The Banking Supervision Department briefed the Committee on the Department's 2009 Annual Report in a meeting which was one of a series to acquaint Members with the activities of institutions working under the National Treasury. The Department described its revised supervisory framework, which incorporated Basel II and was implemented with effect from 01 January 2008. The revised framework, formally known as the 'supervisory review and evaluation process' was based on risk based supervision and a matrix structure: a relationship team assisted by specialist teams with diverse competences. The legal framework for the regulation and supervision of banks comprised three tiers: the Banks Act 1990; regulations and directives, Banks Act circulars and guidance notes. The Department indicated the steps of which the 'supervisory review and evaluation process' consisted.
The Department reported that, notwithstanding the difficult circumstances of the financial sector during 2009, the banking system remained stable and profitable, and capital levels were adequate throughout the year. International regulatory/supervisory standard-setting bodies, for example, the Financial Stability Board and the Basel Committee on Banking Supervision, continued their respective processes of developing or issuing guidance and standards to strengthen the resilience of the financial sector in general and the banking sector in particular. The Department gave details of key Basel Committee press releases. The Department closely monitored and considered developments on the international regulatory and supervisory fronts to promote the soundness of the domestic banking sector through the effective and efficient application of international regulatory and supervisory standards. The Department noted that the International Monetary Fund’s Staff Report in respect of South Africa was completed on 20 July 2009; the report broadly described the South African financial sector as “remaining vigilant”, and indicated that the banking system remained liquid and well capitalised. The Financial Intelligence Centre appeared to be operating effectively. Suspicious transaction reporting and internal control requirements were in place.
During 2009 the Department spent R887 000 on the skills training of approximately 107 employees. The Department continued to provide input and training to regulatory counterparts in neighbouring
The Department presented some of the key trends in the South African banking sector that were predicated on risk-based information submitted by banks during 2009 and updated for the first six months of 2010. It gave an overview of the banking sector as of June 2010; selected South African banking sector trends; distribution of banking-sector assets; total assets, gross loans and advances and respective growth rates; the composition of total assets (R3 010 billion); the composition of loans and advances to customers (R2 308 billion); the composition of liabilities (R2 805 billion); the composition of deposits (R2 454 billion); the sources of deposits as a percentage of total deposits (R2 454 billion); smoothed profitability ratios; smoothed cost-to-income ratio; capital adequacy; total equity (R204.7 billion); financial leverage multiple; capital-adequacy ratios; composition of qualifying regulatory capital and reserve funds (R225.6 billion); composition of aggregate risk-weighted exposure (R1 582 billion); liquidity risk; statutory liquid assets (actual versus required); short-term liabilities as a percentage of total liabilities; credit risk; impaired advances to gross loans and advances (R136.4 billion); specific and portfolio credit impairments; specific credit impairments ratios; and a summary to June 2010. The Department noted that year on year asset growth improved during the second quarter of 2010, but still remained negative. Growth in retail portfolios was still weak and lacking consistency. Profitability ratios were still compressed. There was a deteriorating cost-to-income ratio. There were improved capital adequacy and leverage ratios - compliant with international proposed reforms. The ratio of impaired advances to gross loans and advances was not improving. Overall there was low growth, particularly on the retail side, with lower profitability levels together with sticky impaired advances. In general, activity in the banking sector remained subdued.
In its second presentation, the Banking Supervision Department told Members that
A Congress of the People Member said that the load of paper work imposed by banks on clients was "horrific", and asked why he could not file his FICA forms electronically. The same Member asked if the Banking Supervision Department would have oversight of the Post Bank. A Democratic Alliance Member asked about suspicious transactions and the number of illegal deposits; he observed that it certainly did not appear if the banks' profits had been hurt very much by the crisis; he also asked about the composition of total assets: the vast amount of money the banks was providing to the economy was in the form of home loans - was this not too much and at the expense of more risky areas that would generate more economic activity. He noted that this was an issue of the structure of the loan system. An African National Congress Member asked what could be done to sustain the leading role of
Introduction and Welcome
The Chairperson welcomed Members and the Banking Supervision Department (BSD). He noted that the BSD was a division of the Reserve Bank in its own right. The meeting was part of a continuing briefing process on the financial sector to acquaint Members with the activities of institutions working under the National Treasury, and was the present Committee's first engagement with the BSD. The Chairperson expressed especial interest in international aspects of the BSD's work.
Mr Errol Kruger, Registrar of Banks, BSD, introduced Ms Yvette Singh, Deputy Registrar of Banks, BSD, and Mr Johan Neethling, Senior Manager, South African Reserve Bank.
Banking Supervision Department. Annual Report 2009. Presentation.
Mr Kruger outlined his presentation, which would begin with an introduction; followed by the status of the financial sector status during 2009; international regulatory developments; Chapter 1 of the Annual Report - Registrar of Banks’ review; Chapter 2 - Promoting the soundness of the banking system - Overview of supervisory activities; Chapter 3 - Developments relating to banking legislation; Chapter 4 - Trends in the South African banking sector; and Appendices.
The Bank Supervision Department (BSD or the Department) executed the functions assigned to the Registrar of Banks in terms of the Banks Act 1990 and its mission was: “To promote the soundness of the banking system through the effective and efficient application of international regulatory and supervisory standards.” Mr Kruger emphasised that BSD’s business philosophy was that market principles under laid all its activities and decisions.
Mr Kruger emphasised that the BSD was impartial, and had a single point of entry, with a relationship manager, assisted by a team with diverse competencies. Mr Kruger said that the two deputy registrars were responsible for the day to day supervision. Support staff numbered 25 members, including the information technology (IT) staff members. Mr Kruger said that skills development was very important for the BSD, which invested in training interventions.
BSD had a risk-based supervisory approach - its objective was to add value. Its emphasis was on empowering staff, professional service delivery and ethical behaviour. Mutual trust between the Department and all other key players was emphasised, with regular open communication.
