Monetary Policy Input by Two Economists; Bank Supervision Department of SA Reserve Bank: briefing

Meeting report

FINANCE PORTFOLIO COMMITTEE
7 August 2007
MONETARY POLICY INPUT BY TWO ECONOMISTS; BANK SUPERVISION DEPARTMENT OF SA RESERVE BANK: BRIEFING

Documents handed out
Recent Performance and Challenges for Monetary Policy in South Africa: Prof Stan du Plessis
Views and Comments on recent Monetary Policy issues in South Africa: Prof Melvin Ayogu
Bank Supervision Department of South African Reserve Bank presentation
Bank Supervision Department of South African Reserve Bank Annual Report 2006

Audio recording of meeting: [ Part1] & [Part 2]

SUMMARY
Prof Stan du Plessis, Department of Economics, University of Stellenbosch indicated that favourable trends in the South African economic performance arose from high rates of real output growth, a lack of disruptive imbalances and a low and stable inflation rate.

Professor Melvin Ayogu of the Faculty of Commerce, University of Cape Town, addressed himself to the comments of the Monetary Policy Committee in 2007, the highlights of the March 2007 Quarterly Bulletin (SARB) and his view of the implications thereof for Monetary Policy

MINUTES
Monetary Policy input by Prof Stan du Plessis, Department of Economics, University of Stellenbosch
Prof du Plessis was of the opinion that the robust economic expansion in South Africa may be ascribed to high rates of real output growth, a lack of disruptive imbalances and a low and stable inflation rate. He supported his view by means of statistical slides which showed that this trend had been in existence since 2001 and that year on year inflation in South Africa remained low. It was the longest such trend in the history of the country. In another statistical slide illustrating output variability and inflation variability, South Africa occupied a satisfactory position among emerging economies. He felt that this situation may be ascribed to high rates of real output growth, a lack of disruptive imbalances and a low and stable inflation rate.

He referred to recent academic papers that evaluated monetary policy in SA and supported his view:
- Messrs Aaron J and Muellbauer (2007) Review of Monetary Policy in South Africa since 1994;
- Journal of African Economies: Rigobon, R (2007) Through the pass-through: Measuring Central Bank Credibility;
- Boston, MA, CID Working paper no 143, March 2007;
- Du Plessis, S Smit B and Sturzenegger F (2007) The Cyclicality of Monetary and Fiscal Policy in South Africa since 1994, Stellenbosch, University of Stellenbosch, Stellenbosch working paper 12/2007.

He indicated that Messrs Aaron et al had used interest rate and inflation data to calculate that there was now improved predictability of inflation in SA, an anchoring of inflation expectations and questioned whether the real interest rate was indeed discouraging investment expenditure in SA. By contrast the Rigobon study was devoted to a consideration of the “pass through” of exchange rate shocks to local prices based upon the evidence at the country wide level and at the level of individual items, extrapolating that the evidence showed a marked drop in the pass-through of exchange rate shocks. This was consistent with a large gain in credibility by the SARB subsequent to 2000, bearing in mind that the SA economy had also become more open and that the world economy was more benign. A statistical slide presented graphically Rigobon’s measure of rising credibility subsequent to 2001.

Prof Du Plessis, who was one of the authors of Du Plessis, S, Smit B and Sturzenegger F (2007) in reviewing the “procyclicity” of monetary policy under inflation targeting, said that the authors were of the opinion that there was both a theoretical possibility and a major criticism of inflation targeting but that flexible targeting need not suffer such a downside and that this conclusion was based on a small macro model used to identify supply side, fiscal and monetary policy shocks since the 1960s. The authors concluded that monetary policy had responded counter cyclically to aggregate supply shocks and in a policy simulation the authors calculated that monetary policy had contributed to overall economic stability subsequent to 1994.

Addressing future challenges, Prof Du Plessis pointed out that a more difficult environment loomed based on international imbalances, unstable food prices and energy costs and locally rapid consumer spending (with a large credit component) with economic growth perhaps outpacing capacity, wage settlements and significantly wage demands being high, and above all the effect of administered prices. The SARB’s assessment of the risks as a likely scenario was sketched by the support of a statistical fan chart, based upon the available figures as at May 2007. A further statistical analysis, a chart provided, of the Bureau for Economic Research (BER) inflation expectations survey showed the likely or expected benefits of the credibility of inflation targeting. The conclusion advanced by Prof Du Plessis was that a credible market-based monetary policy achieved decentralised co-ordination between wages and prices and anchored both. This was a decentralised version of what failed attempts at wage-price controls attempted to achieve centrally. A major benefit of such credibility was the flexibility gained by the monetary authorities to respond to shocks in a measured way. He suggested that it was now (with the seeming approach of more difficult times) that the benefits of “flexible” inflation targeting were being appreciated.

