François Groepe: Recent developments in the African region
Keynote address by Mr François Groepe, Deputy Governor of the South African Reserve
Bank, at the Tenth Basel Committee on Banking Supervision-Financial Stability Institute
High-level Meeting for Africa on "Strengthening Financial Sector Supervision and Current
Regulatory Priorities", Cape Town, 29-30 January 2015.
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Introduction
Good morning ladies and gentlemen.
Thank you for inviting me to the Tenth BCBS-FSI High-level Meeting for Africa and to share
my views on the recent developments in the African region.
I will provide you with a brief overview of possible risks for the African region that are
associated with a new round of quantitative easing in developed economies. I will also
discuss the impact of low oil prices on sovereign and corporate debt issuance, and global
growth and the implications of these developments for the region. I shall conclude by giving
an update on regulatory developments.
Despite a strong performance by the US and UK economies, the global economic growth
outlook remains mixed, with the growth prospects having deteriorated in a number of the
other advanced economies, with Japan in a technical recession and the Eurozone remaining
weak amid the possibility of deflation.
The lower oil and other commodity prices have had a significant and divergent impact on
recent macroeconomic developments, with deteriorating prospects in some emerging
markets contributing to the lowering of the IMF's 2015 global growth forecast by
0,3 percentage points to 3,5 per cent with notable downward revisions made to Brazil, China,
Nigeria, and Russia. Growth in China is expected to moderate to 6,8 per cent in 2015 and
although Africa remains one of the high-growth regions, weaker commodity prices pose
downside risk to the outlook.
Currency devaluations and the potential impact on the African region
The global increase in liquidity, resulting predominantly from capital injections by the Bank of
Japan and the European Central Bank (ECB), could have negative spill over effects to
sub-Saharan Africa and emerging market economies (EMEs) in general.
Concerns over losses in the export market as a result of a strengthening of domestic
currencies could give rise to attempts at currency devaluations in some developed
economies and encourage monetary policy easing in the context of a subdued inflation
outlook environment, specifically in industrialised nations. The announcement of further
large-scale asset purchases by the ECB and the Bank of Japan precipitated the weakening
of the euro and the yen, respectively, amidst expectations of monetary policy normalisation in
the US.
Already, Denmark and Canada have cut interest rates, while the proponents of interest rate
increases in the UK are retreating. Subsequent to the ECB's announcement to fend off
deflation threats through an asset-purchase programme, the Swiss Franc appreciated
strongly, increasing the risk of falling exports and a possible contraction.
In Asia, the advent of Abenomics raised concerns that China could respond in an effort to
protect its exports market share and with its growth easing to 7,4 per cent for the fourth
quarter in 2014, the lowest in 24 years, devaluation of the Chinese yuan may be considered
a possible policy option.
In summary, the further quantitative easing may in the short term increase global liquidity and
lead to capital inflows to emerging market economies, but this may be accompanied by
increased currency volatility on the back of dollar strength and in some countries weaker
growth. Currency devaluations flowing from quantitative easing in external markets may also
have a negative impact on countries that export to those countries.
Currency risk, sovereign and corporate downgrades
For the sub-Saharan African region, the past five years of highly accommodative monetary
policies in the US, Europe and Japan have stoked the currency risk associated with the
increase in sovereign debt issuance. The persistent search for high-yielding securities
presents an additional dimension of risk for African countries.
Backed in recent years by comparatively stronger regional growth, African nations are now
able to issue billions of dollars in sovereign bonds, prompting the IMF to issue a warning that
too much debt in the region could derail the best economic period observed in this
generation.
The uptick in borrowing in the region lifted public debt to a ten-year high of 35 per cent of
GDP in 2014. Although such debt levels are much lower than in Europe and some Asian
countries, the associated currency risk is significant. The cost of servicing a US
dollar-denominated Eurobond, issued by an African state may look cheaper than that of a
debt issue in local markets, but if the relevant country's currency declines, the cost of foreign
borrowing could increase, thereby exerting unwelcome pressure on national budgets. This
risk is more pronounced in oil-exporting countries that draw a significant portion of
government revenue from their energy sectors.
As an illustration, Russia's credit rating has been downgraded to below investment rate for
the first time in a decade. A number of oil producing countries on the African continent, too
will need to adjust to the falling oil prices and declining fiscal revenue by cutting fiscal
expenditure and possibly raising taxes.
The risk of sovereign downgrades, on the back of deteriorating fiscal and external balances
could also extend to the corporate sector and may spill over to vulnerable non-oil producing
countries. Yields on corporate bonds, issued by the energy sector, have risen sharply since
June 2014. The prospect of defaults due to over-lending to the energy sector is a possibility
that cannot be ignored.
Unless oil prices rebound significantly to enable borrowers to refinance their debt on more
favourable terms, the cross-sectional risks of multiple exposures of different industries to the
energy sector would be propagated through the financial system. Consequently, share prices
of oil-listed companies, along with those that provide services to the energy sector, could be
negatively impacted.
