T T Mboweni: The South African banking sector - an overview of the past
10 years
Address by Mr T T Mboweni, Governor of the South African Reserve Bank, at the year-end media
cocktail function, Johannesburg, 14 December 2004.
* * *
1. Introduction
Over the past decade, South Africa has established a well-developed banking system which compares
favourably with those in many developed countries and which sets South Africa apart from many other
emerging market countries. At the end of 2004, we find ourselves with a more mature banking sector,
with a moderate level of private-sector indebtedness and a respectable and first-rate regulatory and
legal framework. South African banks are well managed and utilise sophisticated risk-management
systems and corporate-governance structures in conducting the business of a bank.
South Africa's banks are regulated in accordance with the principles set by the Basel Committee on
Banking Supervision. Consequently, our banks comply with international sound practice and offer a
sophisticated banking system to the public. Customers have online, real-time, nationwide access to
bank accounts 24 hours a day, everyday of the year. South Africa's political transformation, together
with the relaxation of exchange controls and the liberalisation of African economies, has resulted in
South Africa becoming an increasingly important financial centre. South Africa is now also well
positioned to provide global services through the international offices of our banks and the presence of
international banks in South Africa.
2. Structure of the South African banking sector
Currently, there are 38 registered banks in South Africa. This number consists of 15 South African
controlled banks, 6 non-resident controlled banks (subsidiaries), 15 local branches of international
banks, and two mutual banks. In addition, 44 international banks have authorised representative
offices in South Africa. Representative offices, however, may not take deposits.
Five major groups continue to dominate the South African banking sector. These groups are the Absa
group, the Standard Bank group, the FirstRand Bank group, Investec and Nedcor. In 1994, these
groups represented 83.8 per cent of the total assets of the banking sector and, currently, they
represent 87.4 per cent of the banking sector. The remaining 12.6 per cent of assets in the banking
sector are currently held by the other 31 banks, excluding the two mutual banks.
Initially, the number of medium to small local banks increased steadily over the past decade. During,
the latter part of 1999, however, these banks faced liquidity pressures, which led to many of these
medium to small banks exiting from the banking system. This downward trend reached its lowest point
with the placement of Saambou Bank into curatorship in February 2002 and the subsequent
integration of BOE Bank into Nedbank. From the last quarter of 1999 to the end of March 2003, some
22 banks exited the South African banking system. It can be said, however, that this phenomenon was
due more to a consolidation of the broader banking sector than a failure of the medium to small
banking sector. Currently, small local banks constitute 3.1 per cent of the total banking sector assets,
in comparison to 21.7 per cent in 1994.
As a result of the political isolation of South Africa in the mid-1980's, international banks terminated
their operations in South Africa. Immediately prior to the advent of the democratically elected
government in 1994, few international banks were doing banking business in South Africa.
Amendments to the Banks Act in 1994, however, allowed not only representative offices and
subsidiaries of international banks to be established in South Africa, but also branches of international
banks. Following the opening of South Africa's financial system in 1994, international participation in
the local banking industry increased significantly, from 3 per cent in 1994 to 9.5 per cent of total
banking sector assets by the end of October 2004.
3. Periods of change in the banking sector
Following South Africa's re-entry into international financial markets in 1994, locally registered banks
have increasingly been expanding their operations into other countries. At the same time, international
banks have been expanding their operations into South Africa. Besides adding further depth and
sophistication to the South African market, these foreign banks began to tap into the South African
labour market. Consequently, the arrival of these predominantly resourceful and experienced banks
posed formidable challenges to local banks. In a quest to survive and excel, South African banks had
to devise means to adapt to the new terrain. As a result of the increased competition, lending margins
have been placed under greater pressure, and several banks have had to expand their businesses
and enter markets with slightly higher credit-risk profiles.
Currently, the major banks offer a wide range of services to both individual and corporate customers.
One-stop relationship banking, with an emphasis on universal banking, instead of isolated services,
has gained in importance during the past few years. Nevertheless, several banks, especially small
local and foreign banks continue to service niche markets, where they hold some form of competitive
advantage.
