South African Reserve Bank briefing

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Finance Standing Committee

01 August 2017
Chairperson: Mr Y Carrim (ANC)
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Meeting Summary

The South African Reserve Bank (SARB) presented its annual report, and indicated that financial stability and prudential monetary policymaking were key aspects of its mandate. Ensuring price stability or low inflation was a traditional function of central banks, but monetary policy could not entirely determine the long term growth potential of the economy. The Bank could therefore not single-handedly solve the problem of structural unemployment in the economy. Currently, due to the relatively low inflationary environment, South Africa’s real and nominal interest rates were at near long-term lows. Inflation, the prime rate and real growth averages from 2010 to 2017 were 5.4%, 9.4% and 2% respectively.

The SARB said the most concerning issue currently was dealing with forces bent on changing its mandate. It emphasised that the national dialogue around institutional mandates should be healthy and well-meaning. Further, the political climate and insufficient demand were significant constraints to business conditions. Confidence had fallen in all five of the sectors surveyed by the Bureau of Economic Research (BER) in the second quarter. Political uncertainty was a concern among the central bankers of South Africa’s main trading partners. Recent developments had had an impact on investor confidence and the economic outlook. Therefore, restoring consumer and business confidence was paramount in turning the economy around.

Members asked about the role of private shareholders within the Bank’s governance framework. The SARB explained the role of its private shareholders. Private shareholding was an historical legacy. Private shareholders did not own the Bank, and their rights were limited. They played no role whatsoever in the setting of, or influencing, the Bank’s key mandates. They had no sway over the day-to-day management of the SARB, and were restricted to a maximum of 10 000 shares (including associates of shareholders) out of two million issued shares. Shareholders did not have any claim on the foreign exchange reserves of the Bank and were unable, by means of a resolution or otherwise, to amend or change the SARB’s affairs by deviating from the prescriptions of the South African Reserve Bank Act (“SARB Act”).

The Democratic Alliance commended the Bank for defending itself; making reference to the Governor’s response to the Public Protector’s recent recommendations pertaining to the SARB. The Bank indicated that the matter of the Public Protector’s recommendations was with the courts. The Bank was duty bound to defend itself when it felt it was under attack, as its independence was guaranteed by the Constitution.

The Committee spoke out strongly against illicit financial flows, describing them as ‘obscene’ and suggesting that not enough was being done. Decisive action was needed, and people had to be prosecuted. The Chairperson said that the Committee should explore the possibility of holding closed discussions with the SARB, the South African Revenue Service, the Hawks and other stakeholders. The Bank indicated that it was actively involved in curbing illicit financial flows, to the extent of identifying such ill practices and referring them for prosecution. The Bank had handed 41 cases of exchange control contraventions over to the police for further investigation and prosecution over the past five to six years, but there had been only one significant prosecution. It added that dealing with cartel practices within the financial sector was very important. It was working closely with the Competition Commission to enable the efficient functioning of markets.

The Chairperson said the Committee would not relent in its fight against illicit financial flows. It had recommended that the Minister should lead the task force to deal with illicit financial flows. However, it was ‘extremely worrying,’ given the gravity of the crisis, that the government had not proposed such a structure but that it had been left to Parliament. He suggested that the Committee write to the Minister enquiring about the progress of the task force, and urged the Bank to follow up on pending prosecutions with relevant authorities. Spearheading the financial sector transformation discourse was in the interests of the Bank.

Meeting report

South African Reserve Bank presentation

Mr Lesetja Kganyago, Governor, South African Reserve Bank (SARB), took the Committee through a presentation on the SARB’s annual report. Financial stability and prudential monetary policymaking were key aspects of its mandate. He pointed out that once the Financial Sector Regulation Bill (FSRB) was signed into law by the President, it would formally mandate the SARB to protect and enhance financial stability in South Africa.

Ensuring price stability or low inflation was a traditional function of central banks. All central banks had this as a mandate in some form, and there were different frameworks that they adopted to ensure they fulfilled it. However, monetary policy could not entirely determine the long-term growth potential of the economy. Therefore, the Bank cannot single-handedly solve the problem of structural unemployment in the economy. Monetary policy should therefore focus on what it could do, and not what stakeholders would like it to do.

