africa, is sourced from banks. Basel III, and especially higher minimum common equity tier 1 ratios mean the banks have to increase their lending rates (or cut staff costs) to stand still in terms of their return on equity. Equally, banks must either raise equity or reduce their risk weighted assets (i.e. loans books) in order to meet the higher tier 1 minimum common equity. Other financial intermediaries who borrow from banks will then have to absorb this higher contribution to funding costs, by increasing their own lending rates (or again, cutting staff costs or reducing their expected return on equity).
IFRS 9, by bringing forward provisioning on loans when advanced (rather than deferring credit provisioning until a credit event), has an impact on profits and therefore reducing common equity. This is magnifying the impact of Basel III. EY estimates the increase in provisioning to be 15% as result of IFRS 9, a survey of British banker for Euromoney estimated 50% (although the latter estimate is widely seen as overstated). Furthermore IFRS 9 requires provisions to be estimated when initially advanced, meaning characteristics such as tenor and security are likely to weigh heavily in such estimates and therefore pricing. Furthermore, availability of longer-term and unsecured loans are likely to shrink. We view these changes in the structure of bank lending markets as creating an opportunity for financial inclusion funds to take up some of the territory the banks are likely to vacate. Furthermore, non-bank lenders with strong access to offshore funds may be able to capture market share from these banks.