National Treasury said the Financial Sector Laws Amendment Bill (FSLAB) forms part of the Twin Peaks regulatory reforms that were introduced in 2011. Since then, Treasury and the South African Reserve Bank (SARB) have done further work to strengthen the framework, particularly in response to moral hazard, where banks may take advantage of the need for the state to bail them out and take increasingly risky decisions in the pursuit of profit. A major component of the framework would be the Deposit Insurance Scheme (DIS) as well as a proposed change in the ranking of creditors.
Members whilst generally hopeful about the Bill, asked if it was in line with international best practice and benchmarking guidelines, if it catered to transformation and consumer education, particularly the rural community. They asked if there would be variable risk-weighted premiums in the Deposit Insurance Scheme, and what would happen to the surplus should there not be bank failure for the foreseeable future. They also asked about over-regulation and increasing cost of compliance by banks which would be passed on to their customers
Treasury explained that some of the concerns would be dealt with more explicitly in the Conduct of Financial Institutions Bill, which it hoped to table before the end of the financial year.
Financial Sector Laws Amendment Bill (FSLAB): informal briefing by National Treasury
Mr Vukile Davidson, National Treasury Director for Financial Stability, said the Amendment Bill sought to introduce powers to improve the resolvability of systemically important financial institutions, as well as additional powers to minimise disruption to the financial sector, minimise costs to the fiscus, as well as to introduce a deposit protection scheme for the first time. This is an instrument which it believes will allow for the protection of the most vulnerable depositors, thereby further aligning incentives in the financial sector. By this, he meant reducing moral hazard and making the institutions that benefit from services to be more accountable for when things go wrong. He introduced the team, explaining that DDG Ismail Momoniat was ill: National Treasury: Jeannine Bednar-Giyose; Langelihle Nkabinde and SARB: Nicola Brink; Jacques Botes; Hendrik Nel; Sabihah Mohamed; Masenye Masemole; Pregasen Moodley.
Background on Twin Peaks Reforms after 2008 Global Financial Crisis (GFC)
The FSLAB forms part of the Twin Peaks regulatory reforms that were introduced in 2011. The founding policy document upon which many of the amendments are based is called 'A safer financial sector to serve South Africa Better, ' and was adopted by Cabinet in 2011. There are currently about 10 Acts covering regulatory issues, all of which are under the Ministry of Finance, with the exception of the National Credit Act. The Conduct of Financial Institutions (COFI) Bill is the outstanding Bill that needs to be processed by Cabinet.
Why we need the Bill?
Baking risks are closely linked to sovereign risk. This means that stresses and risks can emanate from either the banking or financial sector, that can contaminate or constrain the fiscus. This can also run the other way as stresses of the sovereign can spill over into the financial sector and into the economy. This interaction was the basis of the Eurozone crisis in 2009/10/11/12; where a weakness in the banking sectors of a set of countries, referred to as the 'PIIGS' (Portugal, Italy, Ireland, Greece and Spain) led to a sever fiscal crisis and led to huge fiscal consolidation wen authorities had no option but to safeguard the financial sector. Bank weaknesses can also foreshadow big costs for government budgets. Notably, over the past three decades, banking crises Ave contributed to large increases in public debt as seen in PIIGS.
Impact of a financial crises is devastating on the economy
Slide 7 provided further evidence of the devastating consequences of banking crises on government finances and spending as a result of a financial crises.
Bank risks are significant as nuclear risks to an economy
Banks are often compared to nuclear facilities and described as systemically important financial institutions (SIFIs) at the failure of banks has a domino effect. This means that governments will do whatever it takes to avoid bank failure. The issue of moral hazard needs to be addressed as sometimes this means that banks take more risky action to make profits. Profits tend to be privatised but losses socialised.
Banks are different from other companies
This means that they require a failure management process that is different from the normal insolvency process. Because banks work on trust and do not keep 100% of the deposits whilst balancing loans, they are vulnerable. Hence, Treasury is proposing a resolution and deposit framework.