Mr Kruger described BSD's revised supervisory framework, which incorporated Basel II and was implemented with effect from 01 January 2008. The revised framework, formally known as the 'supervisory review and evaluation process' (SREP) was based on risk based supervision and a matrix structure - a relationship team assisted by specialist teams with diverse competences.
The legal framework for the regulation and supervision of banks comprised three tiers: the Banks Act 1990 (Act No. 94 of 1990); regulations relating to banks; and directives, Banks Act circulars, and guidance notes.
Mr Kruger indicated the steps of which SREP consisted (slide 6), and described BSD's organisational structure (slide 7).
BSD’s Annual Report 2009
Mr Kruger said that the Annual Report for the calendar year ended 31 December 2009 had been issued in terms of section 10 of the Banks Act 1990 (Act No. 94 of 1990) and section 8 of the Mutual Banks Act, 1993 (Act No. 124 of 1993). The report presented an overview of the objectives and activities of BSD, with particular reference to the period 1 January 2009 to 31 December 2009.
Financial sector status during 2009
During 2009 the banking sector continued to experience a challenging operating environment. There was a cyclical downturn in domestic economic conditions. In the aftermath of the 2007/08 international financial market crisis, consumer spending remained subdued. The level of impaired advances in existing asset portfolios of banks continued to increase. However, notwithstanding these difficult circumstances, the banking system remained stable and profitable, and capital levels were adequate throughout 2009.
International regulatory developments
International regulatory/supervisory standard-setting bodies (e.g., the Financial Stability Board and the Basel Committee on Banking Supervision), continued their respective processes of developing/issuing guidance and standards to strengthen the resilience of the financial sector in general and the banking sector in particular.
Key Basel Committee press releases were as follows: 13 July 2009 on (1) enhancements to the Basel II framework; (2) revisions to the Basel II market risk framework; and (3) guidelines for computing capital for incremental risk in the trading book. On 07 September 2009 the Basel Committee issued a press release on comprehensive response to the global banking crisis. On 17 December 2009 the Basel Committee issued a press release on consultative proposals to strengthen the resilience of the banking sector and introducing minimum liquidity ratios.
An announcement on 17 December 2009 covered the following areas: raising the quality, consistency and transparency of banks’ Tier 1 capital base; introducing a series of measures to promote the build-up of capital buffers in good times (i.e. a counter-cyclical capital framework); strengthening the risk coverage of the capital framework (e.g. capital requirements for counter-party credit risk arising from derivatives); introducing a leverage ratio as a supplementary measure to the Basel II risk-based framework; and introducing a minimum liquidity standard for internationally active banks (e.g. liquidity coverage ratio and a longer-term structural liquidity ratio).
BSD, as always, closely monitored and considered developments on the international regulatory/supervisory fronts in an ongoing effort to promote the soundness of the domestic banking sector through the effective and efficient application of international regulatory and supervisory standards.
Mr Kruger drew Members' attention to a tabular checklist of BSD's status with regard to the Basel Committee's consultative status (slide 12).
Chapter 1: Registrar of Banks’ review
With regard to the International Monetary Fund (IMF) Article IV Consultation 2009,the IMF’s Staff Report in respect of South Africa was completed on 20 July 2009.The Report broadly described the South African financial sector as “remaining vigilant”, and indicated that the banking system remained liquid and well capitalised. The key findings of the report included the following: credit risk to the banking system was mitigated by supportive macroeconomic policies, more stringent bank loan origination standards and a decline in the demand for credit. South African banks’ reliance on short-term wholesale corporate deposit funding was again highlighted and described as a long-standing structural risk. Dominance of the financial system by a few large financial conglomerates with cross-border share holdings and cross-sector activities posed structural risk. South African banks’ probabilities of default had increased, but were significantly lower than those of several large international banks based in mature economies. The supervision of banks (e.g., the assessment of banks’ stress-testing practices, risk models and risk management practices) had generally been intensified since 2008 in response to rising financial sector risks.
With regard to compliance with anti-money laundering (AML) and the combating of the financing of terrorism (CFT) standards, the Financial Action Task Force (FATF) published a final report on the evaluation of
The Financial Stability Institute (FSI), jointly with the Department, hosted a High-level Meeting on Recent Developments in Financial Markets and Supervisory Responses in January 2009. This focused on developments in financial markets and supervisory responses thereto. The meeting was attended by the heads of supervisory authorities from various
BSD conducted a thematic review of all South African banks’ incentive schemes during 2008 and found that banking organisations generally had sound principles embedded in their incentive schemes, including: alignment with the objectives of the organisation as a whole; business unit bonus pools determined by overall performance of the organisation; consideration of risk management in the performance assessment process; and incorporation of team and business unit performance in individual assessments.
In April 2009 the Financial Stability Board issued Financial Stability Board Principles for Sound Compensation Practices (the Compensation Principles) which should be implemented by banking institutions and be reinforced through the supervisory process at national level.
In September 2009 the Financial Stability Board published the Financial Stability Board Principles for Sound Compensation Practices: Implementation Standards (the Compensation Standards) in addition to its Compensation Principles.
BSD commenced participation in a thematic review conducted by the Financial Stability Board on the implementation of the Compensation Principles and Compensation Standards, which would form part of the areas of focus during 2010.
The international financial market turmoil: Responses by standard-setting bodies
Fundamental weaknesses in international financial markets were revealed by the international financial market crisis that started in 2007.
In response, international standard-setting bodies such as the Group of Twenty Finance Ministers and Central Bank Governors (G-20), the Financial Stability Board and the Basel Committee announced various initiatives, strategies, and new or amended requirements and standards covering a wide range of areas.
Key aims of the broader programme are to introduce new standards to, among other things:
promote the build-up of capital buffers that could be drawn down in periods of stress; strengthen the quality of bank capital; Introduce a leverage ratio as a backstop to the Basel II risk-sensitive measures; and introduce measures to mitigate any excess cyclicality of the minimum capital requirement.