Reviewing the challenges faced by the SARB, Prof Du Plessis said that the observed inflation rate had moved outside the targeted range, for the first time since September 2003. He was of the opinion that Governor Mboweni of the Reserve Bank and the Monetary Policy Committee were right not to “fight the last battle” and could use their credibility and the open nature of Inflation Targeting to map a sensible path to forecast inflation, given that there was a more difficult environment.

In conclusion, Prof Du Plessis said that he would like the Monetary Policy Committee to consider publishing a forecast path for the repo rate. Such a publication, analogous to the fan chart for inflation, should move away from the constant interest rate basis. He felt that this should be a projection or forecast, not a commitment, and as such assist decision makers in the private sector to appreciate the forward-looking character of credible monetary policy. Such a stratagem was not unknown in the world of finance. He used a fan chart from the Central Bank of Norway in support of his contention.

Monetary Policy input by Prof Melvin Ayogu, Faculty of Commerce, University of Cape Town
Prof Ayogu presented his views and comments on recent monetary policy issues in South Africa, basing his views as reflections on the Monetary Policy Committee (MPC) 2007 statements, his view of the highlights of the March 2007 SARB Quarterly Bulletin and his conclusions on the implications for Monetary Policy.

Prof Ayogu pointed out that MPC statements issued in February 2007 were to the effect that there was an improved outlook on inflation with CPIX expected to peak at 5.6% in 2007; a strong demand by consumers sustained by asset price growth, rising meat prices expected to be the main contributor to food price inflation, a robust credit extension growth to the corporate sector increased from 27,6% to 31,8% and credit extension to the private sector declining from 26,1% to 24,3%. Whereas the MPC April 2007 statement was a deteriorated outlook on CPIX inflation despite the observed reduction from 5.6% to 5,3%, further food price hikes expected despite the observed decline in meat price inflation from 16,5 % to 13,9%, yet with meat prices being the greatest contributor and declining clothing, footwear and furniture prices in February 2007. There was an adverse development in “administered prices”, but continued growth in private sector credit extension evidenced by an growth increase from 27,0% to 27,7% in twelve month bank loans, asset backed credit growth, leasing finance and a decline in the total number of household loans. Plus there was the rise to 74% of the ratio of household debt to disposable income together with a steady increase in the cost of financing.

Prof Ayogu stated that the above seemed to be the conclusions drawn from the Bureau of Economic Research at Stellenbosch University, which he held in high regard. He questioned the conclusions of the expectations as conditioned on what set of what information. He also questioned the CPIX forecasts and wished to know upon what information or data such forecasts were based. He continued by reference to the June 2007 statement by the MPC that CPIX inflation had breached the 6% upper target limit, fuelled by strong increases in food and petrol. However, excluding food and energy, CPIX would have been 4,6%. Petrol prices had increased in a year on year basis from a March 7,9% to a April 15,5% and that accordingly the deduction was that there is a strong upward trend in prices, and cost-push inflation. However, he was of the opinion that such increase was not mainly demand driven but was as a consequence of increase in the price of services. He directed his attention to the supposed increase in household consumables and questioned whether such included or excluded increases in school fees, short term insurance premiums, increases in parking fees without which, by reason of the marked absence of user friendly public transport systems, many employed persons would not be able to attend their workplaces. The BER figures reveal a downward trend in clothing, footwear, furniture, prices, recreation and entertainment but he was of the view that such were occasioned by the oppressed consumer already reducing expenditure on such items as compensation for the higher prices. Further, according to the BER, the rise in producer price inflation was 11,1% from 9.5% in March and was regarded as being the highest since December 2002. Prof Ayogu submitted that against such figures the pressure on the CPIX did not appear to be consumer driven, contrary to the conventional or orthodox viewpoint.

The figures produced by the BER were that private sector credit extension grew from 26,2% March to 27,4% April, allegedly based upon mortgage advances, leasing finance and instalment sales and he questioned whether this was real or nominal growth.