Currently, South Africa’s real and nominal interest rates were at near long-term lows, due to the relatively low inflationary environment. South Africa’s 2010 to 2017 averages for inflation, prime rate and real growth, were 5.4%, 9.4% and 2% respectively. Further, the recent global financial crisis showed the devastating effect that financial crises could have on economies. It took years to recover from a financial crisis, as banks and households had to repair their balance sheets. This involved less bank lending, and less household spending.

Mr Kganyago explained the role of the SARB’s private shareholders. Private shareholding was an historical legacy. Private shareholders did not own the Bank, and their rights were limited. They played no role whatsoever in the setting of, or influencing, its key mandates. Private shareholders had no sway over the day-to-day management of the Bank, and were restricted to a maximum of 10 000 shares (including associates of shareholders) out of two million issued shares. Also, they receive a fixed return on their shares of 10 cents per share from profits made. This amounted to an overall dividend payment by the Bank of R200 000 per year. 90% of the Bank’s profits were transferred to the government, and the remaining 10% were allocated to its reserves. Shareholders did not have any claim on the foreign exchange reserves of the Bank and were unable, by means of a resolution or otherwise, to amend or change the SARB’S affairs by deviating from the prescriptions of the South African Reserve Bank Act (“SARB Act”). In terms of the SARB Act, private shareholders approved the appointment of auditors for the Bank and their remuneration, and elected non-executive directors to the Board from a vetted list. The other eight members were appointed by the President. These included the Governor and his/her three deputies. He emphasised that private shareholding represented an additional layer in the governance framework of the Bank, by strengthening accountability and transparency.

Discussion
 

Mr D Maynier (DA) said it was self-evident that, as the governing party was in a political crisis, it was starting to use the private sector and various entities, including the SARB, as scapegoats. He commended the Governor for defending the Bank. He made reference to the Governor’s response to the Public Protector’s recent recommendations pertaining to the SARB. He asked if there had been any interaction between the Governor and ministers on the mandate of the Bank. Also, what was the exact position of the Governor on private shareholding of the bank? The position had to be clearly pronounced. What were the names of the 15 shareholders who had allegedly tried to unduly influence the SARB? Was the SARB’s financial surveillance department investigating alleged exchange control violations? Had the investigations been finalised?

Mr Kganyago replied that the matter of the Public Protector’s recommendations was with the courts. There had been engagements with the Minister following the release of the report. The Bank was duty bound to defend itself when it felt it was under attack, as its independence was guaranteed by the Constitution. On private shareholding, he pointed out that private shareholding was a vestige of the evolution of central banks the world over, and could be done away with. He cautioned that doing away with private shareholders would be very costly if compared to the meagre pay outs shareholders were currently entitled to. However, if society strongly believed it was in its best interests, then it could be done. He emphasised that the current framework of having private shareholders helped with accountability and transparency. He denied that the 15 shareholders referred to had undue influence on the SARB.

The Chairperson indicated that during previous engagements, the South African Revenue Service (SARS) had said it could not shed light on specific cases and individuals allegedly involved in illicit financial flows. Illicit flows were obscene and not enough was being done. He asked what the Bank was doing. Decisive action was needed and people had to be prosecuted. He suggested that the Committee explore the possibility of holding closed discussions with the SARB, SARS, the Hawks and other stakeholders.

Mr F Shivambu (EFF) pointed out that the Bank had indicated that private shareholders did not own it. Who owned the Bank, if it was not the shareholders? If shareholders did not influence its key mandates, then having shares within the SARB was a vanity exercise. He suggested the discontinuation of private shareholding. SARB should be nationalised and its autonomy guaranteed. Also, why was the Bank not creating a conducive environment for the entrance of new players in the banking sector? Outside the “Big Five,” there was no meaningful participation of other players. He asked about the Bank’s practical role in curbing illicit financial flows. Was it a mere spectator while the tax base was being eroded and money moved to Dubai?

The Chairperson commented on the role of the Bank. He asked if it could play some role in stimulating economic growth and facilitating the transformation of the financial sector. Could the Bank not play a greater role, given the prevailing circumstances?