On 25 September 2009, following the Pittsburgh Summit, the G-20 issued a leaders’ statement in which they agreed to, among other things: act together to raise capital standards, implement international compensation standards and create tools to hold large global institutions to account for the risks they took; strengthen prudential oversight, improving risk management, strengthening transparency, promoting market integrity, establishing supervisory colleges and reinforcing international co-operation; enhance and expand the scope of regulation and oversight, with tougher regulation of OTC derivatives, securitisation markets, CRAs and hedge funds; raise standards together so that national authorities implement global standards consistently; conduct robust and transparent stress tests as needed; and strike an adequate balance between macro prudential and micro prudential regulation to control risks.
In December 2009 the Basel Committee issued for consultation, a package of proposals to further strengthen global capital and liquidity regulations. These proposals along with the measures taken by the Basel Committee in July 2009 to strengthen the Basel II framework, formed part of the Basel Committee’s comprehensive response to address the lessons learnt from the crisis related to the regulation, supervision and risk management of global banks.
The Basel Committee initiated a comprehensive impact assessment of the capital and liquidity standards proposed in the consultative documents to determine the final proposals and their calibration.
It was expected that the fully calibrated set of standards would be developed by the end of 2010 to be phased in as financial conditions improved and the economic recovery was assured, with a view to implementation by the end of 2012.
Participation in international regulatory or supervisory forums
BSD was represented on, and contributed to, various international regulatory and supervisory forums, including the following: the Southern African Development Community (SADC) Subcommittee of Banking Supervisors (SSBS), a subcommittee of the Committee of Central Bank Governors (CCBG) in SADC; the Validation Subgroup (SIGV) of the Standards Implementation Group (SIG), an expert subcommittee of the Basel Committee; the Standards Implementation Group Operational Risk, a permanent working group of the SIG; the Trading Book Group, an expert subcommittee of the Basel Committee; a work stream of the Basel Committee focusing on microfinance; and the Basel II Capital Monitoring Group.
During 2009 BSD spent R887 000 on the training of approximately 107 employees. Various training interventions were arranged, such as technical and managerial courses, risk management seminars and supervisory workshops.
The main purpose of the training was to assist staff in implementing sound supervisory standards and practices; keep staff abreast of the latest information on market products, practices and techniques; keep staff abreast of the latest developments in international financial markets and supervisory responses to the financial market crisis; and ensure that staff were equipped with the necessary tools and techniques in order to meet their everyday supervisory tasks.
BSD continued to be involved at a regional level in providing input and training to regulatory counterparts in neighbouring
These interactions included the following: August 2009 - BSD met with senior banking supervision representatives of the Bank of Namibia to share the Department’s experience with regard to various supervisory matters; in September 2009 - BSD provided training/lectured at a workshop on risk-based supervision under the auspices of the Macroeconomic and Financial Management Institute of Eastern and Southern Africa (MEFMI) in Tanzania; October 2009 - BSD provided training/lectured at a regional seminar on consolidated supervision, jointly hosted by the FSI and the MEFMI, in Lusaka, Zambia; and October 2009 - BSD was requested by the IMF, through its support for the development of appropriate regulatory practices, to assist with the implementation of regulations for market risk in Kenya.
Issues to receive particular attention during 2010
These included , inter alia, an ongoing review and amendment of the banking legislative/regulatory framework in South Africa; continued refinement of BSD’s supervisory review and evaluation processes; continued participation in the various international forums to formulate further internationally agreed requirements to strengthen the resilience of the banking sector; further development and implementation of BSD’s common scenario; stress-testing methodology and process in respect of banks’ capital adequacy and liquidity;
continued performance of thematic reviews focusing on back testing of credit risk model ongoing focused reviews of banks making use of advanced approaches to calculate credit risk, market risk and operational risk capital requirements; continued monitoring of banks’ compliance with AML/CFT legislation; continued investigation of illegal deposit-taking by unregistered institutions and persons; and participation in consumer education initiatives.
Chapter 2: Promoting the soundness of the banking system
Mr Kruger noted the soundness of the banking system in the year under review. Credit was one of the biggest risks. However, the worst of the crunch was over. In an overview of supervisory activities, BSD reported that the market risk-related work carried out by BSD during 2009 covered the following: market risk reviews, specifically on banks with approval to use the internal models approach (IMA) for regulatory reporting; a review of the trading activities of one bank was conducted; liquidity risk management formed the basis of BSD’s annual meeting with the boards of directors of banks during 2009; and BSD initiated a thematic review of the asset and liability management process at banks, examining the durability of liquidity risk management in the current turbulent financial climate and in the future under increasingly stressed circumstances. No new applications for using the IMA were received or processed during 2009.
The operational risk-related work carried out by BSD during 2009 covered the following: operational risk reviews that focused on changes in the business environment and banks’ response to it from an operational risk perspective;
a detailed review of the management information reports or “dashboards” used for operational risk management; a detailed review of the scenario approval, governance process and specific scenarios used by banks in their application of the advanced measurement approach (AMA); and processing of a new application received from one of the registered banks to use AMA.
Based on the results of an international operational loss data collection exercise that was performed, BSD provided participating South African banks with a customised analysis comparing their data with industry data at both the international, and where possible, regional or national levels.
Internal capital adequacy assessment process (ICAAP).
The adequacy of a bank’s and banking group’s capital needed to be assessed by both the particular bank and the Department. Various thematic ICAAP reviews of larger banks and some smaller banks were performed during 2009
The process followed to assess a bank’s ICAAP could be illustrated as indicated (figure 2.4) (slide 27).
Developments in respect of Pillar 3 Disclosure
During 2009 BSD determined and performed an analysis of the level of disclosure by banks in
The benchmarking process would be a focus area in 2010.
Stress testing was defined by the Basel Committee as “a risk management technique that is used to evaluate the potential effects of a specific event and/or movement in a set of financial variables on an institution’s financial condition”. Stress testing was a key tool used by the regulator in understanding the appropriate level of regulatory capital to ensure that banks remained solvent during difficult times. Stress testing was an important input to the capital-adequacy process and decisions concerning the adequacy of capital buffer requirements. BSD’s stress-testing framework consisted primarily of two main work streams: the first focusing on the stress-testing frameworks of banks; and the second on common scenario stress testing performed by BSD (using the information obtained from the first work stream).
