South African Reserve Bank & Prudential Authority on 2018/19 Annual Reports

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Finance Standing Committee

11 September 2019
Chairperson: Ms P Abraham-Ntantiso (ANC)
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Meeting Summary

The Committee met with the South African Reserve Bank (SARB) and the Prudential Authority (PA) for a briefing on their 2018/19 annual reports.

The Reserve Bank, in presentation, warned that risks to the SA Reserve Bank’s growth forecasts are on the downside because of uncertainty over global growth. The Bank projects the economy to grow 0.6% this year rising to 1.8% in 2020 and 2% in 2021, with global growth of 3.4% forecast for 2019, but it is expected to slow thereafter. Global growth is unlikely to become more supportive of domestic growth because of US-China trade tensions and the negative impact of Brexit. Geopolitical tensions are affecting commodity prices, with lower global demand resulting in lower exports. SA cannot be saved by the global economy as it is actually slowing down. While domestically there was a rebound in real annual growth in GDP in the second quarter of 3.1% after the contraction of more than 3% in the first quarter, domestic growth remains volatile. Economic activity remains weak with insufficient investment and job creation. The fiscal environment has deteriorated leading to rising bond yields and undermining business and consumer confidence. Long-term borrowing costs are still higher than SA’s emerging-market peers. Inflation remains within the target range with risks being relatively balanced, though there are some key exceptions, namely food prices and rand risk related to credit ratings. Inflation expectations have moderated but are above the 4.5% midpoint of the inflation target range. Most administrative prices are well above the inflation target midpoint and have become an important player in the inflation environment. This affects household expectations of inflation, the governor said. In the year to date, administered prices have risen by 7.1% compared to an inflation rate of 4%. The Bank has forecast for inflation for 2019 of 4.4%, 5.1% for 2020, and 4.6% in 2021.

The Prudential Authority went live on 1 April 2018 with the successful integration of staff from three regulatory authorities. Its Supervisory Framework was finalised and adopted, and certain elements of the framework for financial conglomerates and significant owners have been distributed for external consultation. Further highlights of the year were as follows: the publication of the Regulatory Strategy, 2018-2021; the implementation of the Insurance Act 18 of 2017 and related Prudential Standards for insurance companies on 1 July 2018; the conclusion of memorandums of understanding with various regulatory bodies; the release of a notice regarding the submission of statutory returns for financial market infrastructures; the publication of a draft Prudential Standard containing transitional arrangements for co-operative financial institutions; and the release of the inaugural annual report for the PA on 25 June 2019.

Members said the fee structure and the capital requirements for starting a bank were prohibitive for new players. It could not be that, 25 years into the democratic dispensation, some sectors are still exclusively in the hands of a minority. There are fundamental issues that point to systemic risks as posed by some of these credit providers. They noted that the economy was very weak currently, and there were many reasons for this. As an independent and important institution in the economic space, has the SARB engaged government about the economic challenges? They further asked about the current levels of investor confidence, SARB’s views about government policy and its impact on economic growth?

Meeting report

The Acting Chairperson welcomed everyone to the briefing by the South African Reserve Bank (SARB) and the Prudential Authority (PA) on their 2018/19 annual reports. She invited the presentation from the entities.

Briefing by South African Reserve Bank 

Mr Lesetja Kganyago, Governor, South African Reserve Bank, took the Committee through a presentation on the Reserve Bank’s 2018/19 annual report. The Bank’s mandate is to protect the value of the currency in the interest of balanced and sustainable economic growth. The Financial Sector Regulation Act, which came into effect in August 2017, mandates the SARB to maintain, promote and enhance financial stability in South Africa.

The SARB is one of about six central banks that still have private shareholders, but the public is the beneficiary. There are two million shares in issue and over the past three years, the average profit for the SARB has been about R1.2 billion a year. Dividends are capped at 10 cents a share (maximum pay-out of R200 000 a year) and 90% of any remaining surplus accrues to government, after setting aside contingencies, reserves and tax.

The SARB’s key functions were as follows: Issues banknotes and coin; regulates and supervises certain entities in the financial system; ensures the effective functioning of the National Payment System; manages the official gold and foreign exchange reserves of the country; administers the country’s remaining exchange control regulations; and acts as banker to the government. Ensuring price stability or low inflation is a traditional function of central banks and all central banks have this mandate in some form but they may use different frameworks. Many of the SARB’s functions have socio-economic impacts

Macroeconomic overview and outlook

Mr Kganyago warned that risks to the SA Reserve Bank’s growth forecasts are on the downside because of uncertainty over global growth. The Bank projects the economy to grow 0.6% this year rising to 1.8% in 2020 and 2% in 2021, with global growth of 3.4% forecast for 2019, but it is expected to slow thereafter. Global growth is unlikely to become more supportive of domestic growth because of US-China trade tensions and the negative impact of Brexit. Geopolitical tensions are affecting commodity prices, with lower global demand resulting in lower exports. SA cannot be saved by the global economy as it is actually slowing down. With trade tensions globally not abating we see the risks to global growth on the downside. The timid rebound of global trade at the beginning of the year was not sustained. While domestically there was a rebound in real annual growth in GDP in the second quarter of 3.1% after the contraction of more than 3% in the first quarter, domestic growth remains volatile. Economic activity remains weak with insufficient investment and job creation.

