The R1 trillion axe hanging over South Africa’s neck
Around R980 billion of corporate credit loans of South African banks are tied up in sectors which are vulnerable to the global energy transition.
To mitigate the risks to the financial sectors and exert pressure on fossil fuel-tied industries to adapt, some researchers suggest implementing new policy measures.
This is outlined in a recent study published by the South African Reserve Bank (SARB), titled Transition and systemic risk in the South African banking sector, by monetary policy and macroprudential researchers Pierre Monnin, Ayanda Sikhosana and Kerschyl Singh.
According to the research into the South African banking sector, at an aggregate level, corporate loans amount to R2.8 trillion, representing 37% sector’s total assets and 42% of its total loans.
Of this R2.8 trillion, an estimated 35% (R980 billion) is tied up in sectors which are defined as “transition-sensitive economic sectors (TSES).”
The study outlined the “six sectors that are disproportionately exposed to transition risks [are the] fossil fuel, utilities, energy-intensive, transport, housing and agriculture” sectors.
South African financial institutions face these risks through their connections with businesses, the public, and their owned assets.
South Africa’s transition commitments
The South African government has increasingly doubled down on its intention to transition the country to a low-carbon economy.
According to energy think tank Ember, in 2023, South Africa relied on fossil fuels for 83% of its electricity generation. Its emissions per capita are 1.5 times the global average, while its coal emissions per capita are the highest in the G20.
Back in 2016, South Africa signed the Paris Agreement, where the country committed to transform its economy towards that of renewables to contribute to keeping global temperature rises well below 2°C.
Additionally, at the 28th Conference of the Parties (COP 28) to the United Nations Framework Convention on Climate Change (UNFCCC) in Dubai in late 2023, representatives from about 200 countries, including South Africa, called for “transitioning away from fossil fuels in energy systems, in a just, orderly and equitable manner, accelerating action in this critical decade, so as to achieve net zero by 2050.”
South Africa’s commitments are partially supported by the policy actions detailed in the Just Energy Transition (JET) plan.
Most recently, President Cyril Ramaphosa signed the Climate Change Bill into law on 23 July 2024, which sets the legislative framework for the long-term just transition to a climate-resilient and low-carbon economy and society.
It “enables the alignment of policies that influence South Africa’s climate change response, to ensure that South Africa’s transition to a low carbon and climate resilient economy and society is not constrained by policy contradictions,” said the Presidency.
Recently, Ramaphosa said that the country is looking for R1.79 trillion in investment to “drive huge investments in the electricity grid, green hydrogen, electric vehicles, economic diversification and skills development, amongst others.”
The impact on financial institutions
“This transformation will inevitably impact financial institutions, some of which will reap the benefits of this process, while others will face potential losses,” said Monnin, Sikhosana and Singh.
“Losses in some segments of the financial sector, even compensated by gains in others, may affect the system at large and trigger a degree of financial instability,” added the researchers.
The study outlines that the impact of a transition shock on South Africa’s financial system is not well-documented, but evidence suggests significant indirect effects on the economy—a ripple effect.
The country’s coal value chain is central to this—it forms a large part of the domestic economy and energy generation infrastructure. However, the committed global transition requires a drastic cut in coal production and utilization.
“Transition risks in South Africa are not limited to the coal value chain, however: they will also affect other economic sectors and the economy at large,” said the authors.
For example, the researchers say that a 10% decrease in coal sector output could lead to a “5.8% decrease in total output due to a decrease in the output of the rest of the economy,” with similar multipliers seen in other large sectors like the motor vehicle industry.
Research estimates that job losses in the coal sector are amplified by a factor of 2.7—that is, for every job lost in the coal sector, there are roughly two other jobs lost in the rest of the economy—and by a factor of 1.7 in the motor vehicle sector.
Additionally, “financial markets overall are not currently aligned with a portfolio allocation that will lead to the transition to a sustainable economy; nor do they fully account for climate-related risks,” said Monnin, Sikhosana and Singh
Thus, they say that there is a need for South African banks to enhance their climate risk management capabilities.
Updating policies
Policymakers and regulators are likely to be pressured to devise strategies to lower financial system risks, as banks might need to write off substantial amounts in loans to at-risk sectors.
In the study, the researchers suggest various interventions all aimed at “increasing resilience and mitigating risk build-up.”
They suggest macroprudential measures which aim to enhance the financial system’s resilience to shocks and limit risk accumulation.
This could be by implementing capital requirements to buffer losses and discourage risk-taking, said the authors.
Three “building blocks to achieve these objectives in the context of climate-related risks” outlined include:
- A component to absorb climate shocks: Financial institutions need increased macroprudential measures to handle climate shock-related losses effectively, involving additional systemic capital requirements based on enhanced climate risk assessment methodologies.
- A component to prevent the build-up of climate-related risks: Preventing climate risk buildup requires incentives for financial institutions to reduce their climate impact and promote low-carbon economic activities, using a macroprudential framework tailored to manage systemic climate risk efficiently.
- A dynamic adjustment to transition paths: Systemic risk adjustment according to the economy’s transition path involves a dynamic approach, increasing risk absorption efforts in case of transition delays, and reducing them as an early and orderly transition progresses.
“The macroprudential framework already includes instruments that could be deployed to address climate-related systemic risks,” said the researchers.
Currently, central banks and supervisors largely base their policy decisions and calibrate macroprudential instruments on past data observed over several economic and financial cycles.
But “this is not possible for climate-related risks,” said Monnin, Sikhosana and Singh.
“However, climate-related systemic risks also have their own specificities. Addressing them thus requires central banks and supervisors to review their current implementation practices and, if needed, adjust them,” they added.
“An orderly transition should not jeopardise financial stability – but understanding transition risks for the banking sector, monitoring them and, when necessary, implementing macroprudential measures is necessary to ensure this stability.”
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