Mr Kganyago responded that the Bank was actively involved in curbing illicit financial flows, to the extent of identifying such ill practices and referring them for prosecution. He cautioned that disclosing the exact details of investigations could jeopardise the exercise and further fuel vitriol directed at the Bank. The Bank was owned by the shareholder which was entitled to 90% of its profits -- the government. The Bank was a public interest entity. Furthermore, the market was open to new entrants, but it was very competitive. He pointed out that financial crises had a tendency of leading to further bank concentration, as failing banks were amalgamated and taken over by stronger ones.

On state ownership of the SARB, he pointed out that the state was the largest conglomerate in the country, with over R1 trillion worth of assets. The Development Bank of Southern Africa (DBSA), among other entities, had been specifically created to meet economic development objectives. The SARB’s role was limited to creating a conducive environment for balanced and sustainable growth.

Mr Kuben Naidoo, Deputy Governor and Registrar of Banks, SARB, said Bank officials’ ‘blood boils’ when they hear about illicit money flows. The Bank was doing much to curb illicit flows, but was in most instances a step behind such criminals. Also, it was often not able to curb such illicit flows sufficiently, partly because it was a complex issue requiring multi-stakeholder cooperation. The system was imperfect and not functioning as well as it should. The Bank had handed 41 cases of exchange control contraventions over to the police for further investigation and prosecution over the past five to six years, but there had been only one significant prosecution. The Bank could only take the process up to a certain point.

Mr Naidoo said the Bank was taking steps to reduce bank concentration. In the past few years, it had received three applications for banking licences -- from the Commonwealth Bank of Australia, Discovery and Postbank. Two additional applications had been received in the last few months, and SARB was in the process of evaluating the applications. He emphasised that although transformation was paramount, it was a multi-dimensional proposition that went beyond equity and ownership. Pushing equity to the detriment of the rest of the objectives would not be helpful.

Macroeconomic overview and outlook

Mr Kganyago took the Committee through the country’s macroeconomic overview and outlook. Currently, domestic response to world growth was unusually weak, with South Africa and Venezuela being the only sizeable economies in a recession. The employment outlook was bleak, and jobs were being lost in both the primary and secondary sectors. The official unemployment rate had risen to 27.7% in the first quarter of 2017, while the expanded unemployment rate -- which included discouraged job-seekers -- amounted to 36.4%. However, formal non-agricultural employment had increased marginally in the first quarter, as private sector employment had increased somewhat. Also, moderate employment gains had been made in the mining, construction and trade sectors.

Maintaining positive real interest rates was an imperative for the containment of inflationary pressures in an economy. Growth in total loans and advances to the domestic private sector had improved marginally from March 2017 to May, after having moderated during the course of 2016. The near-term outlook for inflation had improved. Headline inflation had slowed in recent months, and hovered within the three to six percent inflation target band. The slowdown in consumer food price inflation since December 2016 had been fairly widespread among the various food price sub-components. Despite the up-tick in formal non-agricultural unit labour cost growth in quarter one, both measures of nominal unit labour cost had trended lower over the past year. The appreciation in the exchange value of the rand since early 2016 had contributed significantly to the recent moderation in inflation, particularly for underlying goods.

Mr Kganyago indicated that the political climate and insufficient demand were significant constraints to business conditions. Confidence had fallen in all five of the sectors surveyed by the Bureau of Economic Research (BER) in the second quarter. Therefore, restoring consumer and business confidence was paramount in turning the economy around.

Discussion
 

Mr Maynier asked the Bank to explain the consequences of what was being termed the ‘political climate and lack of confidence’, on the economic outlook. Based on the Governor’s interactions with other global financial institutions, what would be the effect of the assault on the SARB by various forces? What were the ‘right things’ government needed to do in order to ensure that economic growth prospects were improved?

Mr Kganyago replied that political uncertainty was a concern among central bankers of South Africa’s main trading partners. Recent developments had had an impact on investor confidence and the economic outlook. Restoring investor confidence formed the basis of the Bank’s contestation of the Public Protector’s recommendations about its mandate. If the aforesaid recommendations were implemented, they would have far-reaching consequences for the economy. The sooner the uncertainty was cleared, the better for the economic outlook. The ‘right things’ to be done included getting rid of the policy uncertainty. Prevailing economic challenges were structural and policymakers needed to look beyond the political cycle.

