MOODY’s acknowledged the strength of South African banks on Wednesday, even after it lowered its outlook for the banking system from stable to negative.

"We recognise the banks have a good track record of performance and have shown resilient core earnings," says Nondas Nicolaides, vice-president and senior analyst in charge of financial institutions.

"Even during the 2009 recession, the earnings-generating capacity of the banks did not decline significantly," he says.

But he warns earnings may slow in the next 18 months, although not significantly. There is also concern about declining asset quality and rising nonperforming loans.

"We are concerned about the nonperforming loans," he says. "Despite the improvement we have seen in asset quality and the decline in nonperforming loans in the last two to three years, with the economic slowdown, we expect an uptick in nonperforming loans.

"But the level will still be within manageable levels," Mr Nicolaides says. Moody’s lowering of its outlook on the banking sector has not surprised bankers, who say it was expected after the rating agency — and rival Standard & Poor’s — recently downgraded South Africa’s sovereign credit rating.

Their reasons included concerns about macroeconomic conditions and the effect of violent mining strikes on foreign investment.

In a report on Wednesday, Moody’s says the outlook for the South African banking system has been changed to negative from stable, reflecting its expectations that weakening macroeconomic conditions — including downside risks related to the broader global environment — will elevate credit risks and put pressure on banks’ asset quality and profitability.

Moody’s also cites the banks’ holding of large government securities. It says this will continue to link their credit profiles to the national sovereign, whose credit worthiness is under pressure from fiscal and economic headwinds.

There was a hint of annoyance from some of the big banks that Moody’s appears to be ignoring the fact that South African banks are better capitalised than some of those in developed economies.

"Given the link between the sovereign ratings and bank ratings (banks are required by regulation to hold sovereign debt as statutory liquid assets), this is not a surprise," Nedbank CEO Mike Brown says.

"But it is disappointing given the standalone strength of South African banks," he says.

The capital ratios of South Africa’s big banks are well ahead of the minimum ratios proposed by the Basel Committee on Banking Supervision under the Basel 3 regime.

The Basel 3 rules will be implemented in phases from next month until 2019. South Africa’s banking registrar, Rene van Wyk, confirmed last month that the country will comply with the rules.

Mr Nicolaides says the next 12 to 18 months will be critical for the banks, owing to concerns about their ability to grow revenues in the face of soft credit demand and bad debts, among other worries.

Moody’s also says the banks’ increasing reliance on short-term wholesale deposits reveals the structural funding challenges that will be worsened by the funding requirements of Basel 3.

"These negative pressures are only partly mitigated by banks’ resilient core earnings generating capacity and our expectations are that banks’ capital buffers will be maintained ahead of Basel 3 implementation," Moody’s says.

FirstRand investor relations director Sam Moss says the group does not expect problems with funding, capital or liquidity "now or following the implementation of Basel 3". She says its credit quality is in line with expectations.

Mr Brown says that funding challenges highlighted by Moody’s are related to the absence of stable and long-term sources of funding under the net stable funding ratio ( NSFR). He says these were not new and did not only apply to South African banks.

The net stable funding ratio calculates the proportion of long-term assets that a bank funds with long-term stable funding.

"The Basel 3 funding requirements they refer to are the NSFRs due for implementation in 2018," Mr Brown says.

"This is not new news and almost everyone believes it is unworkable globally in its current format, especially for any emerging markets have which a developed residential mortgage market," Mr Brown says.