The fiscal environment has deteriorated leading to rising bond yields and undermining business and consumer confidence. Long-term borrowing costs are still higher than SA’s emerging-market peers. Inflation remains within the target range with risks being relatively balanced, though there are some key exceptions, namely food prices and rand risk related to credit ratings. Inflation expectations have moderated but are above the 4.5% midpoint of the inflation target range. Most administrative prices are well above the inflation target midpoint and have become an important player in the inflation environment. This affects household expectations of inflation, the governor said. In the year to date, administered prices have risen by 7.1% compared to an inflation rate of 4%.

The Bank has forecast for inflation for 2019 of 4.4%, 5.1% for 2020, and 4.6% in 2021.

Highlights from the SARB and PA 2018/19 annual reports

The Bank’s performance in five strategic focus areas (SFA) was as follows:

SFA 1: Maintain headline inflation within the target range

Inflation remained within the target range at 4.7% and is projected to remain within the target range over the three-year forecast horizon. Inflation expectations also remain within the target range for the next 24 months.

SFA 2: Protect and enhance financial stability to achieve a safer financial system

No systemic risk events occurred in the financial system. The Governor and Minister of Finance agreed a macro prudential policy framework, including the toolkits and policies to be applied by the SARB to prevent and identify systemic risks and to respond to a systemic event when it occurs.

SFA 3: Promote and enhance the safety, soundness and integrity of regulated financial institutions

The Prudential Authority was successfully launched in 2018 and the relevant institutions were gradually integrated into the Prudential Authority. The programme to establish and embed the Prudential Authority is largely on track. There were no failures of systemically important financial institutions (SIFIs), although some smaller institutions were placed under specific regulatory action.

SFA 4: Enhance the functioning of South Africa’s financial markets in support of economic resilience

Broadening the scope of this SFA beyond reserves management to strengthen economic resilience has been a key focus for the year. The cross-cutting research agenda will take this work forward and it is expected that additional measures may be formulated for SFA 4 going forward. Reserves accumulated were below planned levels at December 2018, partly due to a delay in finalising the reserve accumulation strategy.

SFA 5: Ensure cost-effective availability and integrity of notes and coin

The currency-producing subsidiaries delivered all notes and coin orders effectively, both for the SARB and the international export market. The quality of banknotes fit for re-circulation was however below the desired level.

Financial highlights

Mr Kganyago highlighted that the Bank’s profit of R5.8 billion was R3.6 billion higher than the previous year of R2.2 billion. The South African Mint realised net profit after tax of R0.7 billion, which is a R0.3 billion increase compared to R0.4 billion last year, from stronger Kruger Rand sales. The South African Bank Note Company (SABN) realised significantly higher profit after tax of R0.2 billion, compared to a net loss after tax of R13 million last year, as a result of increased production volumes. African Bank impacted positively, contributing R0.5b to group profits. A dividend of R0.2 million (or 0,0043% of SARB profits and 0.0034% of total Group profits) was paid to shareholders as required by the SARB Act.

Preferential Procurement

Broad-Based Black Economic Empowerment (B-BBEE) performance progressed well from 13.4 points in financial year (FY) 2015/16 to 19 points in FY 2018/19. This is mainly attributable to increased focus in sourcing awards to BO and BWO businesses. On inclusive procurement, the Bank continues to target some of its procurement spend on Qualifying Small Enterprise (QSE) suppliers.

Human resources highlights

The Bank conducted two employee engagement surveys to gain insight on how it can improve employee experience. There has been a positive year on year movement in the employment engagement survey. The Bank’s total staff composition is 74% Black and 26% White. Executive management (GEC) is 100% Black (African, Coloured and Indian) and top management is 55% Black and 45% White. The Bank spent R54.9 million on training and development- this equates to 2118 employees (99.6%) attending a training intervention in FY2018/19.

Briefing by the Prudential Authority (PA)

Mr Kuben Naidoo, Deputy SARB Governor and CEO of PA, highlighted that the PA was established on 1 April 2018, as a juristic person, operating within the administration of the SARB. The PA consists of 242 staff members with qualifications and experience in banking, insurance, actuarial science, law, policy, governance, commerce and finance. On its governance structure, the PA’s Management Committee is responsible for:  the general oversight of the management and administration of the PA to ensure that it is effective and efficient; and the general operations and management of the PA regarding policy as well as regulatory and supervisory matters.