2008 GFC was a wake-up call
Slide 10 detailed the response to the crisis, with slide 11 explaining the key elements of the G20 regulatory reforms which were representative of slide 10.
What South Africa has done
Since Treasury published a broad policy paper in 2011 as basis for the Twin Peaks regulatory framework A safer Financial Sector to serve South Africa Better, there was subsequent work:
2012—Promulgation of the Financial Markets Act 19 of 2012
2015—Second policy paper published by Treasury, SARB and Financial Sector Conduct Authority (FSCA): Strengthening South Africa’s Resolution Framework for Financial Institutions
2015—Banks Amendment Bill in response to the failure of African Bank
2017— SARB discussion paper Designing a Deposit Insurance Scheme for South Africa
2019— SARB discussion paper Ending too big-to-fail: SA’s intended approach to bank resolution
2017 Financial Sector Regulation Act (FSRA)
The FSRA gives the Reserve Bank the mandate for financial stability for both systemic events and the designation of systemically important financial institution (SIFI).
What problems will Treasury be addressing
Following the 2008 GFC, it was recognised that risk is not only to the domestic economy, but a failure of a SIFI affects banks and economies of other jurisdictions. This is especially the case for deeply regionally integrated banking and financial systems as found in Southern Africa, especially since South African banks are central in neighbour economies. In 2008, South Africa remained safe and was not the epicentre of the crisis, but the spill-over and knock-on effect still resulted in almost 1 million South Africans losing their jobs in the period.
Current legal gaps in South Africa
The presentation listed nine gaps in the current legislative framework.
Key objectives of the Bill
- Provide a framework for the resolution of Banks and non-bank SIFIs
- Designate the Reserve Bank as the Resolution Authority with commensurate powers
- Deposit Insurance Fund + Corporation for Deposit Insurance
- Creation of a Creditor Hierarchy to ensure depositor protection in liquidation
The key proposals, framework powers and functions of the Bill were outlined (see document).
Creditor hierarchy: policy rationale
A diagram was provided of the ranking with secured creditors being the first to receive compensation and working down. It sets out both the current and the proposed hierarchy, the latter which would include: covered deposits, first loss after capital (FLAC) instruments and regulatory debt instruments. Reasons for the policy rationale for the new hierarchy were provided.
Deposit Insurance Scheme (DIS)
A key feature of the Resolution Framework is the Deposit Insurance Scheme. It listed 11
advantages of the scheme and provided an overview of DIS policy objective, structural features and funding broken down into percentages.
A summary was provided of the amendments.
There were two technical amendments introduced by the Standing Committee of Finance as well.
• Expansion of Clause 35, to include subsection (b)— a branch as defined in the Banks Act.
• Clause 51 expanded the areas for regulatory cooperation to include standards, directives and promoting awareness of financial customers to the protections from deposit insurance.
Mr Davidson thanked the Members for listening saying he knew it was a lot to cover.
The Chairperson said that he was hearing an apologetic tone from Mr Davidson but he had no idea why, firstly about using Members' time; because it was a very good and very comprehensive presentation. It was refreshing to see new faces in the team and most of them were all very bright. Although he might differ with them ideologically from time to time, it was an impressive new group. There was another aspect of the apologetic tone. He had been in Parliament a long time and Members need to know that what happened in 2008 was horrific. If one looks at what resulted from the greed of the financial sector institutions and those that function in it; very few people paid the price. No one who was high up really paid the price as they were rescued by the State, as Mr Davidson knows better than him. There was therefore no need to be apologetic.
The Bill was long overdue as the Committee was hoping that it would be tabled before the last elections as it knew it was in the pipeline. It is a very good Bill overall. This is not a Bill that people across political divides may agree to, but it simply cannot let the banks get away. Who paid the price for VBS Bank? It was poor people who disproportionately did so. It was horrendous to see the queues. Therefore, the Bill is necessary and there was no need to apologise for it. It was long overdue and in the interest of the disadvantaged and poor. Having said this, it was part of the trudge of the new Twin Peaks model. Mr Davidson had explained some of the Bills that had come already and some that were yet to come, COFI in particular.