BSD performed various thematic stress-testing reviews during 2009 and findings were communicated to the relevant banks.
Developments in consolidated supervision
BSD proactively took the following actions to further improve the consolidated supervision of banking groups: regular supervisory meetings were held between the Department and the Financial Services Board; a policy decision was taken to allow only the acquisition or establishment of cross-border banking operations (inwards and outwards) in instances where a memorandum of understanding with the cross-border banking supervisor had been concluded; BSD was planning to host a supervisory college in 2010 with those African supervisors in whose countries South African banking groups had a presence; and to improve the supervision of banking groups on a consolidated basis, BSD recommended to one of the large banking groups to undergo a restructure.
Chapter 3: Developments relating to banking legislation
The Banks Act 1990 and the Regulations relating to Banks
A key responsibility of BSD was to ensure that the legal framework for the regulation and supervision of banks and banking groups in
international developments relating to the global financial crises (e.g. the G-20 discussions and publications and directives issued by the Basel Committee and the Financial Stability Board); the New Companies Act 2008; the board of review findings; King III; flowing from these initiatives and developments, extensive proposed amendments to the banking legislative and regulatory framework had been issued for public comment.
One of the auxiliary functions of BSD was to inspect and investigate persons and institutions suspected of taking deposits from the general public in contravention of the provisions of the Banks Act, 1990. A graph depicted the investigations performed relating to illegal deposit taking during the past five years: (slide 32).
Update regarding co-operative banks.
The Co-operative Banks Act 2007 (Act No. 40 of 2007) (CBA) was assented to by the President on 18 February 2008 and published as Government Notice No. 737 in the Government Gazette No. 30802 on 22 February 2008. The CBA sought to create a development strategy and a regulatory environment for deposit-taking financial co-operative institutions.
Developments regarding Post bank.
Postbank operated under an exclusion provided for in section 2(vii) of the Banks Act 1990. It was the Government’s intention to restructure its banking interest in Postbank in a three-phased process: phase I - Postbank would operate as a profit centre providing greater autonomy within the existing divisional structure; phase II - Postbank would operate as a fully owned subsidiary of the SA Post Office or Government, providing a complete range of payment and funds transfer services, and an expanded deposit service range;
phase III - Postbank would operate as a savings bank that was an autonomous company owned by the SA Post Office or Government and operate as a fully fledged savings bank extending lending facilities.
Decision of the Board of Review in the review of the decision of the Registrar in respect of an application for authorisation to establish a bank.
In 2006 BSD received an application for authorisation to establish a bank which was refused on the grounds that the Applicant could not satisfy many of the prescribed requirements. In February 2008 the decision was taken on review to the Board of Review (established in terms of section 9 of the Banks Act 1990) which the Board dismissed. In August 2009 the Applicant brought an application in the High Court (
Chapter 4: Trends in the South African banking sector
The BSD presented some of the key trends in the South African banking sector that were predicated on risk-based information submitted by banks during 2009 and updated for the first six months of 2010: an overview of the banking sector- June 2010; selected South African banking sector trends (slide 38); distribution of banking-sector assets (slide 39); total assets, gross loans and advances and respective growth rates (slide 41); composition of total assets (R3 010 billion) (slide 42); composition of loans and advances to customers (R2 308 billion) (slide 43); composition of liabilities (R2 805 billion) (slide 44); composition of deposits (R2 454 billion) (slide 45); sources of deposits (as a percentage of total deposits) (R2 454 billion) (slide 46); profitability ratios (smoothed) (slide 48); cost-to-income ratio (smoothed) (slide 49); capital adequacy: total equity (R204,7 billion) (slide 51); financial leverage multiple (slide 52); capital-adequacy ratios (slide 53); composition of qualifying regulatory capital and reserve funds (R225.6 billion) (slide 54); composition of aggregate risk-weighted exposure (R1 582 billion) (slide 55); liquidity risk (slide 56); statutory liquid assets (actual versus required) (slide 57); short-term liabilities as a percentage of total liabilities (slide 58); credit risk: impaired advances to gross loans and advances (R136,4 billion) (slide 60); specific and portfolio credit impairments (slide 61); specific credit impairments ratios (slide 62); and a summary - June 2010. Year on year asset growth improved during the second quarter of 2010, but still remained negative, amounting to -0.4% at the end of June 2010 (June 2009: 2.2% and December 2009: -6.6%). Growth in retail portfolios was still weak and lacking consistency. Profitability ratios were still compressed - there was a slight improvement at the end of the 1st quarter of 2010. There was a deteriorating cost-to-income ratio. There were improved capital adequacy and leverage ratios which were compliant with international proposed reforms. The ratio of impaired advances to gross loans and advances was not improving, amounting to 5.9% at the end of June 2010 (June 2009: 5.5% and December 2009: 5.9%). Overall there was low growth, particularly on the retail side, and lower profitability levels together with sticky impaired advances. In general, activity in the banking sector remains subdued. (slide 63)
Appendices 1 to 5 and 7 to 10 contained useful administrative information pertaining to the banking sector, such as the following: names and details of the registered banks, mutual banks and local branches of foreign banks; details of name changes and cancellation of registration of banks and branches of foreign banks; names of the registered controlling companies; details of foreign banks with approved local representative offices; directives sent to banks; exemptions and exclusions from the application of the Banks Act 1990; approval of the acquisition or establishment of foreign banking interests in terms of section 52 of the Banks Act 1990; and memoranda of understanding concluded between BSD and foreign supervisors.
Appendix 6 contained 24 tables detailing extensive financial data predicated on risk-based information submitted by banks over a 24-month period ending December 2009 (slide 64).