Progress made during the year

The PA went live on 1 April 2018 with the successful integration of staff from three regulatory authorities. Its Supervisory Framework was finalised and adopted, and certain elements of the framework for financial conglomerates and significant owners have been distributed for external consultation. Further highlights of the year were as follows: the publication of the Regulatory Strategy, 2018-2021; the implementation of the Insurance Act 18 of 2017 and related Prudential Standards for insurance companies on 1 July 2018; the conclusion of memorandums of understanding with various regulatory bodies; the release of a notice regarding the submission of statutory returns for financial market infrastructures; the publication of a draft Prudential Standard containing transitional arrangements for co-operative financial institutions; and the release of the inaugural annual report for the PA on 25 June 2019.

Banks

The South African banking sector is dominated by five large banks, which collectively held 90.5% of the total banking sector assets as at 31 March 2019. Local branches of international banks accounted for 5.6% of banking sector assets at the end of March 2019; and other banks represented 3.8% at the end of March 2019.

The liquidity coverage ratio (LCR) remained above the minimum requirement during the period under review, and amounted to 142.4% at the end of March 2019, mainly due to an increase in high-quality liquid assets. On mutual banks, the sector remained profitable during the period under review, although a declining trend in profitability was evident:

  • Total mutual banking assets increased to R3 136 million
  • The total capital adequacy ratio for the sector remained stable at 23.10%
  • Overdue loans improved to R6 million (2018: R8 million)

Resolution management

The following entities were placed under curatorship during the period under review:

  • VBS Mutual Bank: Curatorship 11 March 2018 and Liquidation: October 2018
  • Nzalo Insurance Services Limited and Bophelo Life Insurance Company Limited: Provisional winding-up on 12 February 2019.
  • Insure Group Managers, which collects premiums for insurers: Voluntary curatorship by the FSCA with the concurrence of the PA.
  • Lion of Africa Insurance Company Limited: Licence suspended on 13 November 2018.

African Bank

The ‘new’ African Bank, which was launched on 4 April 2016, continued to operate in a stable manner in the period under review. As at March2019, its total assets were reported at R28.2 billion and its total deposits at R17.9billion. The PA is the regulator for African Bank, with SARB being a shareholder. Requests have been received from potential buyers to purchase the bank and any such proposal(s) will be for the consideration of the shareholders, which includes SARB, and National Treasury.

In conclusion, during the next year the PA will be implementing numerous Prudential Standards applicable to the industries it regulates.

Discussion

Mr G Hill-Lewis (DA) commented on the profits the SARB was making. African Bank posted a profit of R500 million which presumably includes proceeds from its bad book. Had the audit of that book been conducted to sift out reckless credit agreements that were extended to customers in contravention of the National Credit Act? Had debt-collection companies applied for the write-off of those loans and what quantum of loans had already been written-off as reckless credit? He asked about the drivers of economic growth in the medium term. Was there a balance of payment challenge which needed to be dealt with?

Dr D George (DA) noted that the economy was very weak currently, and there were many reasons for this. As an independent and important institution in the economic space, has SARB engaged government about the economic challenges? What was the SARB’s views about government policy and its impact on economic growth?

Mr G Skosana (ANC) welcomed the presentation and noted the wide range of economic challenges highlighted by the Governor. Owing to these challenges, there has been a widening of the current account deficit. What needs to be done to turn this situation around and sustain the rebound recorded in the current quarter? On preferential procurement, the notable progress was well-appreciated. However, how was the SARB balancing small and big business to ensure that Small & Medium Enterprises (SMEs) also gets a sizeable share?

Ms M Mabiletsa (ANC) asked about the current levels of investor confidence. Was there need for the country to be worried?

Mr I Morolong (ANC) commended the Reserve Bank for maintaining inflation within targets. However, there is a view that the benefits of interest rate cuts meant to stimulate the economy are not transmitted to the consumers; big businesses derive the full benefit. He asked about progress in the investigations into banks that were involved in the manipulation of exchange rates for their own financial gain. 

Mr F Shivambu (EFF) asked about the exact amount transferred to the national revenue fund from the SARB’s profits. Were profits generated by the African Bank also transferred to government? He wanted to know about the percentage of black and white suppliers within the bank’s procurement space. He asked for the names of external asset managers and the processes which were undertaken to engage them. Was the reserve bank able to account for all e-commerce transactions? Was the SARB involved in the conceptualisation of the ‘crazy’ policy document released by the Minister of Finance recently? Was the Governor involved in such an extremely problematic policy position?