The impact of low oil prices on the interconnectedness of financial institutions - a risk
for global growth
The obvious similarities between the transmission mechanism of the 2006 fall in US house
prices and the fall in the price of oil since June 2014 have prompted some analyst to predict
that the correction in the oil price could lead to a plunge in stock markets, with subsequent
negative spill over effects to the global economy.
The global financial crisis had its roots strongly embedded in the procyclical risks that were
amplified and propagated over time by the highly leveraged US housing market. Accordingly,
a sharp fall in US house prices led to bankruptcies of major financial institutions that had
significant exposures to the real-estate market. As companies filed for bankruptcies and the
risk of default increased in the financial markets, refinancing of existing debt became
increasingly difficult. The shutdown of the US commercial paper market made it difficult for
corporates to borrow money over the short-end of the yield curve, resulting in an
unprecedented financial meltdown and significant job losses as economic activity came to a
halt.
Through different financial institutions' interconnectedness, a well-contained and relatively
limited exposure to the US real-estate market soon spilled over to the global financial
system, with negative consequences for regional growth in Africa. While the origins of the
crisis might have been procyclical, it is essentially the distribution of risks during the 2007-08
crisis that amplified the losses incurred.
In less than a decade, since the crisis, we now have another highly leveraged sector - the
US shale oil industry - that capitalised on the rise in the price of oil that started almost ten
years ago. Banks' lending to the energy sector of billions of dollars could pose a systemic
risk to the global financial system as the exposure was seen as low-risk and the pricing of
risk by lenders might have been less robust during the upward swing in oil prices.
Resultantly, the plunge in oil prices has stoked concerns over growth of particularly oil
producing countries, fuelling fears about deflation and intensifying scrutiny of capital
spending across the energy sector, with companies set to slash their exploration and
development budgets. Some estimates put the figure of possible losses related to halting
exploration projects at US$1 trillion.
Moreover, low oil prices are a major threat to high cost oil producers. For as long as prices
remain below US$50 per barrel, a number of those oil producers will struggle to break even.
This could trigger a new wave of bankruptcies and defaults with concomitant negative spill
over effects to the financial sector.
It is evident that although low oil prices could boost consumption its impact on growth could
be mixed, with oil exporting countries particularly negatively impacted by these developments
in the form of deteriorating fiscal and external balances. This will furthermore result in a
sharp decline in the flows into sovereign wealth funds and given the fiscal deficits could
result in significant sell off by these funds.
The lower oil prices may also accelerate the build-up of deflationary pressures and possibly
result in stagflation becoming more entrenched in certain economies.
The impact of low oil prices on revenue projection in the African region
Some sub-Saharan African countries are particularly at risk from the fall in oil prices, with oil
exports accounting for 40-50 per cent of GDP for Gabon, Angola and the Republic of the
Congo and 80 per cent for Equatorial Guinea. In Angola, the Republic of Congo and
Equatorial Guinea, the oil industry accounts for 75 per cent of government revenue, while in
Nigeria oil still accounts for more than 70 per cent of the national budget, leaving public
institutions exposed to the ebb and flow of global energy prices.
Cheaper oil is complicating Ghana's efforts to reduce its significant trade and budget deficits.
In August 2014, it requested a US$500 million bailout from the IMF. In order to meet bailout
terms, Ghana is taxing oil at the pump; however, the fall in oil prices may exacerbate its
difficulties in meeting its debt obligations.
Most oil exporters need oil prices to be considerably above US$57, the projected price for
2015, to cover government spending, which has increased in recent years in response to
rising social pressures and infrastructure development goals. Furthermore, vulnerability to
currency risk increases if the borrower is dependent on the exports of one or two
commodities for revenue.
East Africa is set to emerge as a global supplier of oil and gas within the next decade due to
the recent major oil and gas discoveries in Mozambique, Tanzania, Kenya and Uganda.
Kenya and Uganda alone are estimated to hold 4 billion barrels of crude oil, while Tanzania
and Mozambique claim reserves of 200 trillion cubic feet of natural gas. With the promise of
unprecedented petro-revenues possible, host governments are working on bold, detailed and
comprehensive local content policies as they eye the next phase. All these plans could be
jeopardised if oil prices do not rebound in the medium term.
Lastly, the fall in oil prices has negatively affected revenue projections of oil-exporting
countries and their currencies' exchange rates. While emerging market currencies generally
track inflation differentials over the long run, large moves in the crude oil price have directly
affected exporters' currencies in the short-term, because of a perceived diminished value in
export flow revenue.
Regulatory, supervisory and financial stability matters
Turning to regulatory and financial stability matters, the global financial crisis has
necessitated, among other things, a serious regulatory reform agenda in order to address the
excesses of the period leading up to it; anchor future economic growth and ensure a sound
regulatory and financial stability framework.
The current overhaul of the global regulatory system is broad and covers a range of relevant
financial issues. Some of the key themes thereof include addressing the too-big-to-fail
(TBTF) problem of systemically important financial institutions (SIFIs), building resilient
financial institutions, reducing the opacity of the over-the-counter (OTC) derivatives markets,
mitigating the impact of shadow banking on financial stability, enhancing financial benchmark
transparency and promoting the convergence of accounting standards.