4. Trends in South African banks over the past decade
Generally, the South African banking sector remained fairly stable during the past decade. The first
part of the past decade was characterised by global financial turbulence and banking crises in many
countries. In general, the South African banking sector showed itself to be remarkably resilient during
the crises experienced. The latter part of the decade was characterised by a significant depreciation of
the South African currency and, in 2002, we experienced our own banking instability. Fortunately, and
owing particularly to the solid foundations upon which our banking system is based, 2003 and 2004
were marked by greater stability.
(i) Balance-sheet structure
The aggregated balance sheet of all banks in the South African banking sector grew from
R344.6 billion as at end December 1994 to R724 billion as at end December 1999. By the end of
October 2004, total assets had grown to a record high of R1.436 trillion. Loans and advances grew
continuously over the past decade, from R270.8 billion as at end Dec 1994 to R 1.104 trillion as at end
October 2004. Domestic deposits from the public remained the main source of funding for the banking
sector over the past ten years and amounted to R888 billion in October 2004 (as opposed to
R241.9 billion as at end December 1994).
(ii) Profitability
The efficiency of the banking sector can be determined by expressing operating expenses as a
percentage of total income. Currently, the international benchmark for efficiency is 60 per cent. In the
past, South African banks were able to keep this ratio below or close to the international benchmark.
The ratio, however, has increased from 60.2 per cent in 1999 to 67 per cent in 2002. The high volatility
in efficiency in 2002 indicates that the South African banking sector was indeed experiencing
problems with profitability in the first six months of 2002. This deterioration is confirmed by the return
on equity of 5.4 per cent (smoothed over 12-months) and the return on assets of 0.4 per cent
(smoothed over 12-months) as at the end of June 2002. Since 2002, however, the efficiency ratio has
improved and, as at the end of October 2004, the efficiency of the banking sector was 65.2 per cent.
By the end of October 2004, the return on equity and the return on assets of the banking sector had
similarly improved.
(iii) Capital adequacy
The change in focus of the regulatory authorities from direct controls to a more market-based
approach has been accompanied by an emphasis on proper capitalisation, sound risk-management
procedures and greater disclosure. South Africa adheres to the capital-adequacy guidelines for banks
promulgated by the Basel Committee on Banking Supervision. The requirement to maintain capital
equal to the full ratio of 8 per cent of risk-weighted assets was changed to a rate of 10 per cent by the
Registrar of Banks in 2001. By end of October 2004, the banking sector as a whole had a
capital-adequacy ratio of 13 per cent (up from 9.5 per cent in December 1994).
(iv) Non-performing loans
Of great significance was a decrease in the growth of total non-performing loans during the past
decade. After reaching a peak of R29.2 billion in March 1999, growth in total non-performing loans
declined to R23.8 billion as at end December 2003. During 2004, total non-performing loans continued
to decrease to a level of R20.9 billion. Provisioning by banks remained adequate throughout the past
decade despite non-performing loans being high in the late nineties, as mentioned earlier.
5. Reaction of the regulator to the small to mid-sized banking crises
It is common cause that the South African banking sector experienced certain mini-crises over the
past decade. None was more concerning than the instability experienced by small to mid-sized banks
during the period of the Saambou problem. Saambou Bank experienced a liquidity crisis, emanating
from negative market perceptions, a profit-warning announcement and the sale of Saambou shares by
two of the bank's executive directors. At the time, Saambou was the seventh largest South African
bank and had both a large retail deposit base and a well-established branch network.
In order to prevent a crisis of confidence in the small to mid-sized banking sector, Saambou was
placed under curatorship. Unfortunately, this led to further withdrawals, not only from the smaller
banks but also from larger banks. This loss of confidence significantly affected the sixth largest bank
at the time, BOE Bank, indicating that the lack of confidence could move up the scale and not only
down the scale.
Since such a trend could not be supported, the South African Reserve Bank entered into consultations
with the National Treasury, which ultimately issued a guarantee to all depositors that the government
would fund their withdrawals. This action sent a signal to the market that the authorities were serious
about maintaining the stability of the banking sector.
Several lessons have been learnt from the small to mid-sized banking crises. First, owing to the
special nature of banks, all key players, including, for example, external auditors, analysts, the media
and rating agencies, should appreciate the nature of banking and act responsibly when dealing with
the banking sector.
Second, the regulatory authorities must also be mindful of the fact that all their actions, combined and
separately, constitute signals to the market and that greater problems may result if a bank in distress
is not handled in a manner that provides certainty.
