Making the structural decision - The South African experience

1. ALIGNING FINANCIAL SUPERVISORY STRUCTURES WITH COUNTRY NEEDS:MAKING THE STRUCTURAL DECISION –THE SOUTH AFRICAN EXPERIENCEWorld Bank Conference4 December 2003Gill MarcusDeputy GovernorSouth African Reserve Bank

2. Making the structural decision -The South African experience Overview • Introduction to the South African financial environment • History of process to review the regulatory environment • SA country specific considerations • Rationale for a functional approach • Transitional and other issues

3. South Africa at a glance • Population - 45 million. Much diversity • Rich in minerals • New political dispensation • Sophisticated infrastructure • Key issues: • Unemployment /crime • Low savings • HIV/AIDS • Regional issues (3)

4. Some economic indicators • GDP USD150bn; per capita USD3300 • Deficit before borrowing 2,4% • Inflation (CPIX):5.4% (was 15% in early 1990s) • Interest rates: Prime 12%, Repo 8.5%, 3m NCD 8.25% • Government debt : GDP ratio - 41% • Growth: 2% in 2003? • Gross gold & foreign reserves - USD 20bn • Rand volatility: - 34% in 2001 + 26% in 2002 + 16% in 2003 • Unemployment : 32%

5. The South African financial system • JSE Securities Exchange - South Africa • 16th largest exchange in the world • 450 companies listed, • market capitalisation USD250 bn • SA Futures Exchange (integrated into the JSE) • Modern, offering trading in most risk management instruments • The Bond Exchange South Africa (BESA) • Turnover of USD8.5bn a day; 27% of traded volumes done by non-residents • Sophisticated banking and insurance sectors

6. The SA banking system Number of banks 25 (big 4 = 80%) Number of mutual banks 2 Local branches of foreign banks 14 Rep offices of foreign banks 48 Total balance sheets $ 200 billion Capital adequacy % 12,4 % Liquid assets as % of requirement 115% Return on equity 14% Return on assets 1,2% Operating expenses as % of income 60% Loans overdue as % of total L&A 2,6% (7)

7. Dual character of the SA financial system • Highly developed financial sector • Sophisticated, liquid forex and capital markets • Investment grade rating • Strong banking system • Generally sound fundamentals • Emerging market • Unemployment, poverty, crime • Low savings • Limited access to basic financial services • High HIV/Aids infection rate • Currency volatility

8. Strengths • Strong banking system • Sound laws and regulations • Sound monetary, fiscal, and exchange rate policies • High growth potential • Real-time gross payment and settlement system

9. The current financial regulatoryframework Minister of Finance Parliament Advisory bodies Standing Committee for Revision of Banks Act Department of Trade and Industry Financial Services Board SA Reserve Bank Advisory Committees: • Financial Markets • Pension Funds • Unit Trusts • Long- term insurance • Short-term insurance Office of the Registrar of Banks Office of the Registrar of Companies Office of the Executive Officer Insider Trading Directorate Appeal boards - Banks - Unit trust - Participation bond managers - Portfolio managers Regulated financial markets - JSE • SAFEX • BESA - Insurers - Pension funds - Friendly societies Indicates advisory functions indicates executive functions

10. Process to review the regulatory environment • Parties involved - SARB, BSD,MoF, NT, FSB, PCOF, Banking Council, international consultants • History of the process • Current status? - Uncertainty!

11. Process to review the regulatory environment History– salient events • Apr 1999: Regulation Round-Table • Feb 2000: MoF announces possibility of single regulator • Dec 2000: Multi-lateral workshop of Policy Board “Alternative Financial Regulatory Architectures for SA” • Mar 2001: Second Multi-lateral workshop “Financial Stability and the Regulatory Architecture” • May 2001:Policy Board recommendations to MOF • Feb 2002: MoF re-affirms intentions • Aug 2002: Governor’s Address expresses concerns

12. Process to review the regulatory environment Regulation Round–Table • Objectives of regulation: • Maintain confidence • Ensure fair treatment • Promote efficiency of financial system • Facilitate broad access to financial services • Promote public awareness and understanding • Reduce financial crime • Provisos: • Promote system stability • Enhance transparency • Fix responsibility • Free exit • Appropriate regulatory burden