Mr Mkiva said it was a good presentation and a good Bill. He wanted to check if Treasury uses benchmarks and best practice from successful countries in the West and the Asian Tigers, including China. His reasoning was that a lot of South Africa's legal structures were clearly drawn in the main, from the West. It is then important to test and he wanted to ensure that there was a good mix of best practice from anywhere in the world and not just from one direction so that South Africa can customise and localise for its own environment. It is important not to fly out of the continent, but also check best practice within the continent, such as in Botswana. The authors have applied themselves very well in the detail and chronology of the presentation.
Mr D Ryder (DA, Gauteng) thanked Treasury. He wanted to play devil’s advocate and gain a better understanding. He asked that not too much be read into the angle of his questions. A Bill is being introduced which is designed to produce outcomes but the Reserve Bank already has its reserve requirements that it enforces quite strongly, harshly and consistently, especially with the bigger banks. There was a lot of comment about non-mainstream banks in the briefing which led him to wonder if it was taking a one-size-fits-all approach which perhaps punishes the big banks. One needs to note that the cost of compliance for banks has become substantial in the last 18 years or so, with the introduction of FICA and the Credit Act. He was under no illusion that these costs have obviously been passed on to consumers in one way or the other and the shareholders will be shielded because that is capitalism.
He wondered if it was not trying to enforce something, only to end up with an uneven playing field whilst advancing some illicit market players. Using VBS is not a good example because VBS was not a banking failure, it was a criminal exercise. It was illegal acts done blatantly, without fear of consequences. When people set out to steal, they do not do so to within the regulations. He wondered if a blunt instrument was being used, especially considering the barriers to entry into the industry. This week there was the launch of a young women’s bank which faces an uphill battle as it tries to establish itself. How many more barriers to entry was it imposing with the current Bill.
In 2002, there was the Saambou Bank run that caused it to collapse which had a spill-over effect. He wanted to work out if the Bill was in response to 2002. The presentation mentioned the 2008 global financial crisis but he did not buy that because the implementation of the Basel II Accord by big banks protected South Africa from a lot of the 2008 fall-out. There has since been Basel III and IV, where this had been well-hammered out. South Africa's banking system with the Reserve Bank at the fore has implemented these resolutions extremely well, which has cushioned us well. This is why the comment has been made that South Africa's banking system is streaks ahead of the majority of the world and that it punches above its weight in the banking sector.
He was trying to get to the trigger and asked what was trying to be fixed by the Bill. If it was trying to fix VBS, he did not think it was the right tool. If it was trying to ensure that the system was a bit stronger, was it really necessary to go to this extent and apply it across the board to everybody. He asked if more of a focus could be given to smaller banks. He did not know how one would legislate for this, but careful thought was needed to ensure that people were not being punished. The cost of compliance is expensive, but only if you bother to comply. More guidance was needed on the trigger, what it was trying to prevent and if it was being overly cautious by applying regulations like this across the board.
Mr Mkiva asked to hear from Treasury on transformation. Whenever it considers a Bill, this question is critical for ensuring necessary change, importantly on ownership and adherence to the financial charter set up some time ago, but which many banks have not really complied with. It is important to know that the Bill seeks to address historical factors such as marginalisation of the majority of South Africans who happen to be African and black in general. He wondered if a Bill of this nature is not going to maintain the status quo if it is silent on transformation.
There is the dominance of four banks, plus one. These are historically white banks part and parcel of the South African experience. An appreciation of this fact is important and uppermost on this agenda is to ensure that the African majority form part of the ownership because a bank is central to the means of production in any society, therefore its ownership is critical for its relationship with its citizenry. If it is one-sided, this speaks volumes about regression. What is desired, however, is progression which means a need to address ownership.