Third, the regulatory authorities have also learnt to treat with circumspect institutions that apply for a
banking licence, but which have only the interests of the individual shareholder and not the interests of
the depositor base in mind when making business decisions. An institution can no longer be allowed
to be registered to conduct the business of a bank and, then, simply to ride on the coat tails of the
name "bank", whilst at the same time not conducting deposit-taking business or not acting responsibly
in the interests of the depositor base, but rather in the interests of an unobtainable share price.
Fourth, the Registrar of Banks needs to be mindful of "boutique" banks that are not fulfilling the
definition of the "acceptance of deposits form the general public" and, on the asset side of their
balance sheet, are not acting "in the interest of the general public".
Fifth, as a result of the problems prevalent in the small to mid-sized banking sector during the past
decade, and especially towards the latter part of the decade, the South African Reserve Bank adopted
a policy framework for dealing with banks in distress. This policy framework serves to provide clarity
on the process in place for not only dealing with banks in distress, but also preventing problems in one
bank spreading to other banks. It is, however, only a framework to guide the approach taken, and the
particular approach has to be decided on a case-by-case basis, depending on the specific
circumstances.
Sixth, in addition to the policy framework for dealing with banks in distress, the Registrar of Banks
emphasised the importance of sound corporate governance in banks. In order to investigate the
standard of corporate governance within the South African banking sector, the Registrar appointed
Adv J F Myburgh SC to conduct a review of the status of compliance with sound
corporategovernance practices within the five largest banking groups in South Africa during 2002.
Among Adv Myburgh's findings were that, generally the banks investigated were committed to
adherence to and application of high standards of corporate governance; the banks on their own
initiative reviewed their corporate-governance principles from time to time; and corporate governance
in the banks was generally sound but vigilance was required to ensure continued compliance with the
best practice in corporate governance which is evolving in South Africa and internationally.
inter
Myburgh's recommendations were, alia, that the board of a bank should consist of no more than
about 16 members; a bank's board should not have more than about four executive directors; the
majority of non-executive directors should be independent directors with immediate effect; and banks
should aim for the majority of their directors to be independent directors within not more than five
years.
The Registrar of Banks accepted the recommendations made by Adv Myburgh and is dedicated to
reviewing the commitment to sound corporate governance in the banking sector on an ongoing basis
and is currently reviewing corporate governance in the remaining "non-big five" banks.
It needs to be stressed, however, that the objective of regulatory and supervisory authorities world
wide can never be to avoid the failure of financial participants, and, that, in a sound system, there will
be failures. Instead, the objective is to strive for an optimal balance between, on the one hand, the
cost of controls and intervention in order to address market failures and, on the other hand, the
anticipated benefits of regulation and supervision. The need for a sound relationship and proper
coordination between the fiscal authorities and the regulator can also not be overemphasised.
6. Emergence of the "four-pillar" policy
The four pillar policy relates to having a minimum number of substantial banks (so called "pillars") on
which the domestic banking industry relies and discourages the merger between any of those four
banks. The primary reasons for such a policy relate to the maintenance of minimum levels of
competition, in the interests of prudential and systemic stability, in order to avoid the spread of risk and
to promote reliance on a broader platform of institutions.
Currently, Australia relies heavily on the "four-pillar" policy, which originated in 1990 from its previous
"six-pillar" policy. New Zealand, which effectively has the same major banks as Australia, is protected
by the Australian policy. The Australian "six-pillar" policy discouraged mergers between any of the four
major banks and two major life insurance companies. The Australian government determined that it
would be anti-competitive for the four big banks and two big insurance companies to merge.
In 1997, however, the Australian government scrapped its "six-pillar" policy after the Wallis Inquiry
concluded that increased competition would achieve lower costs, better services and higher
efficiencies for consumers. Nevertheless, the Australian government determined that there was
insufficient competition to allow mergers among the big four banks and thus the "six-pillar" policy
became the "four-pillar" policy.
According to the South African Minister of Finance, who has responsibility for national financial policy,
South Africa also follows a "four-pillar" policy. Recently, the Minister stated that South Africa maintains
a "four-pillar" policy of having four big, locally owned banks regulated by the Office for Banks. The
"four-pillar" policy in South Africa lay at the heart of considering the Nedcor Bank bid for Stanbic. The
arguments advanced and conclusions drawn at the time conformed to that principle.
