New law to prevent future crisis domino effect

New legislation for the financial sector will help stop the “doom loop” that happens when big institutions fail during a crisis.

This is according to treasury deputy director general Ismail Momoniat who, during parliament’s finance standing committee on Tuesday, explained a banking crisis “impacts on your sovereign risk and it impacts on the fiscus and it creates an economic crisis”.

The treasury was in parliament for a presentation on the Financial Sector Laws Amendment Bill, which is aimed at bolstering financial stability in the country. Part of the Twin Peaks reform of the financial regulatory system, the bill introduces regulations to deal with failing banks.

The cabinet approved the tabling of the bill last June. The bill will minimise the use of public funds as a default source to bail out failing banks and other large financial institutions. Major banks will also have to plan for the possibility of their failure.

In its presentation, the treasury noted that banking crises have historically contributed to large increases in public debt.

“For that reason, you find that governments are forced to come in — it’s almost like having a gun to your head — if you don’t it is going to be a worse crisis … And generally financial crises, if they are the cause of a recession, it takes much longer for the economy to get back to recovery,” Momoniat said.

Banks pose a significant risk to the economy, the treasury said. When one major bank fails, there tends to be a domino effect on a number of connected institutions.

“What we don’t like is that when there are profits to be made, they obviously go to the shareholders of the bank … But when a major bank is in trouble, when there are losses, then society has to take the cost,” Momoniat said.

“And that is the problem we are trying to deal with and prevent.”