Michael Metelits
The bad news is that your bank could hit a spot of trouble, run low on cash, find itself with too many people in line to draw funds, and collapse, leaving you with high blood pressure and a chequebook best used for gift-wrapping or reminder notes.
Worse news would be that your bank brought down other banks with it, and that the system was crashing and burning. Luckily, the South African Reserve Bank has measures in place to make sure banks don’t go bust often, and when they do, they don’t take the whole system with them.
The recent troubles of New Republic Bank (NRB)show the process at work, and also some of the problems involved. NRB’s depositors withdrew a large percentage of the bank’s deposits within a few days of press reports slating the bank’s health. When the bank ran out of cash, the registrar of banks at the Reserve Bank appointed consulting group KPMG to run the bank’s affairs at NRB’s request. One of KPMG’s tasks is to look after the interests of the depositors.
The bank is suing the paper which reported its woes, claiming that no bank can withstand a run on deposits, and that the press reports inaccurately fanned the flames. Belief and trust play a large role in the financial world.
It may seem strange that a bank couldn’t keep up with withdrawal demands, but banks loan out more money than they take in, a neat trick and one which keeps the world of capitalist enterprise flowing more or less smoothly. They are required to have a percentage of recorded deposits on hand, but this is substantially lower than 100%. When too many people pull out their money, the bank becomes strapped for cash, and can fail.
NRB is a small bank. Its failure did not threaten larger banks, even less the system as a whole. If other banks had lent NRB significant portions of their own money, the situation might have been different. NRB’s failure would then have led to speculation about other banks’ financial health, and perhaps additional failures.
As Dennis Dykes, Nedcor chief economist argues, “NRB had no potential to destabilise the South African banking system. It’s just too small.”
The Reserve Bank stands between individual bank failures and the failure of the system as a whole through the registrar of banks. His job is to impose requirements on financial institutions to make sure failures do not become widespread.
Rather than micro-manage individual banks, the registrar concentrates on limiting the effects one bank failure can have on the system. As the Reserve Bank’s Andre Bezuidenhout says, “Measures designed to prevent a bank failing would be too restrictive and impair market efficiency.”
The Banks Act and the bank supervision department at the Reserve Bank implement rules consistent with international standards, specifically the Core Principles for Effective Bank Supervision issued by the Basle Committee for Bank Supervision. The rules are complex, but boil down to common sense.
Licensing criteria decide who gets to run a bank; capital adequacy requirements aim to ensure that assets match potential demands in normal circumstances; liquidity measures require banks to have specific amounts of cash on hand for contingencies; corporate governance rules attempt to weed out hopelessly bad management; risk management rules prevent your bank from throwing all your money into highly speculative ventures.
The risk management criteria regulate which loans and investments a bank can make. If too many loans aren’t paid, the bank won’t take in enough cash to meet its requirements, causing liquidity crises. Bad loans and loans in default are, in the industry’s euphemism, “non- performing loans”, and can ruin banks.
The effects of deregulating banking can be seen in the savings and loan debacle in the United States during the 1980s when the government deregulated the types of loans such institutions could make.
The savings and loans began to make lucrative but highly speculative loans and investments, specifically in real estate. When those loans became “non-performing” due to collapses in property markets and overextension by the savings and loans, they went bust, leaving the US taxpayer with a $500-billion hangover. Depositors in savings and loans were protected by the US government up to $100 000.
In South Africa it is risk management that keeps banks and depositors healthy since there is no explicit deposit insurance scheme as there is in the US. Lifeboats to struggling banks do occur: one celebrated example is the lifeboat handed to Bankorp and Trust Bank, bailing them out of bad property loans, which figured in the Tollgate/Absa bank saga. The argument then was that the bank was “too big to fail”, meaning serious repercussions and more banking failures would result if the bank folded.
In past bank failures the government has stepped in to protect small depositors in many cases, such as re-imbursing up to R50 000.
Dykes and Bezuidenhout agree there is little systemic risk to the banking system in South Africa, meaning local depositors and bad loans are unlikely to bring the system down. So cash and capital requirements and loan supervision keep you from destroying your own bank, either by taking out too much money or by defaulting on too many loans.
But what about the Russian menace; the Asian flu; the Brazilian flatulence? Could these international crises take your bank down? In short, yes. International currency and loan crises can affect South African banks in two ways. If the banks have substantial loans abroad which become “non-performing”, they can lose lots of money. This is what economists call international exposure. Standard Bank, among others, lost money in the Russian debt crisis last year, although not a bank-threatening amount.
Also, instability in markets like Russia dampens sentiment for emerging markets as a whole, leading to capital flight. Foreigners won’t put their money here, and citizens will invest abroad rather than at home. Depositors do funny things with their money when they don’t trust banks. This capital flight can cause a liquidity crisis in which the financial system doesn’t have enough money to operate, leading to bad loans and failures.
Furthermore, as Bezuidenhout points out, “Capital outflows reduce liquidity, putting upward pressure on interest rates, which could increase defaults on bank loans.” If banks don’t have enough money, they have to charge more for it (higher interest rates) when they lend it. This means more loans are likely to default.
So the safety of banks, particularly in emerging markets like South Africa, is increasingly tied to flows of capital and decisions that are made outside our borders. Every time the international financial system edges toward crisis, depositors’ money is at risk all over the globe. This gives every depositor a stake in how money moves internationally, what the government does in the face of these movements and how financial institutions are regulated.
ENDS