By contrast, credit extension to the corporate sector accounted for the strongest increase in bank lending, and he advanced the opinion that the increased cost of borrowing pushed up the product prices (for non tradable goods it was even higher) and he questioned what % of the advances financed the CPIX basket items.

In support of his questions he had added a statistical chart which reflected that the MPC forecasts for CPIX 2007/08 would reveal a peak of 6,3% in June 2008 while the actual CPIX developments in 2007 April to June were a hike of 6,3%.

Addressing the highlights of the SARB Quarterly Bulletin for March 2007, Pro Ayogu directed his attention to the figures for domestic expenditure, real consumption expenditure by households which revealed a decline in expenditure on semi durable goods, but that there was an increase in real expenditure on semi durables, a slow growth of expenditure on food, beverages and tobacco as well as household consumer goods and a concomitant strong growth in spending on household fuel and power, medical and pharmaceutical and petroleum products. This was while the real disposable income of households grew at a slower rate, in fact the ratio of household debt to household disposable income increased from 73% to 73,5% and there were developments in Gross Savings as a % of GDP. Prof Ayogu suggested that there was the appearance of a zero sum game and he supported such view by a statistical chart.

Turning to the aspect of employment, Prof Ayogu drew attention to the fact that gains in employment in the Public Sector marginally outperformed gains in the Private Sector. Overall employment in the non agricultural sector rose by 528 000 jobs but employment in the manufacturing sector had declined slightly since the third quarter of 2006. It was noteworthy, and of concern, that employment in the electricity generating sector suffered the most substantial decreases in employment opportunities.

Turning to the aspect of prices, Prof Ayogu drew attention to the fact that CPIX inflation had accelerated considerably since mid 2006 and that petrol and food price hikes were the main catalysts for this development - a view he supported by a statistical chart. Unfavourable weather patterns (drought) pushed up the maize price and the production price index had more than doubled since 2006.

In commentary on this, Prof Ayogu drew attention to the fact that “other goods” carried the second highest weighting of the total CPIX and made a significant contribution to the hike in inflation. However, it was not transparently clear what such other goods were, nor whose interests such represented.

Turning to the aspect of Foreign Trade, Prof Ayogu drew attention to the fact that a strong demand for imported goods had continued since 2006, which had deteriorated the current account. As an example, imports of crude oil caused a 100% growth in the value of imports from 7% (excluding) to 14% (including). The Current Account deficit was financed but terms of trade had deteriorated slightly since 2006, which opinion was also supported by a statistical chart.

Turning to the implications of this for Monetary Policy, Prof Ayogu felt that given the current developments the most salient question was which components of borrowing were more sensitive to interest rates and how much did such components feed into the inflation that the Reserve bank was attempting to fight?

Turning to the aspect “Missing Money and Non Inflationary Taxes”, Prof Ayogu firstly defined non inflationary taxes (“nonift”) as the change in the cost of borrowing solely attributable to the monetary authority’s response (by raising or lowering the discount rate) to anticipated changes in inflation.  He suggested that the amount of nonift that the banks could pass onto their customers versus absorb was an indication of relative market power and that in South Africa the banks seemed to be able to pass on the full cost of nonift to their customers. Ultimately banks were left with uncollected money, which boosted their lending capacity and thus undermined the SARB’s monetary policy objectives. Consequently, he posited, Banks earned higher profits which were passed onto the investors in the form of dividends (windfall gains) and that investors’ consumption profile was permanently raised via such windfall gains thus fuelling inflation. He added that within the South African context the distribution of investors was skewed towards the rich and so nonift also became a regressive tax with the consequence that the poor carried the burden of inflation and were likely to be drawn into a debt spiral.

Prof Ayogu suggested that the social welfare effect induced by nonift must be weighed against the benefit to be achieved by a reduction in aggregate credit growth.

Prof Ayogu suggested that the monies from nonift currently uncollected should be collected and thereafter ploughed back in the form of research and development on climate, agricultural research, following the Israeli moves to produce crops which were drought resistant or required less water than current crops, alternative energy research, mass transit systems, other supply side management issues (Science and Technology) and accordingly would, he suggested, be the missing link in the inflation fight.