Secondly, the banks are given an instruction or mandate to be very involved in consumer education of the population and are expected to put resources into this so that the people of a country are educated about their constitutional rights when it comes financial institutions they engage with on a daily basis – depositing, withdrawing, seeking insurance and other banking sector products. There has been leniency in what has been expected of them, especially in rural communities. He did not see this kind of education. South Africans are victims of unexplained bank charges. It is important that the Bill seeks to address this and ensure that no charges are effected without a consumer's consent. The bank should not allow this as millions, if not billions of rands are taken illegally, through these deductions and unauthorised stop-orders. The Prudential Authority needs to address these matters as a matter of urgency.
Lastly, the banks are expected to play a role in the social investment programmes of the country, like all corporate citizens. He knew that banks did this in urban areas in particular, but almost half of the country's population resides in villages. He would love to see banks giving back to rural communities and show visibility by putting their money in social investment such as building schools and infrastructure so that structures like ATMs are set up in the middle of nowhere and in rural communities as ATMs cannot belong only to townships and cities. He wanted Treasury to look into this and to make a compelling case for banks when they make social investments and appreciate that the country is primarily rural in its complexion and appreciate that their clientele comes from across the length and breadth of the country, including rural and peri-urban areas.
National Treasury response
Mr Davidson replied that Treasury ensured that it looked at a diverse set of countries where those financial systems have features that look like South Africa's. It was particularly interested in countries with a similar developmental experience to South Africa, including Latin American countries and some of the Asian Tigers. These countries were coordinated through the G-20 body that specifically focuses on financial sector issues, called the Financial Stability Board; where the Asian members are a mix of developing and advanced economies. The developing economies being China, Indonesia and India. These countries have also implemented a substantially similar framework, but slightly calibrated for domestic conditions. The objectives outlined in the presentation have been consistently implemented in those countries as well as peer countries like Brazil, Argentina and Mexico and the large and advanced economies like the EU and the US. It has insured that these proposals are consistent with international best practice. On the continent, South Africa is moving with its peers, with Botswana and Namibia both being in advanced stages of introducing similar mechanisms for deposit insurance. This speaks both to the need and desire to have coordinated regulatory improvements in one's respective jurisdictions.
One-size-fits all, over-regulation and increasing cost of compliance
There were two important things to consider. The Bill seeks to reduce moral hazard, which ensures that those that benefit in good times are able to pay in bad times. This may necessitate an increase in compliance costs to ensure this happens. It is not something that Treasury hopes will happen, as it does not hope for a failure, but it recognises that it needs to plan to ensure that if one ever occurs, it has the tools to sufficiently deal with the crisis. The second issue goes to the heart of trust and confidence. It does not really matter that one institution is not the source of the problem. What is being seen in other jurisdictions as well as in South Africa, is that even if there is a problem in a relatively small institution, as was seen with African Bank, that is passed on to other institutions. Therefore, bolstering the confidence and stability of the entire system is necessary and an important part of what the Bill seeks to do. It learnt a lot of lessons, particularly as they apply to deposit insurance from VBS, but it is important to know that this is not the problem it is seeking to address. It learnt very important lessons in the failure of African Bank, which was instructive in thinking about how a small bank failure affects larger banks. Part of the resolution of African Bank required the largest banks to provide the resources to aid in the resolution of African Bank. The banks did not do this out of the goodness of their hearts. They realised that it was important to stabilise African Bank because the trust and confidence concerns about African Bank could easily be transmitted to their own banks. Is underscores the fact that it is not entirely appropriate to think of these institutions as islands as they are all interconnected since what happens in one area is important for others. He asked his SARB colleagues to add any thoughts.