Within each of these themes there are a number of regulatory initiatives, such as the
regulation and resolution of SIFIs under the TBTF problem and Basel III and proposals for a
basic capital requirement for insurers to strengthen the theme of building resilient financial
institutions. This list, although not exhaustive, suggests the significant scope and amount of
the work still ahead. Compounding the problem further are the implementation and
monitoring processes, such as FSAPs and related peer reviews to assess progress made
with the implementation of internationally agreed regulatory standards by member
jurisdictions.
Given the extensive range of regulatory reforms currently under way, South Africa has since
last year been calling for a consolidation phase where emphasis should be placed on the
adoption and implementation of agreed international regulatory standards and greater
understanding of the impact of new regulatory reforms on emerging market and developing
economies (EMDEs). This call was firstly made to avoid unacceptable, uneven, and differing
implementation of these new standards, thereby creating regulatory arbitrage opportunities
globally, and secondly out of concern for the impact of the cost of new regulatory
developments on EMDEs. Also, given the nature of "Tenth BCBS-FSI High-level Meeting for
Africa" meeting, we need to alert global regulatory authorities and standard setters that there
is a possibility of a widening gap between regulatory standards in advanced economies and
those in sub-Sahara Africa, where a number of countries are only now implementing Basel II.
South Africa, as a member of the G-20 and the FSB, is able to participate and, hopefully,
influence formulation of policy, but unfortunately a number of our peers on the continent are
not as fortunate as us and hence are denied this opportunity. South Africa, therefore,
welcomes the recent decision by the FSB to allow opportunities for non-FSB members to
contribute to this process and it supports the monitoring processes that have been put in
place. We furthermore welcome the decision not only for the reasons highlighted above, but
also so that we can obtain an independent assessment of the progress that South Africa has
made in this regard.
Recent domestic developments
On 1 January 2013 South Africa implemented the Basel III framework. The implementation
period for several of the Basel III requirements that were incorporated into the domestic
banking regulations commenced on 1 January 2013 and includes transitional arrangements,
which will be phased in until 1 January 2019. The purpose of the transitional arrangements is
to afford banks sufficient time to meet the higher standards while still supporting lending to
the real economy.
South Africa underwent an FSB peer and thematic review in 2013 and recently participated
in an IMF/World Bank Financial Sector Assessment Program (FSAP), which was finalised
towards the end of 2014. The purpose of FSAPs is to assess the stability of member
jurisdictions' financial systems as a whole, and not that of individual institutions. FSAPs are
intended to help countries identify key sources of systemic risk in the financial sector and
implement policies to enhance its resilience to shocks and contagion. Overall, the
assessment of South Africa's financial sector and the supervision and regulation thereof was
positive, with the report noting a high level of compliance and strong supervision, but found
that the financial sector operated in a challenging economic environment and some gaps
were identified.
Regarding the implementation of a twin peaks model of financial regulation, South Africa
decided in 2011 to change its regulatory architecture into a twin peaks regulatory system.
The original 2011 policy document on the twin peaks model set-out key proposals aimed at
enhancing financial stability, consumer protection, and financial inclusion.1 In terms of the
twin peaks model, the approach will change from regulation by institution to regulation by
objective. In this new approach, the South African Reserve Bank (SARB) will be responsible
for the prudential oversight of banks, insurers, financial conglomerates, and financial market
infrastructures and it will also become the Resolution Authority. The current Financial
Services Board will be re-named the Financial Sector Conduct Authority (FSCA) and will be
responsible for the market conduct of all financial services institutions, including banks.
Under the planned twin peaks approach, there will be opportunity to streamline the
supervision of the financial system between the SARB and the yet-to-be-formed FSCA.
There will be a phased approach to the implementation of a twin peaks model, starting with
the enactment of relevant legislation to establish the relevant regulators. In December 2014,
the National Treasury (NT) released, for public comment, the cabinet-approved second draft
of the Financial Sector Regulation Bill to give effect to the establishment of the necessary
regulators, their powers and responsibilities. It is noteworthy that chapter 6 of this proposed
Bill deals with coordination, cooperation, collaboration, consultation and consistency between
regulations, a matter raised in the 2014 FSAP report. South Africa, as it seeks to strengthen
its financial system and regulatory framework, is willing to learn from all relevant
stakeholders, whether here or abroad, and adopt these lessons to domestic circumstances.
Conclusion
It is clear that the slump in oil prices poses risks to financial system through its possible
impact on stock market developments. The highly indebted US shale oil producers are
possible trigger points and should be monitored. There is a risk that losses may intensify in
the derivatives market.
These negative developments can affect global growth, which could remain weak in a
deflationary environment, forcing central banks to inject more liquidity into their respective
economies in an attempt to revive economic activity. Finally, while low oil prices are generally
positive for consumers and business confidence, an extended period of low oil prices could
pose a number of risks for global financial stability.
I have also highlighted the scale of the global regulatory reform process under way and some
of the challenges in this regard. Given the growing complexity and interconnectedness of the
global financial system, it is imperative for regulators in individual jurisdictions to cooperate
and coordinate their efforts in the interest of a more robust global financial system. It is in this
spirit that I wish you well as you share your experiences, ideas and insights at this meeting.