Turning to the aspect of saving and direct investment in South Africa, Prof Ayogu stated that the conventional view was that South Africans saved too little, or not enough. He proceeded to ask what was saving? What were the different ways of measuring savings in developing counties? How did institutions influence savings? What were the other factors that affected saving? What were the factors that influenced savings? The conventional view was that one should save for one’s old age. However, in Africa, and South Africa, there were extended families which called upon whatever income, whether disposable or not, there might be which was utilised for education, improvement of housing structures (shack dwellings), purchase of agricultural implements or livestock, all of which in the “Western mind” might be regarded as non saving but which amounted to investment with the hope/anticipation of a later return or benefit to the source from which such funds came. Thus he suggested that saving should be redefined by economists, at least those concerned with Africa. He referred to the definitional problems to be gleaned from the use of variables, the dependency ratio, the current view of investment in education as being consumption, although it was building human capital, and the feature of intergenerational considerations in saving / little bequest motive.

Prof Ayogu suggested that saving does not depend on income. This concept would have to be re-examined, and that self control as a lens of why too much was spent and too little saved, the borrowing on costly credit and the emotional factors of impatience and the contextual situation all required further and deeper examination.

Prof Ayogu drew attention to the difference between what he called homo economicus and home psychologicus, the role of economic structures and processes which encompass a preference formation in which certain material acquisitions and satisfactions were prioritised by consumers leading to affluenza. The wants and constraints may symbolize aspirations for freedom from the power relationships that oppress in daily chores, including and encompassing gender, race, class and sexuality. In such a scenario moments of “binge” sustain, and rehearse, the hopes of liberation, regardless of their unrealism but which represent contemporary culture.

In conclusion Prof Ayogu pointed out that cross country evidence shows that those who believe they have little freedom over their lives were less likely to save and that such belief holds good over a number of demographic and behavioural factors, and income and wealth levels. Emotional life was more important to the individual than MPC decisions.

Discussion
Mr M Mbili (ANC) asked about the accuracy of the SARB information/statistics vis a vis international peers and the cost of inflation targeting and whether the most suitable response was being obtained from the Reserve Bank.

Mr D Gibson (DA) asked if flexible targeting of inflation was producing normal, below normal or above normal targeting. Could such forecasting not be wrong? Secondly the Harvard economists were advising the Government to put the interest rate down if the Government wished to make growth of the economy its number one priority but that in an effort to contain inflation the Budget surplus might be utilised even if it brought the value of the currency downwards.

Mr Mnguni (ANC) stated that it seemed to him that the Harvard economists were pushing a line to interact the rule to no effect. Secondly, in South Africa there was a higher level of home ownership, whatever the actual legal definition, than in other parts of Africa and as suggested by Pro Ayogu this might be seen as saving.

Mr Y Bhamjee (ANC) said that there seemed to be a contradiction between pages 8 and 14 of Prof Du Plessis presentation with regard to the effect of interest rates on economic stability and he wished to know the reason therefore. On the question of the flexibility of 3-6%, he asked for an explanation of the underlying issues and if were any other issues, other than price stability, considered by the Reserve Bank. Lastly had the flexibility meant that the Reserve Bank had lost credibility?

Mr Mbili wished to know what was an appropriate response by the Reserve Bank to inflation.

Pro Du Plessis answered that price levels depended upon both the supply and demand sides. With inflation there was a sustained rise in prices and rising prices determined other increases. In his opinion the Reserve Bank was trying to avert the secondary effects of inflation by trying to anchor inflation or prices, despite the fact that it had little control over the inputs. What the Reserve Bank was attempting to do was prevent price shocks, extremely quick rises in prices, by forecasting rises or increases. The ultimate aim was to smooth it out so that price hikes or spikes were not regarded with a sense of immediacy or panic. Thus the long term view would prevail over panic short term reactions to events.

With regard to evaluating the forecasts, he had not seen the model or what constituted the entries into the model, which would effect the outcome. The Aaron research was an attempt at evaluation of the Reserve Bank and there had been relatively high inflation in 2000 and 2002 which could not have been expected. The inputs to that inflation were at large and could not have been expected and yet over time the modelling had absorbed the spikes and produced adequate figures.

In answer to the costs of inflation targeting, one had to ask what were the alternatives. These were the benefits from a money target system, an exchange rate system and an eclectic system.

