The Finance Ghost: A tough period for local banks

Banks may sound like they have a licence to print money, but don’t be fooled by that old joke. They can only “create” money if there’s demand for credit, allowing them to extend loans and advances; and generate a net interest margin on the differential between what they can charge on those loans and what they must pay to their funding providers (including depositors). If an economy has stalled, then demand for credit tends to stall as well.

A flurry of banking updates came out in the past week (23–27 June 2025), giving us insight into how four of the five large banking groups are performing. The only one missing is Capitec, which has achieved by far the strongest year-to-date share price performance (what else is new?) and remains a disruptive force that can still grow in difficult conditions. As for the others, the halfway mark in 2025 reveals that banks have been a poor choice for portfolios this year.

The themes across the updates are similar, making this a good excuse to dig into what makes banks tick. We start with the most fundamental part of their business models: extending loans.

Banks want high interest rates

An important point to understand is that banks love high interest rates. Sure, high rates put the credit book under pressure and can lead to an elevated credit loss ratio when rates move up, but rates have to be extremely high before the benefits of higher pricing on loans are outweighed by credit losses. The reason for this is that when rates go up, banks charge you more on your loans, but they don’t necessarily pay their depositors a higher amount. This locks in a better net interest margin (NIM). Also, they enjoy the endowment effect, which refers to income earned from lending out the equity on the balance sheet – and that equity doesn’t have any interest rate-linked funding charges.

These are complex concepts. If you remember nothing else, just remember that higher interest rates drive a higher NIM and thus better profits.

So, it stands to reason that when rates are falling, banks tend to struggle. Although the credit loss ratio improves, it’s unusual for it to improve by so much that it offsets the effect of lower interest rates (Absa’s latest update is a rare exception to this). In the same way that the credit loss ratio didn’t fully offset the benefit of rates moving up, it won’t fully mitigate the challenge of rates coming down. The only thing that can make up for lower rates is a significant uptick in demand for credit, allowing banks to extend more loans and generate strong profits, even if individual loans are cheaper for borrowers than they used to be.

The thing to remember is that lower rates can still be fine for banks, provided there is economic growth and demand for credit. This brings us to the main problem at the moment.

Banks want you to borrow money from them

If there’s one theme that was clear in the recent banking updates, it’s that demand for credit is muted in this environment. Although rates have come down a bit, it’s just not enough to drive meaningful growth in the economy. In fact, the banks find themselves in an uncomfortable situation in which lower rates have now put NIM under pressure, but there’s nowhere near enough growth in loans and advances to offset that pressure.

To make it worse, the narrative in the latest updates suggests that most of the growth in credit is coming from corporate borrowers rather than retail clients. These are sophisticated borrowers who put pressure on the banks to give them better pricing, so this is a margin-dilutive source of growth.

If we consider this trend against the backdrop of the growth in credit sales at retailers, it looks like consumers are demanding credit at point-of-sale for their discretionary purchases rather than credit for larger purchases like vehicles and homes. There just isn’t enough certainty in this environment for consumers to feel confident about taking on substantial debt, especially as rates remain stubbornly high.

Read more: The Finance Ghost: Banks vs bricks — which is the smarter bet in a tough market?

So, where does this leave the banks?

Luckily, there are some growth engines beyond just South African retail borrowers. One such example is Africa, where Absa flagged that the performance of African currencies has been ahead of their expectations this year. This benefits Standard Bank and Absa the most, as they boast the strongest African banking franchises among the local peer group.

Another source of growth is an improving credit loss ratio, although this isn’t an indication of maintainable earnings. When a credit loss ratio has been at elevated levels and moves back into the target range, earnings net of credit loss provisions will be given a short-term boost. But once that provision is in the right range, shareholders don’t get that benefit again.

The best defence in this environment is a business that generates strong non-interest revenue (NIR), which means operations focused on earning fees, trading and insurance revenue. FirstRand is traditionally strong in this space, having built excellent businesses outside of their traditional banking space (such as RMB). Standard Bank also had a positive story to tell in this metric in the latest update, with NIR making up for the weakness in the lending business.

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Of all the local banks, Nedbank has the smallest exposure to these growth engines. This means that when the core South African banking businesses are doing well, Nedbank’s share price tends to outperform its peers. But when the local banking story isn’t promising, Nedbank lags severely. With its share price down 14% year-to-date, you can see how bearish the tone around South African banking has become.

Read more: The Finance Ghost: The lowdown on Capitec, Balwin and ADvTECH

Unless you’re Capitec, of course, with a share price increase of 14% year-to-date. Put differently, if you put R100 in Capitec and R100 in Nedbank at the start of the year, your Capitec position would now be worth 32.5% more than your Nedbank position (R114 vs R86) – and that’s over just six months! DM