The impact of securitisation on the effectiveness of the bank lending channel in South Africa

This study analyses the existence of a bank lending channel in South Africa and investigates the impact of the securitisation activity on the effectiveness of the bank lending channel during the period 2001–2010 using data from the South African banking sector. Structural Vector Auto Regression (SVAR) and Structural Vector Error Correction Model (SVECM) methods are used to interpret the impulse responses of bank lending to structural shocks (monetary policy) and to securitisation. The conclusion is that the bank lending channel is present and efficient in South Africa during the sample period with a lag and that securitisation acts as a shield against monetary impulses by constituting an additional source of funding for banks. University of Johannesburg 2013 6 IINTRODUCTION I.1. Background The progressive openness of South Africa to the world economy has contributed to the liberalisation of its banking system. Facing mostly liquidity problems in this new, highly competitive environment, South African banks investigated many processes, such as securitisation, in order to improve their situation. Broadly speaking, securitisation enables banks to increase their liquidity while reducing asset risk by transforming illiquid assets into marketable securities. As a result, the role of banks in ensuring the link between monetary transmission and loan supply has changed. Traditionally, if a bank has to keep higher levels of capital reserves (monetary contraction), there will be fewer funds available for the lending activity and the bank will automatically increase its loan rates, therefore altering consumer and business spending. Thus, in order to insulate their lending activities from monetary policy shocks, some banks use a non-traditional source of funding such as securitisation. In other words, securitisation acts as a shield against the transmission of monetary policy impulses via the lending channel, since it can be considered as an additional source of funding. In South Africa, the securitisation market became effectively active in 1999, ten years after the first two securitisation issues. This was mostly due to the economic sanctions applied in the country until 1994, and the presumed sophistication of this new financial instrument. But the South African securitisation market has grown exponentially since 2000 (Moyo and Firer; 2008). Securitisation issues increased from ZAR 482 million in 2000 to ZAR 25.5 billion in December 2012 1 . The rapid growth of securitisation activities was a direct consequence of a 10 per cent rise in the regulatory capital requirements for South African banks imposed by the BIS. The year 2000 also coincides with the adoption of an inflation-targeting regime in South Africa by the South African Reserve Bank. Monetary authorities must now regulate the economy’s response to monetary policy in order to keep an inflation target range of 3 to 6 per cent. But in 1 Cf. www.banking. org.za University of Johannesburg 2013 7 their study, Burger and Marinkov (2008) observed a 40 per cent failure of monetary authorities in maintaining inflation within the target range. A view common to most economists in recent years is that the efficacy of the bank lending mechanism has changed over time as a result of financial innovation, and especially securitisation. In South Africa, economists have found controversial results about the existence and the effectiveness of the bank lending mechanism. Sichei (2005) demonstrated the existence of a functional bank lending channel in South Africa over the period 2000–2004; while Ludi and Ground (2006) found that only demand-driven loans are responsive to monetary impulses in South Africa using a VAR approach, i.e. the bank lending channel has failed to transmit monetary policy shocks to the economy. The study conducted by Smal and De Jager (2001) provides an alternative solution to this dilemma. They observed a fourto six-quarter lag between a change in the repo rate and the economy response. But none of these studies have mentioned the securitisation activity as a possible cause. There is little evidence on how securitisation has modified the behaviour of banks towards the monetary transmission mechanism in South Africa compared to developed countries. In developed countries, many researchers have focused their attention on the impact of securitisation on the monetary transmission mechanism. Loutskina (2005) found, with respect to most of the findings in the literature, that securitisation activities participate in rendering banks more liquid in the U.S. and therefore enable them to supply more loans. Moreover, she demonstrated that securitisation acts as a shield against funding shocks since it can be considered as an additional source of funding (loan financing and liquidity). As a result, the bank lending activity is less dependent on monetary policy. Altunbas, Gambacorta and Marques-Ibanez (2009) examined whether