The benefits from the money target system were not as good, as our previous experience showed. The benefits from an exchange rate system were not always achievable and he referred to South America and Kosovo as examples. There were benefits from an eclectic system but unless one had an authoritative personality such as Alan Greenspan such too, had provided illusionary benefits.

Given the alternatives, inflation targeting implemented over a long time frame was the optimal system.

Addressing Mr Gibson, Prof Du Plessis said it seemed that if the value of the interest rates were maintained artificially low the value of the currency was reflected in the exchange rates of the currency. Prudence required a longer term view. Additionally, cutting interest rates did not seem to bring the anticipated benefits claimed by so many parties and in this regard he wished to have feed back. A danger was that the projection would possibly lead to weakness being led back into the system and the Reserve Bank projections could be wrong. It seemed to him the chance of gaining credibility was better than nothing.

About the slides on pages 8 and 14, he was of the view that scepticism was quite justified and that these were viewed with a certain pinch of salt and it was in order to ask whose model this was, for all models were inadequate and should be viewed against all the caveats.

In respect of flexibility, he felt that this was adequate provided that it was not adopted to meet circumstances. The flexibility had to be worked in so that over the long term, the model was retained but adjusted in the light of hikes and spikes. These were the very hikes and spikes which over the long term flattened out into the average, or expected average. To do anything else would be an ad hoc answer to circumstances and the abandonment of a policy for a mechanical approach. Previously the Swiss and Germans had been able to implement such a system but had been forced to adopt a policy without a staggered hierarchy of goods.

Prof Du Plessis felt that the results may have tainted the credibility of the Reserve Bank a little but not among those who understood what was being attempted and then only partially among the opposition. All in all he felt that the target was a reasonable approach but was not to be regarded as permanent.

Pro Ayogu stated that money rates went up and down and there was a cost to an inflation programme. He chose rather to regard money as the oil in an engine. If it was there, there was no problem. If it was not, what was the result? The question to be asked was what was expected of a monetary policy? Were the expectations moderate? What was being targeted? Employment or Growth in the GDP? What model were the Harvard economists using and would the temporary setbacks wash out in the long run. Could the model sustain any shocks?

Pro Ayogu said that the University of Stellenbosch and Prof Du Plessis (for both of which or whom he had the greatest respect) had much to answer for regarding the bundle of entries in their bundle. As an example he referred to the 1980s when the USA had both a remarkable trade deficit and an oil problem. The American trade deficit was exacerbated by the American consumers decision to purchase the more fuel efficient motor vehicles produced by Japan but this decision simultaneously eased the oil problem. America took steps to curtail the trade deficit but the Japanese then surprised the American authorities by establishing factories and assembly points within the continental USA for the production of Japanese motor vehicles. This pleased the American Trade Union movement by the increase in labour requirements, pleased the American authorities by lowering the demand for oil but displeased the American authorities because the trade deficit was either untouched or increased.

Pro Ayogu said that currently the Reserve Bank had a mandate and was doing a good job in respect thereof with its inflation targeting. However, he felt that questions such as was it the correct mandate, did the current macro financial system / plan suffice were more appropriately questions for Parliament rather than bureaucrats or technocrats and he was posing such questions in the hope that Parliament would review the Inflation Targeting Policy so that ultimately the best system and policy for South Africa and all who reside in it, not just vested or established interests, would be achieved.

Mr Bhamjee asked what effect the current account deficit had on inflation and had this been taken into account when the MPC debated the issues. Additionally with regard to wage negotiations simplistically it seemed the employers were offering 7% increases and the employees were requesting 8.5% increases. He wished to know what was a reasonable percentage increase which would not be inflationary in the long term. With regard to the Harvard economists, he asked what their training was which exceeded the training of South Africans and why it was always necessary to seek expertise from overseas. Why could we not produce and African or South African viewpoint or expertise?

Further why was the money supply always a measure? With regard to the concept of nonift taxes what did Pro Ayogu mean as we were always told that corporate taxes were too high but they were being used for the Gautrain etc etc and were directed to science and technology.

Mr Gibson said that in the African context, South Africa was reputed to have a very high incidence of house ownership. The total quantum (value) of mortgage bonds as opposed to the number thereof was lower than might have been expected and he asked how this was taken into account when assessing savings.