Mr Kganyago replied that potential growth, an outcome of investment — both physical and human — remains very low. There is need to lay the basis for sustained growth if the country is to make any impact on the jobs situation. To get the domestic environment right requires ensuring a sustainable fiscal framework and a commitment to macro-stability. Reducing supply-side disruptions, such as load-shedding and strikes, and improving policy certainty across several domains are a basis for driving business confidence. Low business confidence is hitting investment and reducing growth and will have to be restored to stimulate economic growth. Flows of foreign direct investment into SA are low compared to its emerging-market peers. He noted that restoring confidence is the cheapest form of stimulus and that he and the President are at one about the need to strengthen business confidence. The profits from African Bank are from the ‘good’ book, not the previous one. Profits from the African Bank are not dividends declared but a consolidation of its balance sheet; the bank had not yet declared dividends. The largest procurement items for the SARB are notes and coins from its subsidiaries. R1.8 billion was spent on black-owned businesses and R300 million on the rest of the suppliers. Despite having called for structural reforms of the economy, the Bank has played no role in the formulation of the Treasury’s economic plan. This is because it is the preserve of the government. It was correct that the SARB was a participant in the colloquium convened by the Minister of Finance but this did not mean the document was from SARB. The said document made rounds even long before the said colloquium as convened. The reserve bank would give comments just like every other stakeholder. The capacity of the National Payment System to monitor e-commerce is limited as it was not designed to do that; the NPS reflects gross amounts instead of individual payments. Monitoring online transactions is largely the purview of the South African Revenue Service. SARB was consulted in the specialised investigations into the allegations of currency fixing involving some banks, the matter had gone to a tribunal and the outcome was awaited.

Mr Naidoo said as at 31 March 2018, the National Credit Regulator’s (NCR) investigation into African Bank’s lending practises required the Prudential Authority to write-off a sizeable sum of R67 million from its loan book because of reckless lending. However, the investigations were still underway and there probably will be an additional R30 million to be written-off in the current financial year. On the bank’s profits, the Reserve Bank Act provides for the bank to withhold a certain amount as a contingency reserve so that a situation whereby the central bank runs in negative equity is prevented. After the 2008 financial crisis, the Reserve Bank was making losses and it is only in the last few years that it had started to turn a profit. In some way, the bank was still rebuilding its reserves. The SARB’s balance sheet and its profits are due to government in a direct or indirect way. This was all in the financial statement. It is true that when banks seek to raise capital, this could affect the transmission of interest rate cuts from lenders to consumers. However, the bulk of the capital that banks are required to hold in the last few years, in line with regulations, was met in 2013/14. There has not been a discernible increase in capital that has been imposed from a regulatory point of view since then. The PA therefore does not believe that the capital requirements are a disincentive for banks to lend in the current conjuncture.  

Mr Shivambu said the fee structure and the capital requirements for starting a bank were prohibitive for new players. It could not be that, 25 years into the democratic dispensation, some sectors are still exclusively in the hands of a minority. There are fundamental issues that point to systemic risks as posed by some of these credit providers. Transformation of the banking sector was crucial and this was a historical obligation. Legislators would need to check how laws could be amended expeditiously. Also, consumers had to be protected from reckless lending practises by banks.

Mr Skosana asked if the PA intends to come up with measures to reduce bureaucracy and red tape in how financial institutions conduct their business.

The Acting Chairperson asked about the capital adequacy ratio imposed on banks. What should the minimum capital held by banks be and was it adequate?

Mr Kganyago pointed out that the PA Management Committee is a creature of the Financial Sector Regulation Act. On specific questions about transformation, the SARB could appear before the Committee with a comprehensive presentation on a later date. On systemic risks, there has to be a distinction between conduct issues within the market and those of a prudential nature. If a bank’s books reflect non-performing loans, this is dealt with by the PA. However, if a bank is involved in reckless lending practises, this is a conduct issue best dealt with by the NCR. There was once a proposal to have a Dedicated Banks Act which would have dealt with bringing in different banking categories to cater for niche markets. De-concentration of banks has been a huge subject on its own since the 2008 financial crisis.

Mr Naidoo agreed that the country had a consumer indebtedness problem. However, there is no consensus on what should be done about this. One school of thought believes supply induces demand, thus supply of credit has to be curbed. On the other hand, some believe this is not the right way to deal with indebtedness as it would push the public into the underworld of unregulated suppliers of credit. There needs to be broader discussions as kicking the banks out of that market could have negative impact to the public. There are higher requirements for unsecured lenders to reduce the incidence of systemic risks. The capital and prudential framework prevents the probability of having systemic crises. Slow but steady progress is being recorded. The SARB is not the owner of the residual debt service. On how much of the audit book had been audited, this information was with the NCR.

The Acting Chairperson appreciated the engagements and thanked everyone for their attendance.

The meeting was adjourned.

 

 

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