Mr Jacques Botes, SARB Senior Resolution Specialist, added to the response on regulatory costs, saying that the costs should not be considered alone as there will also be benefits introduced by the framework. SARB had done a cost-benefit analysis and had consultants conduct a cost-benefit study that was published at the end of 2020. There are a number of things that will benefit banks, such as the DIS for small players. There is a risk for depositors if they look at VBS as there is a risk to the access of funds; hence deposit insurance will bring in a certain benefit to this end. Additionally, when you look at the models that rating agencies use to rate the instruments of banks – new resolution rating models are being considered. Currently, no bank instruments can pierce the sovereign ceiling, but if a proper resolution framework is introduced with the necessary loss-absorbing instruments, there is a possibility that some of the instruments issued by the banks can pierce the sovereign debt ceiling. There are accordingly a number of benefits. Over-and-above this, unfortunately, bank failures do pose a trade-off as they have a cost and somebody must bear that cost. Although it can be said that no South African banks failed as a result of the 2008 GFC, it can look at the 2008 crisis and take lessons from it. For example, the US government had to spend $700 billion on bail-outs. The question is if South Africa can really afford one of its bigger banking institutions to fail—not that there was a great likelihood of this happening—before taking action.
This is why the example of the 2008 global financial crisis is often used as there are a lot of lessons to learn before they happen locally. The VBS and African Bank cases are similar. However, SARB does not necessarily say that because there was a VBS and African Bank failure, that a new resolution framework is needed. It looks at the lessons from these failures. It might not derive a lot of resolution lessons from VBS, but on deposit insurance, it learnt a lot of lessons as it had to do an ad-hoc depositor pay-out. It looked at the vulnerable depositors that were sleeping outside of the Bank until the government came out and said that there would be a guarantee. This situation is to be avoided as there was a lot of hardship for a lot of the depositors, and having an explicit depositor guarantee scheme would avoid that hardship. In the African Bank case, there were a lot of lessons learnt from that, as Members know, amendments had to be made to the Banks Act to introduce certain provisions allowing the curator to take certain actions. If we scale this to some of our systemically important financial institutions, we can see that the current framework is not sufficient should one of those fail. This is why additional measures are needed and what the new framework will provide for.
Part of the core mandate of the DIS is the consumer education aspect and dimension in recognition of the importance of consumer education.
Mr Davidson said that this is an important issue. Although the Bill does not deal directly with transformation, it does advance these objectives in its crafting. It does this in two important ways:
1. The protection of the most vulnerable amongst us is an incredibly important and progressive mechanism. It was recognised as so amongst stakeholder deliberations and it knows by how it has designed the features of deposit insurance; which is calibrated to cover the mid-90s as a percent of depositors in the country. This is something that will have a meaningful impact among the most vulnerable of us.
2. To ensure competition in the sector, the DIS will bolster confidence amongst consumers to move their accounts from larger banks to smaller and more agile new entrants in the full knowledge that even if the worst happens, their deposits will be protected. It really expects this to bolster and improve competition, particularly for new entrants in the financial sector. Although transformation is not explicitly being dealt with, in the scope of the Bill, it expects significant benefits and advances to the transformation and competition agenda through this Bill. He asked his colleague to speak about upcoming legislation which is more squarely designed to deal with this.
Ms Jeannine Bednar-Giyose, Treasury Director: Fiscal and Intergovernmental Legislation, replied about the transformation question raised by Mr Mkiva, which is very important. A large section of the Bill constitutes amendments to the FSRA, which includes among its objects transformation of the financial sector and also provides for consideration of transformation as one of the key elements of the regulation and supervision of the financial sector. Since these provisions are being incorporated into the FSRA, it will be incorporated into the overall framework which includes transformation as an important consideration of regulation and supervision of all financial institutions, including the banks.
A lot of transformation elements relate to the conduct of financial institutions. An important element of the COFI Bill, which is being finalised with the hope of being tabled this year, is it will promote transformation requirements, particularly requiring financial institutions to have transformation plans and policies in place, as supervised by the Financial Sector Conduct Authority as well as strengthen powers to make requirements in respect of transformation. Treasury envisages that the COFI Bill will provide a very important element to promote transformation in the financial sector, which will be an important aspect for both the Prudential Authority and the Financial Sector Conduct Authority to consider in its supervision. The Financial Sector Conduct Authority would ensure that it is an important aspect of the governance and operations of all financial institutions. The Conduct Authority has already been issuing conduct standards for banks in how they treat financial customers, including closing accounts. There will probably be additional standards issued by the Conduct Authority to address impacts on financial customers that may need to be addressed. Treasury would engage with the Committee in the not-too-distant-future, when the COFI Bill is tabled.