Banking Supervision Department on the International Financial Market Crisis Background
Mr Kruger outlined the presentation. He outlined the run-up to the sub-prime market turmoil; what went wrong? What complicated it? What did
Mr Kruger gave definition and characteristics. He explained that sub-prime lending meant loans granted to lower-end/sub-prime clients who ordinarily would not qualify. A higher interest rate was charged for a higher risk, often with initial low “teaser” rates - resetting after +/- 2 years. In extreme cases, such loans were referred to as “Ninja” loans, i.e.: loans to persons with no income, jobs or assets. Sub-prime lending had occurred predominantly in the
Mr Kruger described the global economic environment prior to sub-prime turmoil as an environment of euphoria.
There had been strong economic growth, low interest rates, high levels of liquidity, investors looking for yield, buoyant financial markets, increasing asset prices, and a relaxing of credit granting standards.
Mr Kruger described the condition of the United States (US) housing market. In earlier years there had been only fixed rate mortgages (FRMs). In the 1980s Adjustable Rate Mortgages (ARMs) had been introduced in the 1980s.
The shift from FRMs to ARMs had resulted in rapid growth. In 2001 sub-prime mortgages had equalled 5% of market. 2/28 lending had been based on the borrower’s ability to pay in first 2 years at low “teaser” rates and not the remaining 28 years.
Mr Kruger described developments in US during 2006. The housing market had begun to cool. The introduction of the so-called ARMs and the manifestation of the teaser rates with additional equity in the home were postponing the inevitable. What went wrong was that the housing market began to cool and housing prices started to decline. Such price decreases had not been seen since the 1940s.
Sub-prime lending based had been based on the premise that housing prices would continue to increase. Sub-prime mortgages with “teaser” rates had began to reset. Customers were unable to meet their higher payment obligations, and were unable to refinance their loans (negative equity).There was a rapid increase in non-performing sub-prime mortgage loans. Customers were not able to refinance the loans with the result that they owned more than their houses were worth. Then they could not repay their loans.
Impact of global economic environment
High levels of liquidity and low interest rates resulted in low-yielding investments globally. Investors were actively searching for better yielding assets. The high-yielding US sub-prime mortgage market appeared attractive.
Mr Kruger described the Originate-to-distribute model, asset securitisation, collaterised debt obligations (CDOs), and the explosion period during 2001-2007. The return on securities in good times masked the problem.
Linkage between sub-prime mortgages, securitisation and CDOs
Mr Kruger described the role of rating agencies, the linkage between sub-prime mortgages, securitisation and CDOs. The first step was the origination of sub-prime mortgage loans. The second step was the securitisation of sub-prime mortgages - mortgage-backed securities. Securities were rated and sold to investors. The “Tranche”/grade approximate breakdown was given (slide 10). The third step was that various “tranches” of lower grade mortgage-backed securities were repackaged, assigned ratings and sold off to conduits (structured investment vehicles ( SIVs) as CDOs. SIVs were attracted by high yields (slide 11).The fourth step was that the conduit (SIV) owned five year CDOs worth R1bn. Salient issues were long-dated paper funded by 90-day investments with liquidity risk and roll-overs. roll-overs (slide 12).
Impact of defaulting sub-prime loans on structured products
The Impact of defaulting sub-prime loans on structured products was an increase in sub-prime loan defaults. The market lost confidence in ratings assigned to structured products backed by sub-prime loans. The re-financing of CDOs dried up. 90-day funding gave way to overnight funding. Banks had to take assets/securities back on the balance sheet. Inter-bank lending dried up and therefore banks obtained liquidity from central banks. The end-effect was stricter mortgage lending criteria, leading to recession.
However, the secondary effects of the turmoil impacted the South African economy as a whole (e.g., the global economic slowdown impacting demand, production, exports, etc.).The impact was exacerbated by cyclical factors prevalent in the domestic economy (e.g., high interest rates, inflationary pressures, increasing bad debt impairments, etc.).
A warning had been issued to banks in 2005/06. The stages of the banking cycle were illustrated (slide 16).
Issues raised with banks in 2007 were described (slide 17). These included details of direct/indirect exposure to sub-prime market; a list of securitisation schemes - funding details and recent reviews; a review of off-balance sheet activities; details of third-party support to conduits - ALCO, stress testing, etc; participation in geared/leveraged portfolios; and foreign funding and reliance thereon, roll-overs, and changes in pricing.
Banks had no direct exposure to sub-prime mortgage market. There were traditional cash-backed securitisation schemes. Banks acting as third-party liquidity providers with contingent liabilities were included in ALCO processes. There was no behavioural change re foreign funding lines, and no alarms raised.
Meetings with chief executive officers and chairs of board risk committees continued in 2008, with regular communication, including meetings on a monthly basis, with the chief executive officers (CEOs) and chairs of board risk committees to monitor developments in the respective banks and the banking sector in general. The BSD requested banks to review continuously their positions and report back thereon. However, no adverse reports were received.
Developments during April to September 2008 and beyond included a review of banks’ securitisation schemes. As to initial findings, nothing untoward was observed. Subsequent to September 2008 there was a continuous monitoring of domestic and international developments and the impact thereof on the banking system. There was ongoing interaction and close monitoring of South African banks. There were, inter alia, meetings with boards of directors and board sub-committees; prudential meetings with senior management; focussed on-site reviews (credit risk, market risk and operational risk); and thematic reviews of liquidity risk, interest rate risk, and other risks.
