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UPDATE 1-Higher public debt threatens S.Africa's financial system, c.bank says

(Adds more details)

JOHANNESBURG, Nov 24 (Reuters) - A massive increase in projected government debt poses a “major threat” to financial stability in South Africa, the central bank warned on Tuesday, while problem mortgages were also a risk.

South Africa’s government debt is now set to hit 82% of gross domestic product this year as the Treasury grapples with the impact of the COVID-19 pandemic.

In its bi-annual review on the soundness of the financial system, the South African Reserve Bank (SARB) said this meant close links between the financial sector and government were now a serious worry.

“The interconnectedness between the financial sector and the sovereign has emerged as a major threat to financial stability in South Africa,” the document said.

Domestic banks hold 23% of total government bond holdings and pension funds account for a further 29%, meaning any deterioration in the public finances has a perceived impact on these institutions’ own creditworthiness, it said.

A perception the government may have limited ability to shore up a struggling bank was also a problem in a country without any deposit insurance scheme for consumers, it continued, and drove bank funding costs up.

If lenders were forced to reduce their lending, the government may face its own funding challenges, it added, while any stress experienced by the sector would spread into the economy and hurt government tax revenues.

However, the SARB said a stress test had shown that, in aggregate, South Africa’s systemically important financial institutions had enough capital to withstand even a very severe economic downturn.

Nevertheless, bad loans were set to keep rising. Mortgages especially were a significant risk, it continued, because a large proportion of these were restructured in the wake of the pandemic, disguising possible defaults.

“The size of each mortgage loan is much larger than any other retail loan category, meaning that even a relatively small number of defaults could begin to erode a bank’s provisions,” the central bank said. (Reporting by Emma Rumney; Editing by Olivia Kumwenda-Mtambo and Alex Richardson)

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