Current indications are that a number of international banks are interested in acquiring one or two of
our four pillars. Even if such interested was approved, it seems important to the Reserve Bank that
there still remain four pillars upon which our banking system rests. The presence of
internationally-owned banks will most certainly introduce more competition which in theory should
benefit consumers.
The authorities will therefore have to examine each application to buy into one of our four pillars on a
case by case basis. The world is changing very fast and the regulatory authorities cannot be seen to
be standing in the way of globalisation and rapid changes. These changes should be welcome as they
are indicative of the increasingly positive outlook for South Africa. The authorities have therefore to
face up to the task of anticipating and keeping abreast of changes to meet the new challenges and
opportunities. 'Nothing is stable except stability' and progress is measured by 'constantly changing
when circumstances change', as the great philosophers of old would say.
7. Current challenges for banking policy, especially in view of international banks'
interest in acquiring local banks
Closely related to the consideration of a four-pillar policy in a country is a consideration of whether
international ownership of any of those "pillars" should be permitted and, if so, on what conditions. In
that regard, the banking system of New Zealand serves as a good example of a country that, whilst
having predominantly non-resident owned banks, has maintained a sound financial system for
decades.
Should international interest in our local banks culminate in international ownership, the supervisory
regime would have to follow the internationally agreed framework of "home-host" banking supervision.
This is already in operation in that South African-owned banks have a presence abroad and
internationally-owned banks have a presence in South Africa. The success of such a system relies
largely on both the home-country and the host-country regulator ensuring compliance with the Basel
Core Principles for Effective Banking Supervision and the various guidelines flowing therefrom. In that
regard, regulators seek to ensure that their requirements do not obstruct home-country requirements
and, consistent with meeting their responsibilities, dovetail as much as possible with those
requirements.
Maintenance of a sound and efficient financial system and an ability to respond to a crisis effectively
are crucial prerequisites for a country's economic and social welfare. Therefore, host-country
supervisory arrangements are essential, as are structures for coordinating home and host supervision.
Home-country and host-country supervisors should be able to rely on and support one another at all
times.
When banking groups have international shareholders, it is important for the host-country supervisor
to be able to rely on the shareholder of reference in times of need.
8. Challenges going forward
Three important challenges face the South African banking system, including bank supervisors, in the
forthcoming number of years. These challenges are the implementation of the New Capital Accord, or
Basel II, as the Accord is commonly known; the provision of the broader access to banking services;
and the full implementation of anti-money laundering measures.
(i) Basel II
The principles of Basel II are intended to align capital-adequacy requirements more closely with the
key elements of banking risks and to provide for banks to enhance their risk-measurement and
risk-management capabilities. The revised capital framework is furthermore an attempt to adapt to
new developments and instruments and to be neutral towards financial innovation. Although the aim is
not to stifle innovation, the framework is also not intended to encourage capital arbitrage. Basel II will
evidently bring with it a higher supervisory and compliance burden, because of the Accord's greater
complexity.
The Office for Banks has embraced the principles contained within Basel II and is of the opinion that
Basel II is suitable for application in both G10 and non-G10 countries, since it provides a menu of
approaches suitable for both sophisticated and the least sophisticated banks. Implementation of
Basel II will be one of the high-priority strategic focus areas of the Registrar of Banks in the
forthcoming number of years. Basel II will be implemented within the South African banking sector on
1 January 2008. Parallel runs will take place during 2007. The Office for Banks has and will continue
to direct resources towards developing a supervisory framework involving all approaches offered by
the new Accord.
Basel II will have a significant impact not only on banks, but also supervisors, who will have to
re-engineer their processes and tailor their organisational structures to meet the Basel II standards. In
collaboration with other supervisors, the Office for Banks is currently developing its Basel II
implementation strategy. This process requires, amongst other things, a thorough understanding of
the provisions of Basel II, the design of appropriate supervisory processes and the development of
complementary tools to discharge supervisory duties. Ultimately, the new capital-adequacy framework
has the potential to improve risk management in banks and to align economic capital more closely
with regulatory capital. Co-operation between banks and supervisors, between supervisors of different
countries and between different banks is therefore essential for the successful implementation of
Basel II.