Ms Bednar-Giyose said that consumer education is another very important objective that is also facilitated through the Conduct Authority in particular and which will be implemented to some extent through the COFI Bill.
The Chairperson said that this was an initial foray and there would still be public hearings and then line-by-line deliberations but the Committee should aim to finish the Bill before the end of the next quarter. Members would have time to look more carefully at the Bill before the Committee returns. Had he heard correctly that the Standing Committee only made two amendments to the Bill?
Mr Davidson explained that the two additional amendments were requested by Treasury itself, and they were technical drafting corrections.
Ms Bednar-Giyose added that there were a few other minor technical corrections proposed but it has not been formally adopted by the National Assembly. When the Bill is passed and comes to the NCOP, it can go into these in more detail as they were merely technical amendments.
In response to the Chairperson asking if there were any substantive changes made by the Standing Committee, Ms Bednar-Giyose confirmed that there were none.
Mr Ryder spoke to the responses to the African Bank situation and said that one of the Bank's problems was the risk weighting of its book and its inability to manage that properly and account for it in predicting the potential for fall-out. He asked if there was consideration for having a risk-weighting to any of the DIS contributions. Would the percentage be flexible or variable, depending on risk weighting? He knew that banks took a lot of time and effort to categorise their risk-weighting and the risk of their books. This could possibly be quite a logical step to reward banks for making lower-risk advances but on the other hand this could marginalise banks that have a more developmental aspect. Secondly, what would happen if there are no bank failures in the next 20 years and a massive surplus is built up in the DIS? What would be done with this money? He asked if this would become a fund available for looting or if there would be a review with the potential for giving some of these funds back.
Risk-weighting of DIS premiums
Mr Hendrik Nel, SARB Deputy General Manager: Financial Stability Department, and DIS CEO,
replied that SARB was not applying a risk-weighted premium for banks at the moment. It is something that would be looked into going forward, but at the moment it is a flat-rate and equal rate for all banks on their premiums.
Having no banks failing would be wonderful but it would not build up massive surpluses in the DIS. SARB was very aware of the compliance burden on banks. In developing the funding model for the DIS, it came up with a unique funding model, where it reduces the burden on the banks through a liquidity tier, where banks invest a specified amount, depending on the cover deposits held by the banks. This amount will be invested with the corporation on which they will earn interest; but this would be up to a certain amount. There is a specified amount for the deposit insurance fund, beyond which it will not go. Therefore, there will not be a build-up of massive surpluses in the deposit insurance fund but it will only build up to the point that it can cover the failure of one or two banks simultaneously. It looks at probabilities of failure and build-up of funds to be able to cover depositors.
The minutes of the 23 March; 11, 18, 25 May; 2, 8 June 2021 meetings were adopted.
The Chairperson requested that banalities be excluded from the minutes, including ‘The department proceeded with its presentation,’ ‘The Chairperson thanked Members for their attendance’ and asked that they focus on substantial matters. He was not going to thank Members for doing their job and as a matter of principle and could not thank Members for going what they were paid to do.
Mr Z Mkiva (ANC, Eastern Cape) said that it was good to say thank you as a kindness.
The Chairperson agreed to do this as a courtesy, however if Members expected it, they ought to go through the Chief Whip and the NCOP Chairperson as they could instruct him to do so since he was accountable to the Committee and the norms of Parliament but not silly rules. Some things such as 'the meeting proceeded,' or 'the submissions proceeded,' were not necessary. The reason he was bringing it before the Committee was the staff were given guidelines for minutes and some of them are embarrassing. As it was now minuted, the staff no longer had to do these. However, he would thank Members, only as a courtesy.
The Chairperson asked if there was anything else and as there was none, he thanked everyone and adjourned the meeting.
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