Mr D Hanekom (ANC) interjected that the Governor should point out what could go wrong. Corruption, thieving and looting were key concerns that needed to be identified clearly and be dealt with.

Mr Kganyago agreed that such identified wrongdoings had a negative impact on business confidence. If nothing was done to bring alleged perpetrators to book, the credibility of the country’s legal institutions and the rule of law could be brought into question.

South African Reserve Bank annual report

Mr Francois Groepe, Deputy Governor, SARB, outlined the Bank’s 2016/17 strategic focus areas. Driving the economic wellbeing of all citizens was paramount. As part of its inflation-targeting monetary policy framework, the objective was to maintain headline inflation within a three to six percent band. The target had been marginally missed, as average inflation had been 6.3% for the financial year 2016/17.

In an effort to protect and enhance financial stability, the Bank had recently published a macro prudential policy paper. It had held an information session with industry and received comments on the issue. However, the target to formulate the framework for measuring systemic risk had not been met. Also, the research proposal for a systemic risk measurement (SRM) toolkit had not been completed.

To protect and enhance financial stability, and to achieve a safer financial system, the Bank had established a crisis planning working group to oversee preparatory work for the first crisis simulation exercise. It had also drafted the Special Resolution Bill which included proposals to establish a pre-funded deposit insurance scheme. On its objective of maintaining an optimal level of reserves and to enhance their management, the Strategic Asset Allocation had been approved, and the compilation of the risk budget and review of the fund management programmes were in progress.

The Bank recognised that establishing mechanisms to manage external shocks effectively, was key. A framework to manage shocks was being developed. While progress was behind target, the Crisis Reaction Manual for Financial Markets was in the process of being finalised and would be incorporated into the SARB’s crisis management and resolution framework.

Discussion

Mr Shivambu said the SARB would need to deal with a number of issues at its next appearance before the Committee, such as the diversification of bank ownership within the financial sector space -- bank ownership should reflect the demographics of South Africa -- and how financial institutions’ cartel practices were to be dealt with. Further, there should be a task force to deal with illicit financial flows, constituted by various stakeholders. Perhaps the Bank could be mandated to convene such a platform, as it still had some veneer of credibility. Efforts to fight illicit financial flows ought to be consolidated and integrated.
 
The Chairperson pointed out that some of the issues Mr Shivambu was raising were under the ambit of Parliament. The Committee had recommended that the Minister should lead the task force to deal with illicit financial flows. However, it was ‘extremely worrying,’ given the gravity of the crisis, that the government had not proposed such a structure, and that it had been left to Parliament. He suggested that the Committee write to the Minister enquiring about the progress of the task force. He added that spearheading the financial sector transformation discourse was in the interests of the Bank.

Mr Kganyago replied that having to deal with some of the issues raised by Mr Shivambu would be a challenge, as it involved making public choices. Having the Bank make such choices, as an unelected body of bureaucrats, could be problematic. On dealing with illicit financial flows, the Bank could only bring in its expertise on ‘following the money’ and identifying leakages. It was not in its competence to capture criminals and prosecute them. It could only identify wrongdoing. He emphasised that, with all its good intentions, it might not be able to effectively address the challenge of illicit financial flows. He added that dealing with cartel practices was paramount. The SARB was working closely with the Competition Commission to enable the efficient functioning of markets.

Mr Naidoo added that the regulation of market players to deal with issues of conduct was paramount. Establishing a dedicated market regulator outside the Bank would be a positive development. The Bank was willing to be part of a task force dealing with illicit financial flows.

Mr Kganyago, in conclusion, said that the most concerning issue currently was dealing with forces bent on changing the mandate of the SARB. He emphasised that the national dialogue around institutional mandates should be healthy and well-meaning.

The Chairperson, in closing, said the Committee would not relent in its fight against illicit financial flows. It was well understood that law enforcement authorities might not be willing to prosecute because of the influence wielded by implicated individuals. It could also be due to a genuine lack of capacity and expertise. He urged the SARB to follow up on pending prosecutions with relevant authorities.

The meeting was adjourned.

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