Events surrounding the crash of African Bank have prompted the South African Reserve Bank to make changes to its supervisory practices.
This emerged at the release of the Reserve Bank’s bank supervision department’s annual report on Tuesday this week, and may be a tacit acknowledgment of the weaknesses in the regulatory environment thrown up by the lender’s collapse.
In the face of other developments, such as the investigation by the Competition Commission into several banks’ foreign exchange trades, the report nevertheless revealed a banking sector in relatively good health, with overall credit risk in decline.
When African Bank hit the rocks last year, the role of regulators – and why they had not done more, and sooner – was questioned by analysts. This included the national credit regulator, which had, it was argued, not done enough to stamp out rampant unsecured credit growth at African Bank, especially during 2011 and 2012.
The Reserve Bank said at the time that it had been actively working with African Bank on its poor provisioning, its rapid credit growth and the need to rethink its business model. These interventions could not save African Bank and it had to be put under curatorship after its share price collapsed in August.
In its annual report the bank supervision department said: “Following the events leading to African Bank’s curatorship, the department has considered its supervisor practices and procedures with a view to future changes and enhancements.”
At the same time the proposed Financial Sector Regulation Bill will institutionalise co-operation between various financial sector regulators to address the “regulatory gaps” that have developed.
The draft Bill is part of the implementation of the “twin peaks” model of financial regulation that South Africa and other nations have adopted in the wake of the financial crisis.
The Reserve Bank also instituted a commission of inquiry into activities at African Bank, under advocate John Myburgh. The commission’s report has been delivered to the Reserve Bank, which it is still “processing”. It would make a decision at a later date, in consultation with the minister of finance, whether to release all or part of the report, said deputy governor Kuben Naidoo.
Registrar of banks René van Wyk said he could not share specific changes to supervision practices that may be in the offing, but the events surrounding the lender’s collapse had highlighted key problems – including the weakness of a bank with a single business model and the lack of a shareholder of reference.
A shareholder of reference is a significant shareholder, though not necessarily a controlling one, with a long-term view of their holding in a company, and unlikely to sell their investment just because of fluctuations in the share price.
Registrar of banks René van Wyk. (Russell Roberts, Gallo)
These problems were issues that shareholders – and not just the regulator – should watch, Van Wyk noted.
“African Bank was operating for 20 years and shareholders supported it, but its vulnerability in a certain economic climate having a single line product was clearly highlighted,” he said.
The lender, unlike other banks, held almost no deposits. Its business model depended on wholesale funding from capital markets that it used to finance unsecured loans at high interest rates.
Although it is not a regulatory requirement for a bank to have a shareholder of reference, African Bank was one of the only banks in South Africa that did not have one when it collapsed, according to Jean Pierre Verster, of 36One Asset Management.
Examples include PSG’s share-holding in Capitec Bank, and Barclay’s shareholding in Barclay’s Africa or Absa Bank.
Shareholders of reference are more strategically aligned to the objectives of the company and, “all things being equal”, could be convinced to help recapitalise a bank that was in trouble, provided they had sufficient money available and stood to lose enough in the event of a collapse, said Verster.
African Bank was dominated by institutional shareholders that had to adhere to their clients’ investment mandates, he noted.
“They would have less appetite to keep investing in a company when they always have the other option of selling to the market,” said Verster.
A shareholder of reference provided comfort to the market during a crisis, Van Wyk told the Mail & Guardian.
“In any crisis that an organisation may experience, market confidence is paramount,” he said
“Banks, locally and internationally, experience difficult times and often the market looks at the shareholder of reference and does not overreact as it would have in the absence of a shareholder reference.”
Despite the effects felt by the financial sector following African Bank’s fall, Van Wyk said “there is nothing wrong with our banking system. The statistics reflected [in the annual report] are great.”
Bad debt
The ratio of impaired advances to gross loans and advances – a key ratio for assessing credit risk in the sector – had declined from 3.64% in December 2013 to 3.27% in December 2014, according to the report. But selected asset classes, namely small and medium-sized enterprises, corporate, retail credit and vehicle and asset finance categories, were experiencing increasing default exposures, rising to 38.12%, 10.76% and 13.78% respectively.
This was not a crisis as these exposures represented a small proportion of the sector overall, according to the bank supervision department.
It was focusing on these areas, but Van Wyk said it was satisfied that banks were “fully alive” to potential problems. Impaired advances declined from R108-billion in December 2013 to R106-billion in December 2014. Total assets on the banking sector’s balance sheets grew from R3.8-trillion in December 2013 to R4.2-trillion in December 2014.
During the course of its regulatory activities, the Reserve Bank had, however, fined all four of the country’s major banks a total of R125-million for failure to comply with requirements to combat money laundering and counter the financing of terrorism. These were administrative sanctions and not as a result of the banks’ actively facilitating any illegal activity.
Banks were fined for failing to meet requirements such as cash threshold reporting – whereby any cash deposits exceeding R25 000 are flagged by a bank’s systems and reported to the Financial Intelligence Centre.
Standard Bank was fined R60-million, FirstRand Bank R30-million, Nedbank R25-million and Absa R10-million.
Credibility
The Reserve Bank was concerned about the effects that other developments, notably an investigation by the Competition Commission into foreign exchange trading by several banks, would have on the sector’s credibility.
It was crucial that people felt the market had “fair outcomes” and that the system determining the exchange rate was credible, said Naidoo.
The Reserve Bank had instructed local banks to co-operate in the investigation, but its own separate review of foreign exchange trading activity had not revealed anything untoward, said Naidoo.
The implementation of the twin peaks reforms, including those envisaged in the draft Financial Sector Regulation Bill, would be positive, he said. “There is a sense that our regulatory framework has gaps in it. We think that the twin peaks reform process will address those gaps and, in some ways, institutionalising co-operation between the regulators is one way of filling those gaps.”
The Bill is in its second draft and has yet to be put to Parliament.
It made provision for, among other things, a council of regulators as well as a committee of ministers overseeing departments with regulators that affect the financial sector, Naidoo said.
The twin peaks model of regulation would see the creation of a prudential regulator, under the Reserve Bank, whose authority will stretch to include not only banks but also other financial services firms such as insurers.
A second market conduct authority will be housed under the Financial Services Board, aimed at ensuring customers are treated fairly.
According to the treasury, reforms under the “twin peaks” model will reduce the potential for regulatory gaps and arbitrage and “will support more consistent and complete supervision and regulation, developing comprehensive market conduct, prudential, and stability regulatory frameworks to be applied across the financial sector as a whole, rather than on an industry basis”.