New bank regulations may depress SA’s economic growth
THE GLOBAL financial crisis of 2007/2008 showed that banking matters. With $12 trillion (R158.72trln) written off, and five million jobs lost, the trust between customers and their bank, and the electorate and their government was fractured.
Therefore, the establishment of the G20 – and South Africa’s participation – was embraced. The Financial Stability Board (FSB) was supported, and our regulators helped develop remedial actions at the standard-setting authorities in Basel and Madrid. But at what cost?
For emerging markets such as ours, it is a concern that the G20, through the FSB and the international standard-setting bodies, have crafted a one-size-fits-all approach. This is not a true reflection of the way the world works.
South Africa, which has a highly rated banking system and was largely unaffected by the crisis, now faces the dilemma of choosing between two equally unpalatable options. We must either impose a tax to cover the cost of implementation, or actively change the role of banks in the economy.
Rebuilding consumer confidence in the financial system is a key outcome of the FSB. However, every aspect of a financial system that served its people well, has been undermined by aggressive changes in policy, regulation and supervision.
The question is, once the desired changes have been effected, will the public that the banks serve still want the services we offer, and will bankers still want to be in banking?
For banks, the standard-setting authority, the Basel Committee on Banking Supervision (BCBS), is global best practice. The Basel II reforms introduced from 2004-2008, rewarded banks that invested in advanced risk management techniques with lower capital usage.
At the same time, Basel II allowed for the transfer of risk away from the banking sector, to make banking less risky. This is not the same as being more resilient, a lesson learned from the crisis.
North America and Europe got it wrong. The US originate-to-distribute model was reckless and rating agencies also did not always rate dubious derivatives accurately.
The introduction of Basel III, based on the lessons learned from the financial crisis, repositions banking for resilience to external shocks.
The banking sector can transfer the risk to those speculators willing to take the risk, but must at the same time be able to absorb shocks transmitted back into the banking sector by failures. Basel III focuses on strengthening two key areas: capital and liquidity.
It increases capital requirements and the quality of capital to be held by banks. Shareholders in banks must take the first loss on any failure, as the capital regime was designed to do. However, raising capital to meet growth in banking business is now proving challenging. The expectation that banks are better managed and therefore less risky, which should equate to lower returns to shareholders, may not be as palatable to shareholders as assumed by the Basel committee.
Liquidity was the other component of the Basel III reforms. By building liquidity buffers, banks are supposed to be able to absorb shocks and ensure markets continue to function.
But these assumptions are designed around financial centres where markets are deep and liquid. In many jurisdictions, the sovereign is the only entity that can qualify under these strict criteria and markets are also not deep enough to accommodate a sell-off without materially changing the price of the instrument.
Basel III provides little in the way of national discretion to assist countries whose systems do not naturally fit the objectives of the new international best practice standards.
South Africa has a credit economy rather than a savings economy, and our bankable population don’t generally save through the banking sector.
With our companies holding surplus profits with the banks, as they wait for opportunities to invest in the economy, we find the Basel standards for the net stable funding ratio difficult to achieve, as we are expected to magically source longer-dated deposits.
Unless South Africa can aggressively change from a credit economy to a savings economy, there is no other alternative than to carry a tax for our system that does not easily follow these new international best practices. That tax is passed through to the borrowers, for example via mortgage loans.
Global standards with limited national discretion, implemented uniformly across the globe is a noble idea, but it has not worked. Implementation approaches between Europe and the US are described as bifurcated.
The obsession with national interest has introduced legislation forcing emerging markets to comply or stop using their financial systems and face sanctions.
The FSB is tasked with implementation and co-ordination, but this seems to have not been done. The BCBS has also taken a long time to finalise the Basel III text and with recent changes in the US, it seems unlikely this will happen soon.
The international standard-setting bodies have designed complex solutions to the global financial crisis that are better suited to international financial centres in the UK, Europe and US.
Globally systemic banking institutions should indeed be regulated at the highest standard, but domestic banks with no international reach may not need to be regulated so stringently.
Although national discretion is not promoted, an apply-or-explain approach would give regulators flexibility to adapt the domestic application to ensure the banking industry does not compromise its ability to service its customers.
The onslaught of international best practice has been distracting, to the point where banks have withdrawn from markets and geographic areas.
Unintended consequences abound, from the withdrawal of correspondent banking from anti-money laundering standards to the lack of liquidity in bond markets and the drying-up of securities markets.
The expectation that banks bail out failing banks and be flexible enough to carry external shocks may come with a cost too big for the consumer and the economy to bear. Real economic activity and job creation is under threat and banks may need time to decide if they are good at, or have the appetite for the role that is left for them.
Innovation is at an all-time low, as banks spend more money on compliance than designing new products.
We worry that the ways standards are being applied will see banks change their risk appetite, withdraw from markets and return to conservative, old-school banking that will frustrate the objectives of governments and depress economic growth.
There is an opportunity for regulators to call on standard-setting authorities to complete the existing round of new standards and to wait a few years before attempting any more changes.
The obsession with national interest has introduced legislation forcing emerging markets to comply or stop using their financial systems and face sanctions.
Cas Coovadia is the managing director of the Banking Association South Africa and currently serves as the chairperson of the International Banking Federation. He is also treasurer of the African Union for Housing Finance.