BSD’s interaction with the board and board sub-committees
The key role and responsibilities of the board was recognised in the regulatory and supervisory framework applied by BSD. There were annual meetings with the audit committee of each bank. "Flavour of the year" topics covered during meetings with the board and board sub-committees focussing on key risks or issues were described, for example, in 2000 the functioning of the audit committee and its role vis-à-vis the compliance function and the role of collateral in credit risk management, and in 2001 the management of risk inherent in derivative activities and the role of the compliance function. In 2003 there had been discussion on the strategy and plans for the implementation of Basel II. In 2007 there had been discussion of the internal audit function in respect of AML/CFT; in 2008 involvement of board remuneration sub-committee in the incentive schemes of the bank, the board members’ involvement in the bank/banking group’s ICAAP and the board’s involvement in the bank/banking group’s operational risk framework; and in
2009 benchmarking of the functioning of the banking group’s audit committee against the principles relating to an audit committee, as contained in the Draft King III Report on corporate governance, and banks’ compliance with the “Principles for Sound Liquidity Risk Management and Supervision” issued by the Basel Committee on Banking Supervision during September 2008. In 2010 "Flavour of the year topics" covered were: a comprehensive presentation by the external and internal auditors and audit committee of banks on the key external and internal audit findings in respect of the latest financial year-end as brought to the attention of the audit committees; a discussion of the key concerns regarding banks’ control environment as identified by the external and internal auditors; a presentation by the chairpersons of banks’ risk and capital management committees regarding the functioning of the said committees during the past year, including methodologies and practices followed to ensure compliance with regulatory requirements pertaining to such committees; and consolidated supervision - a detailed discussion on respect of the management and board oversight of the risks posed, and the controls instigated to mitigate the risks posed, by diversified banking groups.
International regulatory developments
International regulatory/supervisory standard-setting bodies (e.g.: the Financial Stability Board and the Basel Committee on Banking Supervision (BCBS) continued their respective processes of developing/issuing guidance and standards to strengthen the resilience of the financial sector in general and the banking sector in particular. The main thrust of regulatory/supervisory issues during the period 2008 to 2010 were those flowing from initiatives being undertaken by the BCBS in response to the global crisis. Key initiatives included strengthening banks’ capital base; raising the quality, consistency and transparency of the Tier 1 capital base of banks/banking groups; Introducing a framework for counter-cyclical capital buffers; and assessing the need for a capital surcharge to mitigate the risk of systemic banks.
Further initiatives included strengthening the Basel II framework in the area of securitisation and trading book positions; introducing a leverage ratio as a supplementary measure to the Basel II risk-based framework; introducing a minimum global standard for funding liquidity, which included a stressed liquidity coverage ratio requirement; and recommendations to reduce the systemic risk associated with the resolution of cross border banks. There were also initiatives to promote forward-looking provisions based on expected losses, and align compensation practices with long-term performance and prudent risk-taking.
Key BCBS press releases were listed, including, during 2009, enhancements to the Basel II framework; revisions to the Basel II market risk framework; guidelines for computing capital for incremental risk in the trading book;
comprehensive response to the global banking crisis; and consultative proposals to strengthen the resilience of the banking sector and introducing minimum liquidity ratios.
A minimum primary capital adequacy ratio of 7% (internationally currently 4%) was prescribed. The predominant form of banking sector primary capital was common shares and retained (formally appropriated) reserves. South Africa (SA) did not allow hybrid instruments to the same extent as its international counterparts. Strict qualifying criteria applied. Hybrids might not exceed 25% of total Tier 1 capital. Discussions with the CEOs of six largest SA banks early in 2009 focussed effort by banks to further improve capital levels and quality. The banking sector primary capital adequacy ratio as at June 2010 was 11.2% (June 2009: 10.7%). The banking sector total capital adequacy ratio as at June 2010 was 14.3% (June 2009: 13.7%).
The BSD was in full support of proposals by the BCBS regarding the introduction of a formal/prescribed counter-cyclical buffer. The existing regulatory and supervisory framework already made provision for counter-cyclical measures to be taken by BSD, e.g., the Registrar might apply a Pillar 2 capital add-on. In mid 2005 banks’ attention was drawn to the banking cycle and the need to plan pro-actively, during the euphoria of good times, for the hard times in the cycle in order to ensure their future sustainability.
Discussions with bank CEOs were held in January 2009 resulting in the levels and quality of capital being addressed in a focussed manner. At present there was no formal or prescribed capital surcharge in respect of systemic banks; however, BSD applied a risk-based supervisory approach with specific focus on systemically relevant banks.
BSD was in full support of the guidelines by the BCBS regarding the strengthening of the Basel II framework in the areas of securitisation and trading book positions. Amendments to regulatory and supervisory framework that are required to give effect to the enhancements to the Basel II framework are being considered.
Monitoring of banks’ leverage ratio was introduced as part of the revised supervisory review and evaluation process subsequent to the implementation of Basel II. The South African banking sector leveraged between 15 and 20 times (as at June 2010: 15.4 times). In comparison, many large global banking institutions were leveraged in excess of 30 times, and as high as 60 times.
The Leverage multiple formula was total liabilities and equity divided by total equity attributable to shareholders.
Stressed liquidity coverage ratio
Liquidity risk management formed the basis of the BSD’s discussions with the boards of directors of banks during 2009. Thematic reviews covering liquidity risk management had been performed at various banks. A liquidity simulation exercise was already performed certain of the large banks. The remainder of the large banks were to be focussed on during 2010. Should BSD be concerned about liquidity risk management or the level of liquidity risk exposure of a particular bank, a Pillar 2(b) add-on might be applied.
Proposals by the BCBS relating to an international framework for liquidity risk standards were expected to have a potential material impact on SA owing to structural peculiarities of the SA financial system (e.g., low retail savings, and the short-term nature of funding).
Systemic risk - cross-border banks
BSD had regular interaction with regulators and supervisors in key financial jurisdictions. Memoranda of understanding (MOUs) were in place with regulators in key financial jurisdictions. SA was represented on the BCBS (and certain sub-committees and working groups), the Financial Stability Board and the G-20.
Provisioning in terms of Basel II was already forward-looking. This measure was mainly related to IFRS provisioning, of which SAICA forms part of the international forum.
The Compensation practices of banks were thoroughly reviewed and discussed with board remuneration committees of banks during 2008 based on a format similar to what was now being proposed by international standard-setters.
SA banks were requested to complete a self-assessment based on the compensation guidance issued by the Financial Stability Board and findings of the assessment would be followed up with banks on a business-as-usual basis.
