First off, let us analyse how the banks would look at the proposition that Treasury offered to them. Very simply, the funding would come from the Reserve Bank at the repo rate plus 50 basis points 4.75% (4.25% +0.50%) and they were to offer these relief loans at prime, or 7.75%, utilizing their good lending practices and risk management processes.  This gives the banking industry 3% to cover their operating costs, cover their regulatory capital requirements, provide for credit losses and provide a return to their shareholders.

The banks 3% profit share was allocated as 0.5% guarantee fee, 0.5% costs and 2.0% as a credit spread.  This is a very narrow space for a bank to operate in, especially in an uncertain market and with a customer that is unknown from a credit perspective. To mitigate this risk, Government would guarantee the amount of the borrowing up to 94% of the loan, asking the banks to cover the first 6% of the loss.  Government further indicated that in order for the guarantee to operate, a review/audit of the banks lending practices may be required, which has a cost implication.

While one may say that there is enough incentive offered by the government for the banks to cooperate and relax their lending restrictions, there is still significant uncertainty if you are the head of risk in a bank.  Your cost of evaluating an SMME in a low data environment is significantly higher than the 0.5% estimated.  Valuable and scarce resources will need to be allocated to evaluate the qualitative and quantitative factors present in each SMME applicant.

There is also an overriding factor that in these uncertain times, the probability of default in many of these SMME’s will be elevated for the obvious reasons. Default estimates released by the external credit agencies indicate that default rates are expected to be between 1.5x and 2 .5x higher than the long-run average default rates for the next few years. The impact of COVID-19 on default rates is already evident in the latest financial results released by the local banks. To compound the impact on ECL (expected credit loss), these loans would be subordinated to other liabilities in the financials of the SMME, and consequently the LGD (loss given default) will tend towards 100%. It is with respect that we think that Government may have miscalculated the banks’ ability to be the appropriate platform for the distribution of the loans?  The most obvious observation is to analyse who needs these loans. The SMME market; that is generally considered “unbanked” and rely on smaller trade and development finance companies who know this market well.  They also rely on government institutions such as the IDC and PIC and other Development Finance Institutions (DFI) to fund their business.  This developmental finance market may be a better platform to understand their customer and assess the risks associated with the SMME market, and by the design of the the program, assist the government in managing their exposure over the 5 year period.

Importantly these SMMEs have a very different profit motive than traditional listed banks and a larger risk appetite which their charter acknowledges is part of their mission.It is thus clear to see the dilemma facing the banks in lending to an SMME market place and achieve the profit hurdles at the prime rate.  The 94% government guarantee does assist the banks in capping their total losses but it still may not be sufficient incentive for a bank to increase its risk appetite and lend to higher risk borrowers. For this reason, the DFI platform, if enhanced with sophisticated credit risk management and reporting capabilities, would be a more effective and suitable platform for distributing the relief loans.About us.  Anchor Point Risk is a global provider of credit risk solutions.

Our credit solution environment contains a number of modules to rate, price and value your counterparties against international established benchmarks. Our suite of products are all housed on a centralized data platform from which credit and pricing decisions can be made and monitored.

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