Rules and tribulations: New regulations strengthen and shape the sector

Banks face a rapidly evolving regulatory framework in the coming years, with 2013 in particular marking a watershed. While South Africa’s score for financial regulation and the soundness of its banks in the World Economic Forum’s annual “Global Competitiveness Report” has improved from sixth in 2009 to second in 2012, the rules are changing fast.

Changing Structures

At the forefront of international changes in regulations, South African banks are facing an overhaul of the institutional structure of oversight at the same time as they cope with revised capital adequacy and risk management requirements under Basel III rules. New legislation under discussion since 2011 and to be tabled in parliament in 2013 will centralise oversight of the financial sector under two key institutions, a “twin peaks” system: the South Africa Reserve Bank (SARB) will expand its current jurisdiction over prudential rules for banks to all financial institutions, while the Financial Services Board (FSB) will gain new powers in regulating the market conduct of banks for the first time. The Treasury will retain responsibility for overall policy implementation.

“Promoting systemic stability by regulating individual institutions or markets has become increasingly difficult as the financial system is now more connected,” Norman Muller, head of the capital markets department at the FSB, told OBG. “A macro-prudential approach to regulation has become a prevailing theme in both national and international regulatory reforms.” While the transition will be gradual over the coming years, the new structure will give regulators broad new powers to oversee financial groups holistically. The Financial Markets Act passed by parliament received the president’s signature in early February 2013 and establishes the framework for transitioning to the new system (see Capital Markets chapter).

To Basel III 

With banks already reporting under Basel II rules in 2012, the average capital position of lenders has long been well above minimal requirements. A series of quantitative impact studies (QIS) have been run bi-annually since June 2011, which have found general compliance with planned capital adequacy ratios (CAR). “We have always insisted that our banks hold more capital than required under Basel, partly due to the concentration of our banking system,” Gill Marcus, governor of the SARB, told OBG. All banks had capital levels in excess of the Basel III requirements for 5.25% core Tier-1 capital, 1.75% non-core Tier-1 capital and 2.5% Tier-2 CARs. While these are set to rise gradually to 9%, 1.5% and 2%, respectively, (and an extra 2.5% counter-cyclical buffer) by 2019, lenders are unlikely to face significant difficulties in complying. Banks’ average CAR increased from 15.05% in 2011 to 15.84% in 2012, with Tier-1 CAR rising from 12.19% to 12.55%, according to the SARB.

Yet these aggregate figures obscure domestic banks’ high reliance on short-term (but domestic) wholesale funding as well as their dependency on lending to residential mortgages and highly indebted consumers, according to the IMF. Tighter lending to individuals and for property purchases, along with competition for deposits and longer-dated fixed income securities in 2012 have only started to address the requirements of Basel III. Implementation of the liquidity coverage ratio (LCR) has been delayed for all members of the Basel committee, however, with banks required to meet 60% of LCR obligations by 2015 and 100% by 2019.

The rule forces banks to hold a buffer of highly liquid assets and top-rated bonds in order to handle any run on deposits for up to 30 days. In a show of support for its banks, the SARB announced in May 2012 the establishment of a Committed Liquidity Facility, to help banks plug any potential shortfall in high-quality liquid assets to cover lending positions, although few lenders are expected to access it.

Maturity Mismatch

While the LCR is not expected to pose any challenges for banks, the net stable funding ratio (NSFR) rule, requiring banks to hold a certain share of long-term deposits (of over one year) and other funding sources to cover risk-weighted assets, has emerged as a greater concern for both the industry and regulators. “The SARB seems to have established the facilities and commitment to resolve the short-term liquidity issues the banking industry in South Africa was facing towards achieving its Basel III commitments,” Roland Sassoon, CEO of Sasfin Bank, told OBG. “However, there remains concern that over the long term the stable funding ratio for the country will not be where it needs to be.” While the impact of banks’ maturity mismatch does not pose a problem for systemic financial stability given the existence of exchange controls, debate at a global level has focused on whether the NSFR should be relaxed for emerging economies. “Of course the maturity mismatch between short-term deposits and long-term lending is an issue, but in a closed rand system we could deal with any imbalance through our domestic banking system,” René van Wyk, registrar of banks and head of the bank supervision department at the SARB, told OBG. “We have clearly stated that we will stand behind our systemically important banks.”

Further Clarification

Banks’ hopes that the NSFR rule would be relaxed by the time of its implementation in 2019 were bolstered when the Basel committee met in Cape Town in late January 2013. “The NSFR will be refined between now and the end of 2014,” Stefan Ingves, the chairman of the Basel committee on banking supervision, told the meeting. “Clearly, we still have work to do, but increasingly it is about getting the technical details correct rather than new far-reaching ideas.” The main argument has been that emerging markets should not be subjected to rules as strict as those applied to their developed market peers. South African authorities have also worked within the G20’s Financial Stability Board on new rules covering the shadow banking sector to reduce the scope for regulatory arbitrage by financial institutions.

“Many shadow banking arrangements aim at bypassing bank capital requirements, thereby achieving a higher effective leverage than prudential regulation permits,” Muller told OBG. “Although work is still at a policy stage, the FSB is focusing on banks’ interactions with shadow banks, money market funds, securitisation, securities lending and repo.”

Protecting Clients

At the same time, the array of consumer protection and market conduct rules has expanded, presenting new compliance issues for lenders. The National Credit Act passed in 2007 created a set of rules protecting clients, insuring fair and competitive practices for financial services, and prompting banks to help borrowers in distress.

Combined with its role to educate consumers, the new National Credit Regulator under the Department of Trade and Industry has become increasingly active, calling for a R300m ($36.57m) fine on unsecured lender African Bank in February 2013 due to alleged improper conduct. Meanwhile “treating customers fairly” (TCF) rules planned for 2013 will strengthen customers’ recourse mechanisms. However, banks have condemned the rapidly rising cost of compliance. “Overall, the sector is facing huge compliance burdens and this is limiting the entry of new players,” Sassoon told OBG. “A decade ago, one could establish a bank with R50m ($6.1m) in capital. Since then, regulations have become a hindrance towards the sector expanding its number of participants.”

Financial Intelligence

Beyond new capital, risk management and consumer rights requirements, the sector faces high costs and uncertainty from anti-money laundering rules. Established by the 2001 Financial Intelligence Centre (FIC) Act, the FIC, which reports to the Minister of Finance, enforces strict compliance.

Original “know your customer” rules have broadened to include information sharing and collaboration with foreign tax authorities. The US’s Foreign Account Tax Compliance Act in particular brings onerous new requirements for disclosing accounts held by individuals linked to the US. While implementation of the act has been delayed until 2014, banks would be required to disclose any clients with US citizenship or linked in some way to the US. Lenders have complained of high compliance costs. “We have seen much more aggressive enforcement of anti-money laundering rules in recent years, driven by the FIC in collaboration with the SARB,” Windsor Chan, the deputy general manager of China Construction Bank, told OBG. “All banks operating in South Africa have to ensure sufficient resources and dedicated staff in-house to meet the compliance requirement and are subject to regular review by the sector’s regulatory authorities.”

Yet the Treasury dismisses such concerns. “Increased levels of compliance also add to South Africa’s credibility as a sound, stable and attractive destination for investment,” Pravin Gordhan, the minister of finance, said at an FIC gathering in 2011. Although the details of reform are still evolving at the global level, the South African regime stands at the vanguard of stricter and more comprehensive oversight. While this will lead to additional costs for Africa’s leading banks, their strong risk management and prudential provisions have put them in the forefront both on the continent and globe.