Anticipated legislative framework amendments
Key issues emerging from G-20 working groups, BCBS, Financial Stability Board, FSAP assessments of SA, thus far, should not require material amendments to the Banks Act, 1990. However, various amendments to the Regulations relating to Banks would be required. Key areas of focus on future amendments to the Regulations included mitigation of risks related to systemically important banks and strengthening of the cross border bank resolution framework (slide 39).
Other topics included capital framework: risk coverage of the Basel II framework - banks’ trading books, off-balance-sheet exposures, securitisation, and re-securitisation; definition of capital; leverage ratio; funding liquidity framework: global funding liquidity standard; and home/host cooperation. (slide 40). Further Basel II capital framework enhancements were indicated (slides 41-42.
Proposed amendments to the Regulations relating to Banks - Draft 1 essentially incorporated the amended Basel II requirements published by the BCBS on 13 July 2009 namely: enhancements to the Basel II framework; revisions to the Basel II market risk framework; and guidelines for computing capital for incremental risk in the trading book.
Proposed amendments to the Regulations relating to Banks - Draft 2 relate mainly to comments received in respect of draft 1; financial returns; credit risk returns; securitisation and resecuritisation returns; leverage multiple or ratio; and corporate governance.
Future drafts to be issued would include comments received in respect of draft 2; market risk; consolidated supervision; off-shore operations; related party exposures; economic returns; new returns - IMF studies and questionnaires; further pronouncements of the Basel Committee; IMF/World Bank ROSC Report; and various policy related matters.
In conclusion the BSD proposed to implement one comprehensive set of proposed amended regulations on 01 January 2012 that would incorporate the package released by the Basel Committee on 13 July 2009, as amended; all comments received from banks and other interested persons on the draft documents released for comment; further finalised documents or pronouncements of the Basel Committee; and further or improved requirements, corrections and refinements - the BSD policy process; the IMF/ World Bank Reports on the Observance of Standards and Codes (ROSC) Report; and other South African Reserve Bank (SARB) Departments.
Certain work streams of the G20; Financial Stability Board; BCBS and the International Accounting Standards Board (IASB), impacting the regulatory framework, were set to continue during 2011 and 2012. Further proposals, where necessary and relevant for SA, would be incorporated during the next round of amendments to the Regulations. Expected implementation date of next round of amendments was expected to be at the earliest 01 January 2013.
The BSD noted an internationally agreed precondition that further proposals must not impede the recovery of the real economy.
The Chairperson had asked Mr Kruger to combine the two presentations for the sake of saving time. He noted that the first was about the regulatory environment, the second about what had happened. The Chairperson said that the information presented would be of great value to the Committee. The submission was highly relevant. The Chairperson observed that the unemployed would like to have access to the “Ninja” loans, loans given in extreme cases to persons with no income, jobs or assets.
Mr N Koornhof (COPE) asked with reference to (slides 16 and 37) about compensation practices. He believed that the salaries of CEOs were out of control in
Mr Kruger replied that BSD would make the compensation guideline of the Financial Stability Board available. by the end of September 2010.
Mr Koornhof asked when BSD thought that the banks would complete their self-assessment. Was there a time limit and what were the Reserve Bank’s expectations?
Mr Kruger replied that BSD expected banks to complete their assessments by the end of September 2010. Thereafter BSD would need to constitute a team to conduct an audit of those assessments. This would probably take about two months, and the results were expected to be ready by the end of the year.
Mr Koornhof said that the load of paper work imposed by banks on clients was "horrific". He asked why he could not do his FICA procedures electronically.
Mr Kruger acknowledged that the amount of paper work involved in customer verification was voluminous. He replied that the Financial Intelligence Centre (FIC) was the body which prescribed what was needed for verification. He understood that from the head of the FIC that the FIC had examined an electronic data base, but Mr Kruger was not sure if the FIC had made any significant progress. It was not in the ambit of the BSD to implement.
Mr Koornhof asked about the Post Bank (slide 34). Would the BSD have oversight of it? He said that it was unfortunate that the legislation for the Postbank lay not with the Standing Committee on Finance but with the Portfolio Committee on Communications.
Mr Kruger replied that the BSD had been involved in the process of the Post Bank, and BSD would play an oversight role.
Dr D George (DA) asked about capital surcharges.
Mr Kruger replied that the BSD had the capital surcharge, in terms of the systemic risk, was very much related to the risk-profile of an institution. Some risk profiles indicated the need for a greater buffer of capital to be available. It was not related to the financial transaction charge.
Dr George asked about the problem of unusual transactions and terrorist financing.
Mr Kruger replied that suspicious transaction reports went directly to the Fiscal Intelligence Centre (FIC). The BSD as supervisors would not know what the status of these reports was. However, from a supervisory perspective, the BSD would try to ensure that proper processes were followed, and that no money laundering took place. The BSD worked quite closely with the FIC.
Dr George commented on the number of illegal deposits made (slide 32). It appeared that the number was increasing slowly. It did not appear that the BSD was succeeding in its aim to reduce the number.
Mr Kruger replied that a number of issues had inflated this year's number of illegal deposit takings.
Dr George observed that it certainly did not appear if the banks' profits had been hurt very much, despite the major crisis in the economy (slide 38). He was not sure what the smoothed percentage meant.
Mr Kruger said that smoothed profit referred to an average over 24 months. On a smooth basis it would appear to be reasonably level but on a month on month basis there would be variability.
Dr George asked about the composition of total assets. If one examined where the money was in he system, the vast amount of money which the banks were providing to the economy was in the form of home loans. He asked if too much money was going into home loans, rather than into a more risky, but more productive area that would generate more economic activity. This was an issue of the structure of the loan system.
Mr Kruger said that the demand from companies for credit had somewhat diminished over the past 24 months. With lower levels of economic activity, companies ran their businesses from a viewpoint that the less indebted they were the better. Also export destinations tended to be less lucrative than previously. The financial condition of most of the companies in
Dr Z Luyenge (ANC) asked to what BSD attributed the stability of
Mr Kruger replied that the right environment over the past couple of years, and ensuring that the management of the risk in the industry had received the proper attention in the various levels of authority in the organisations, were major factors. Also the "temporary risk appetite" was a factor. Furthermore, South African banks had not been exposed to sub prime funding of loans. Also the imposing of monetary policy had contributed. The quality of the management of the banks was a factor too. Bank managements had had previous experience of such economic cycles. Lastly there was the issue of exchange control, which had helped curb excessive exposure to the market.