Prof Ayogu responded to Mr Gibson by questioning what figures, and their source, were being used. Was house ownership to be regarded as ownership in the suburbs or the townships and even squatter camps? The lower income group were excluded from loans from the formal banks and yet they were repairing, renewing or improving their dwellings. In his opinion it was this asset price expenditure which was driving consumption and yet it was ignored in the conventional statistics. The quality of and distribution of house ownership did not, in his opinion, put South Africa in the middle of any ranking.

With regard to wage demands, currently conventional thinking linked such with productivity in the fight against inflation in which case everybody was happy. He ventured to suggest that this, too, might be reviewed by Parliament for there was a case to be made for not tying wage increase to productivity gains, but if it was, what productivity gain? And in whose favour?

With regard to nonift or an inflation tax currently the banks charged their customers a differential above the repo rate. This might be 3%. If the MPC increased the repo rate the banks immediately increased their rate to their customers maintaining the differential rate and he suggested that this was an inflation tax which he called the nonift, or inflation tax. He asked where that money went: to the Receiver of Revenue in the form of increased taxation; to the shareholders in the banks as dividends? Just where did it go?

The Chair expressed the opinion that if the banks were really competitive they would not all be doing exactly the same with regard to this feature.

Mr Mbili asked if all the items in the current basket of CPI deserved to be there and whether the basket of CPI should not be reconstituted.

The Chair asked to what extent did global interest rates impact upon South Africa’s current account deficit in the double entry bookkeeping system.

Mr Gibson wished to know the effect of the money supply upon inflation.

In response, Prof Du Plessis stated that all inflation problems should be reviewed over a long period to avoid knee jerk, ad hoc fixes as the economy was a complex entity and only very long runs provided a satisfactory answer. As regard money supply controlling inflation, this theory had fallen out of favour a long time ago as the relationships between inflation and money supply were too varied and intricate for a simple fix. In fact taken over a 30 year period money supply and inflation targeting achieve comparable results and inflation targeting was more practical.

With regard to global interests, inflation affects the liquidity of all markets, developed, developing and minimalist. South Africa had a developed market and was able to raise money for development in international spheres, unlike Lesotho. The concomitant danger was that if the investors were not satisfied with the returns and safety and security of their investment, they would withdraw and direct their investment in areas where they felt their money investment was safer and more likely to provide the required return. This was the cost of having investments and growth in one’s country.

With regard to the items which constituted the CPI basket, there had been great debate but no one had arrived at any items which either should be included or withdrawn and which would produce a more acceptable grouping and percentage of measurement.

Prof Ayogu said that he was concerned about the items and the weightings accorded and wished Parliament to consider such. In his opinion the economic challenges facing Africa required addressing and perhaps the answers were not in conventional thinking. The conventional view of saving was seen as the amount of money for the credit of anyone in an institution. Yet in his view, the African extended family by improving their livestock or homes or tools, were in fact saving because the members of the extended family had until now looked after the person from whom the money came for the livestock or house improvements. The question should rather be an empirical examination of how people choose to live and not a prescriptive requirement of how they should live.

With regard to bargaining for wages and other issues, Prof Ayogu said that the Labour Movement must move to be more relevant and as with other segments of society, dispense with the sacred cows of the past.

Finally with regard to the schools of economists there was an attitude that anything African was not holy. African should be challenging in their thought and develop a line of approach that demands an improvement on extra African developments or their replacement by approaches acceptable to the rest of the world.

Afternoon session
Bank Supervision Department of the SA Reserve Bank briefing
Mr Errol Kruger, Registrar of Banks, accompanied by Senior Analyst Mr Eugene Bates, agreed to do his best to present the report as succinctly as possible. He requested the Committee Members to always be aware that what he would be saying was to be read against the fuller contents of the handout which in turn was an executive summary and abridged version of the Bank’s Annual Report for 2006 by the Supervision Department of the Bank (see documents).

Discussion
Mr Mbili (ANC) asked why the capital adequacy ratio was set at 10%, what the difference between fee income and trading income was and what items were allowed to be off the balance sheet.

Mr D Gibson (DA) asked what statistics there were on money laundering, prosecutions thereof and the success rate, and whether Financial Intelligence Centre Act transgressions could be identified by bank presentations. Secondly why did the banks increase the lending rates as the Reserve Bank increased its repo rate and why the banks seemed to operate as a cartel in this regard? Additionally had Basel 11 completed its recommendations, and if not, when?