The Accord Implementation Forum established by the Registrar of Banks and representing banks and
various other stakeholders is functioning well and is assisting the banking sector and the regulator with
identifying and addressing the risks that may arise prior to and during the implementation of systems
designed to ensure compliance with Basel II.
There will be continued amendment of the regulatory framework and the supervisory process and
procedures, as well as development of complementary tools, in order to cater for the requirements of
Basel II.
(ii) Broader access to banking facilities
One of the most topical issues in the current South African financial landscape is the need to extend
access to banking facilities on a wider basis than is currently the case. In South Africa, the regulation
and provision of financial services to the poor has largely been based on exemption notices to the
Banks Act. The South African Reserve Bank announced through the Bank Supervision Department's
2002, Annual Report, that it envisaged amending the regulatory framework in order to allow for the
establishment of different classes of banking institutions, such as second-tier and third-tier banks.
Draft legislation has been published by the National Treasury in the form of the Dedicated Banks Bill
and the Co-operative Banks Bill, as a means of providing access to the banking sector to interested
participants and thus ensuring a flow-down of banking services to the wider community. It is essential,
however, that the new legislation should ensure that the business of such institutions is conducted in a
safe and sound manner, conducive to the orderly growth of the financial sector, whilst contributing to
poverty reduction in both rural and urban areas. Comment on the Dedicated Banks Bill and the
Co-operative Banks Bill may be provided until the end of January 2005.
(iii) Anti-money laundering
The Financial Intelligence Centre Act, 2001 (FIC Act), imposes duties on certain institutions to
introduce anti-money-laundering measures, to train their employees, to report suspicious transactions
to the Financial Intelligence Centre (FIC) and to retain client information. The banking sector has
therefore begun a concerted campaign to comply with the FIC Act and to fulfill the sector's obligations
in terms of local legislation and international guidelines.
In May 2002, South Africa applied for membership of the Financial Action Task Force (FATF), an
intergovernmental body that develops and promotes policies, nationally and internationally, to combat
money laundering. South Africa was granted FATF membership in June 2003.
As from February 2003, banks and several other institutions have been reporting suspicious
transactions that may involve money laundering to the FIC. Banks have to make detailed reports of all
unusual and/or suspicious transactions to the FIC. In addition, banks have to report the number of
such reports to the Registrar of Banks. Although this has been a challenge for banks, resulting in
additional system and resource requirements, banks have shown a commitment to comply with their
duties.
The Bank Supervision Department has an obligation to monitor compliance by our banks with the FIC
Act and other anti-money laundering guidelines. In order to ensure compliance with the requirements
of the FIC Act, a circular was issued in December 2002. The circular provided guidelines on the types
of measures that banks had to implement in order to prevent them being used to launder the proceeds
of crime. In terms of the circular, each bank has to furnish the Bank Supervision Department with a
detailed plan, with time frames by which the bank intended to achieve full implementation of and
compliance with the FIC Act and the FIC Regulations.
The initial deadline of 30 June 2004 by which banks had to verify the identities of some 17 million
clients was extended to a range of new deadlines, starting on 31 October 2004 for high-risk clients
and ending on 30 September 2006 for the lowest risk clients.
The Bank Supervision Department, in its role as a supervisory body, will continue to monitor progress
with the implementation of anti-money-laundering measures. It is also the intention of the Registrar of
Banks to incorporate anti-money-laundering measures into the planned on-site visits to banks.
9. Conclusion
In summary, therefore, the South African banking sector remains stable, and we are convinced that
further growth of the industry may be expected in 2005. Such growth, however, will be accompanied
by certain challenges. Besides preparing for the implementation of Basel II, South African banks will
continue to be encouraged to follow international sound corporate governance practices. Furthermore,
the Office for Banks remains mindful of the need for banks to ensure that the objectives of the
Financial Services Black Economic Empowerment Charter are met. For the Charter to succeed,
co-operation by all stakeholders is a necessity, and the South African Reserve Bank will continue to
support and assist banks in meeting their objectives. Taking into account the strengths of our banking
sector, we can look forward to a sector that can continue to establish itself as one of the most
sophisticated and integrated banking sectors in the world.