Dr Luyenge observed that the status of
Mr Kruger replied that it was necessary to be continually vigilant. Secondly, one needed to remain extremely humble and not to imagine that because one survived, everything was necessarily in order. It was necessary to remain focussed and continue to do even more of what had been done already to ensure that one remained on top of these issues. From a global perspective it was necessary to look at development in line with the standards that were being proposed. These standards should be incorporated into
Dr Luyenge asked what points of emphasis BSD could identify as the pillars of the South African economy in remaining stable and not easily affected by the global crisis.
Mr Kruger said that BSD was adopting a forward-looking approach. External threats were an operational risk. It was necessary to consider at external threats and decide what the scenario to assess the environment in which they operated was. One had to be careful not to be over prudent but to retain a balanced view.
Dr Luyenge asked about employment equity plans in the sector.
Mr Kruger said that all companies in
Mr D Van Rooyen (ANC) asked about employment equity in the BSD itself. He said that most of he previously disadvantaged people had never had the chance to be involved in that kind of work.
Mr Kruger replied that BSD was part of the South African Reserve Bank, which had its equity plan. This also had to be reported to the Department of Labour on an annual basis. The BSD itself did fully support and endorse that plan. On an overall basis the plan had a target for 50%: 50% in race and gender. In the main the BSD was on track with its employment equity plan. The challenges lay in the area of management, particularly in the retention issues. There was only one banking supervision institution in
Mr Van Rooyen observed that the presentation was very important in view of the Committee's mandate of oversight. It would assist Members to fulfil their role.
Mr Van Rooyen observed that the presentation had focused mainly on external threats and risks, and asked what other things should be taken on board.
Mr Kruger categorised these under operational risks. These were incorporated into the regulatory environment in January 2008. One also had to be careful not to become over-prudent, and to be so over-sensitive to risk that one ended up not doing any business. At the same time, it was necessary to keep a balanced view of what was going on externally to know how to deal with any particular threat.
Mr Van Rooyen said that a mention had been made of the Cooperative Banks Act. He asked about progress towards implementation, more especially in terms of creating a conducive environment for cooperative financial institutions. This was an important tool.
Mr Kruger replied that this had been an initiative spearheaded by the National Treasury. The Act had been enacted and applications received. Mr Kruger said that he would be happy to obtain more information on the number of applications and forward it to the Committee.
Mr Van Rooyen asked about SADC and the lessons that had been learned from BSD's participation in those forums. What were the challenges that
Mr Kruger replied that in terms of the forums that were in operation, the BSD's involvement had been quite proactive. The issue that emerged was the different environment in which each country operated. The key issue was proper risk identification as well as the issue of proper governance in the organisation and how well the organisation's management was equipped. Also the role of the regulatory authorities in facing the challenges was important.
Mr Van Rooyen asked what went into consumer education. What was BSD's target group?
Mr Kruger replied that the BSD had liaised with the Financial Services Board, and had shown a number of clips on television, in particular programmes that would be shown at a time when particular target groups were expected to be watching, as well as looking at documentation in layman's terms. The approach was to try to keep it simple at grass roots level.
Mr E Mthethwa (ANC) observed that when a bank repossessed a house and resold it, it cost the same amount as the original purchaser had agreed to pay, but who could not keep up with the repayments on his or her mortgage bond. He asked if there was any regulation applicable.
Mr Kruger replied that there was no provision in the Banks Act for reselling.
Mr Mthethwa asked why banks outsourced so much legal work in connection with property sales. It surely made sense, since they provided finance, to offer conveyancing services. Purchasers of houses had to pay such heavy legal fees.
Mr Kruger replied that property sales had to be registered with the deeds office and that banks did not have a conveyancing section, since it was a specific discipline. He said that he could ask the Banking Association if it had anything to table on the subject.
The Chairperson asked if there were any further responses.
Ms Singh said that BSD had engagements with the Southern African Development Community (SADC), and participated in workshops to assist in upgrading the level of banking supervision.
Dr George asked who really took responsibility for irregular transactions. He had learned that these were dealt with through the criminal justice system. FIC had told him that FIC referred these transactions. Was that the end of the matter? What was the role of the BSD? He could not see the process doing what it was supposed to do. As Mr Koornhof had observed, so much information was collected from the men and women in the street, and so much information was reported by various institutions to the FIC, but what happened next. Had there been any consequences to that process? Had there been a case in which there had been a report to the FIC of an irregular or unusual transaction, after which there was an outcome and a consequence? "I don't know the answer."
Mr Kruger replied that he had seen in the press of a number of court cases in which people had been found guilty of a number of charges of money laundering, and sentences had been imposed. He could not talk on the FIC's behalf. However, it appeared that such cases entered the justice system.
The Chairperson thanked Mr Kruger and his colleagues. He noted that BSD’s approach had been more one of prevention. However, when the Chairperson considered the international regulatory bodies, he was moved to ask which crisis was triggered by the banking sector in BSD's own analysis. He said that he observed a reaction to the crisis rather than a dialogue to prevent a recurrence. He asked what had led to less than adequate supervision at an international level. He said, with reference to American consumers, that the crisis had been driven by the inducement of false credit. He observed that BSD had said in its business philosophy that its approach was predicated on risk-based information submitted by the banks. He asked if it was not an approach based on risk-based information submitted by the banks that had led to the crisis, because the supervisory bodies had relied on the information from the banks themselves.
Mr Kruger said that the BSD had been annually reviewed by the International Monetary Fund (IMF) and the World Bank, which had regulatory and supervisory rules. This had stood
The Chairperson thanked the Mr Kruger and his colleagues.
The meeting was adjourned.
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