Mr Asiya (ANC) echoed Mr Gibson about the increase in rates after the announced increase in the repo rate. He asked where this money went. He was of the opinion that the public was carrying the flak on this. Where did this money go? What did the banks do with it?

Mr Mbili (ANC) asked who set the minimum capital requirements and what did these amounts constitute? Why was liquidity required of the banks? Further, Absa had been taken into bed with Barclays and there were rumours about Nedbank and Standard Chartered bank. What did this mean for South Africa and could our banks be held in South Africa?

Mr Kruger replied that capital adequacy requirements ensured that if there was a rush by depositor/investors to recover their investments/deposits, that the bank  would have sufficient reserve from which to pay such claimants. If not, a bank or even the banking sector could experience a liquidity crunch. Internationally and in SA the set 10% was regarded as a sufficient cushion against such an eventuality but even this capital adequacy could not prevent the collapse of a bank or the sector in a real emergency. A capital adequacy requirement was applied globally and provision therefore made in the regulations which operate in South Africa in accordance with Basel guidelines.

Mr Kruger explained that the difference between fee income and transaction based income. Fee income was the earnings the Banks make from advising their clients, such as merchant banking considerations as to whether to merge with or acquire another entity.  Transaction income arose from the use of the banks’ services, such as a cheque or an ATM withdrawal.

With regard to off balance sheet liabilities, these arose when a seller had sold immovable property and the purchaser has been afforded a loan, to be secured against registration of a mortgage bond. The Seller and his conveyancer requested guarantees from the purchaser’s bank providing the loan so that the Selling party could be satisfied that the purchase price would be forthcoming. The Purchaser’s bank provides guarantees, which are merely contingent liabilities for such bank, until the eventual registration of the sale and the mortgage bond in the Deeds Office. On date of registration of the transaction, the paying bank moves such liability from its off balance sheet liabilities to its balance sheet liabilities. There were many other commercial transactions which led to off balance sheet entries as contingent liabilities.

On the matter of money laundering and terrorism funding, he said that the Financial Intelligence Centre Act (FICA) relied upon the parties to know their client and they all had different procedures for identifying clients. In such circumstances there were requirements for the identification of contracting parties. If such systems fell into abuse, such as when an agent did not fully identify a party and such had been reported to the bank regulatory authorities, there were provisions in FICA for fining the parties concerned. Although there were provisions for tipping off, such did not provide the bank regulators with numbers of transgression. This information was within the sphere of the prosecuting authority.

The increase in the repo rate and the consequent increase by the banks of their lending rates was a matter which fell outside the sphere of the bank regulator and was a matter for the MPC and the determinants of Monetary Policy. Off the record and personally, he felt it might be a good idea to have the financial markets report to the banking regulator in this regard but currently it was out of the mandate of the banking regulator.

Mr Kruger commented about the Basel regulations, saying that Draft 4 of the proposed amended regulations had been drafted and they would be proceeding to the requisite committee for consideration and approval. Thereafter, they would be submitted to the Minister of Finance for consideration and approval.

With regard to the question of where did the money go once an increase in the repo rate had been announced, he said that the banks had increased their lending rates. The opposite side of the double entry bookkeeping system meant that the banks had to pay out to their investing clients from whatever they were “gaining” from an increase in lending rates.

With regard to the Minimal Capital Requirements for Banks, capital was always a long-term asset from some source and had to be paid for. The return on capital indicated whether a bank was being run efficiently and profitably. If the return on capital was too low or non-existent, that bank would not have capital and would not be able to remain in business.

With regard to Absa / Barclays and Nedbank / Standard Chartered, there has been no approach to his Office and the press reports appeared to be incorrect. The Office of the Bank Regulator, if it fell within its mandate, might be requested for an opinion or investigation. Thereafter such a report would proceed to the Minister of Finance who had regard to whatever might be the question at hand on the macro level.

Mr Mbili (ANC) asked for clarification on the relationship between the Office of Bank Regulator and the Financial Services Board. Did the SA Reserve Bank regulator also regulate the banks in the SADC region and had legislation been passed stipulating that banks were to report to their clients.

Mr Gibson (DA) sought clarification on the position in America with what were known as sub prime lending loans. If these were non-performing loans, was the 20% allowance therefore adequate?