the bank lending channel mechanism changes were caused by the securitisation activity in the euro area. The new development highlighted in this research is to know whether, due to securitisation, bank lending changes are conditional upon business cycles. They found that the insulation from monetary policy shocks depends on the degree of activism on the market, and is eventually reduced during economic downturn. According to them, “securitisation activity is pro-cyclical; this insulation effect vanishes in bad times and could even reverse in an amplification of the bank lending channel”. University of Johannesburg 2013 8 I.2. Research problem/question The introduction of new financial instruments is a challenge for the conduct of monetary policy. The banks’ extra liquidity and capital relief induced by securitisation activity reduce the effectiveness of the bank lending mechanism, i.e. monetary shocks have no or less effect on loan supply, thus on the real economy. As an emerging market, the problem is to know whether the securitisation market in South Africa can have a significant effect on the monetary transmission mechanism. The question that this dissertation addresses is, using a SVECM methodology, whether asset securitisation activity affects the monetary transmission mechanism via the bank lending channel in South Africa. I.3. Research hypothesis I hypothesize that an efficient bank lending channel is present in South Africa and is negatively affected by the securitisation activity as it helps banks maintaining stable credit supply by diversifying their sources of funding. I.4. Significance of the study The aim of this paper is to evaluate whether securitisation activity affects the transmission mechanism of monetary policy via the bank lending channel. In recent years, securitisation activity has expanded in South Africa, changing the monitoring role of banks, and reducing their fundamental role of liquidity transformation. As a result, banks maintain a major role as originators of credit, while progressively losing importance in their function as primary holders of illiquid assets. All these developments may have contributed to a change in the way banks grant credit to borrowers and react to monetary policy shocks. I.5. Research objectives University of Johannesburg 2013 9 The main objectives of the study are on the one hand to test the existence of a bank lending channel in South Africa by examining the reaction of active banks to monetary shocks, and, on the other hand, to assess the impact of securitisation on the lending activity. University of Johannesburg 2013 10 IILiterature review II.1. The securitisation process II.1. 1. Brief history In 1934, the Housing Act was enacted in the USA. Its role was to provide a framework for home mortgage loans issued by private lenders. Therefore, in 1938 the Federal National Mortgage Association was established. In 1968, the association was divided into two distinct entities: the Government National Mortgage Association (Ginnie Mae) and the Federal National Mortgage Association (Fannie Mae) which later became a privately owned entity after the removal of the government-held stock. Securitisation activity was first introduced by Ginnie Mae in the early 1970s. Ginnie Mae was responsible of the development of the housing sector in the US by managing a Mortgage-Backed Securities (MBS) program. Because MBS are backed by the full faith of the United States, these securities bear no risk of default. Therefore, investments in MBS highly increased and the secondary market grew rapidly as Fannie Mae and Freddie Mac (Federal Home Loan Mortgage Corporation) entered the market for re-sale purposes. Securitisation was later used in capital markets as an instrument to satisfy investor demand and which generated more complex products such as Collateralised Mortgage Obligation (CMO) and Asset-Backed Securities (ABS). II.1. 2. What is Securitisation? Traditionally, banks sell deposits to the public in order to raise loanable funds. These loans used to be the unique source of funding for banks which were obliged to keep them on their balance sheet until the borrowers paid them off. The securitisation activity provides an alternative solution to this situation. According to Henderson and Scott (1988), asset securitisation is a financing technique whereby loans and other receivables are removed from the banks’ balance sheet and are then packaged, underwritten and funded by investors. It is the “pooling of homogenous, financial, cash flow University of Johannesburg 2013 11 producing, illiquid assets and issuing claims on those assets in the form of marketable securities”. II.1. 3. The asset securitisation process The securitisation process can be divided into five parts: the origination; the structuring; the credit enhancement; the placement and trading; and the servicing. Karoly (2006) summarised them in three important steps: firstly, the owner of the assets (originator) securitises them by selling them to a Special Purpose