Mr Mbili (ANC) referred to securitization of mortgage loans and asked what impact this had on total household indebtedness and whether South Africans were safe in this regard. Further he asked why the charges on the Manzi accounts were so high, especially as these were accounts destined for low income earners.  He also asked about the legislation for the changing or turning over of auditors of banks.

In reply Mr Kruger stated that there was a good relationship between the Office of the Bank Regulator and the Office of the Financial Services Board. If there should be an instance when both offices were investigating the same entity they would do so from their respective mandates and on conclusion of their investigations, they would collaborate with one another to achieve the required finalisation of any complaint by way of a consolidated report. In this regard the two Offices had quarterly meetings at which various groups were represented  

With regard to the Republic of South Africa and SADC countries, there was an agreement that the host country would be in charge of any necessary investigations, if required, and inform the Regulator in the other country. This was in accordance with the provisions of Basel 11 which had prepared regulations for the proper global regulation of banks which summarised, was host to home and home to host.  

With regard to the changing of auditors, the auditors had initially expressed reservations about this policy but once the first turnabouts had taken place, they were of the opinion that this was an exemplary arrangement and that a fresh pair of eyes was beneficial to the whole process.

Mr Kruger felt that the two questions regarding sub performing loans and securitization of mortgage loans could be answered together. Sub price lending was effectively the selling off of such loans by way of securitization and the amount of 1.5% was in reality a small component of the whole bill. Securitization was the selling off of mortgage loans and was not the selling off of badly performing loans (incipient or potential bad debts) if done in the legal framework. Both activities were an attempt to achieve financial stability but if there was contagion, it was difficult to foresee the result but the percentage involved was low and not out of kilter or disproportionate. The question of incipient or potential bad debts was an area of risk management and audit performance.

With regard to the alleged excess charges on the Manzi accounts, these account did not fall within the purview of the Office of the Regulator who did not supervise them. The National Credit Act filled this gap and it was a question for the regulators of this Act. He could not comment on the fees on these account.

Mr Moloto (ANC) asked in terms of what legislation or practice, there were derivative swops.

The Chair was of the opinion that on the open forward position the fluctuations were high. With regard to the 40 illegal deposit-taking institutions, he asked what the percentage of successful prosecutions might be.

Mr Kruger replied that derivative swaps as an aspect of bank business was not growing, and was in fact relatively small. The banking system had developed this practice but it seemed to be tapering off. But in this regard, with the proliferation of credit, the public needs to know when they were dealing with a bank, and were afforded protection. The credit assessment was a double-sided aspect. The banks needed to know who their clients were and their risk profile and the investing public also needed to know who they were dealing with and the risk profile of the banks.

This was not an open position. If the banks were within the 10% guideline there was a margin of safety but there were fluctuations with corporate activity. There were always bigger operations and the Central Bank operations were not excessive in striving to maintain the 10% level.

With illegal deposit taking operations, these were becoming increasingly more sophisticated and passing themselves off as legal entities in accordance with the legal advice obtained. There had been four big ones closed down, two in the Vaal Triangle, one in Mpumalanga and one in Tshwane. It was not easy to ascertain who the players were and when challenged such players use all the legal mechanisms to oppose such action. The bank regulator was only alerted to their existence when there were complaints about non payment by which time it was too late and the bank regulator was reactive.

Mr Gibson asked for the number of successful prosecutions.

Mr Kruger replied that his office was alerted and conducted their investigations and then handed the matters over to the prosecuting authority and thus far there has been no report back to his office.

Mr Moloto (ANC) asked how there could be compliance with FICA when people come from across the South African borders and presented themselves at ATMs with seemingly legal cards to make withdrawals and what was being done about co-operative banks.

Mr Kruger replied that in terms of the FICA, every client was required to be a fit and “proper person”. There were procedures in FICA to censure those who had certified as fit and proper, those who were not.

The Co-operative Bank Bill was still in the legislative drafting process. There was a distinction between proposed co-operative banks with a R20 million threshold. Above this threshold, Mr Kruger’s Office would be the regulator and below this threshold there would be another regulator. As this Bill was still a work in progress, he was not able to elaborate further.

Mr Asiya (ANC) pointed out that all regulations lay in the province of Parliament and especially this Committee. Any regulations agreed to in terms of Basel and the Office of the Bank Regulator and the Minister of Finance, still required approval by this Committee.

At this point the Committee adjourned.