13. Process to review the regulatory environment Round–Table consensus? • Systemic regulation: • SARB is best placed to carry out • Prudential regulation: • Banks and non-bank financial institutions supervised through a unified prudential regulatory agency • Conduct regulation: • Market conduct and prudential regulation as distinct operations within the same institution

14. Process to review the regulatory environment Round–Table consensus? • Systemic regulation: “The SARB is without question the institution best placed to carry out the important function of safeguarding systemic stability. Its responsibility for monetary policy, the payments system, its lender of last resort role and its operational capability in money and forex markets means that it is uniquely positioned to detect and respond to systemic risks.” - Summary report of the regulation Round-Table, 16 April 1999

15. Process to review the regulatory environment Round–Table consensus? • Prudential regulation: “These considerations led to broad consensus at the Round Table that prudential regulation of banks and non-bank financial institutions can most effectively be carried out through a unified prudential regulatory agency.” • Conduct regulation “. . degree of agreement that it may prove most appropriate to have market conduct and prudential regulation as distinct operations within the same institution” - Summary report of the regulation Round-Table, 16 April 1999

16. Process to review the regulatory environment Policy Board recommendations • No single correct model • Integration likely to benefit conglomerate supervision and perceived public accountability • But with probable reduced effectiveness of banking supervision and increased systemic risk • So: Need certainty of a clear decision • Recommend establishment of a task team with focus on: • Institutional capacity building • Formal coordination mechanisms Presumption?: Single regulator would be a new institution outside of the SARB

17. Process to review the regulatory environment SARB position post-Saambou? • “With the recent liquidity problems of some small banks, it was again evident that the least-cost resolution of a banking crisis would always depend on a special collegial interaction between the RoB and at least four other departments in the Bank. The policy formulation, decision-making, coordination and rapid execution of the many interventions that were necessary would have been almost inconceivable in a situation where the supervision of banks was not part of the Bank.” • “. . .the capacity to perform effective banking supervision is crucial to price and financial stability. After careful consideration of the issues, I am therefore convinced that it is in the best interests of the South African economy that banking supervision should remain in the Bank.” - Governor’s address – 27 August 2002

18. Key issues and considerations • Market developments • Regulatory effectiveness • Political accountability • Country-specific issues

19. Key issues and considerations Market developments • Technical/product innovations • Deregulation/liberalisation • Internationalisation • Conglomeration • Complexity of risk management • Cost pressures

20. Key issues and considerations Regulatory effectiveness • Objectives: • Securing systemic stability in the financial system • Ensuring institutional safety and soundness • Promoting consumer protection • Regulatory arbitrage • Adding other public-policy objectives • Facilitate broad access to financial services • Promote public awareness and education • Reduce financial crime

21. SA Country-specifics • Openness of the economy and the degree of discretion of the SARB • Concentration of banking • Quality of settlement systems and time to react • The safety net and deposit insurance • Existence of complex financial groups • The role of state- and foreign-owned banks

22. SA Country-specifics Openness of the economy and the degree of discretion of the SARB • Open economy • Exchange control in place • Large degree of independent discretion • Monetary policy executed through banks as agents • SARB is banker of banks • Link between price and financial system stability • Bank supervision more than just a convenience for SARB

23. SA Country-specifics Concentration of banking • 80% of banking assets concentrated in big four • Border between micro- and macro-prudential issues becomes fuzzy • Distinction between systemic and prudential regulation fades • In extreme case, every bank problem is systemic in nature • SARB likely to want to retain oversight of banks • Acclaimed effectiveness of banking supervision

24. SA Country-specifics Quality of settlement system and time to react • Highly sophisticated real-time gross payment and settlement system • High percentage of inter-bank transactions flow through SARB settlement system • In crisis, massive funds can be switched from a bank in distress • Intimate knowledge of prudential standards of banks is crucial • Real-time risk information is useless if time to react is slow – hence SARB needs extremely close link with BSD

25. SA Country-specifics The safety-net and deposit insurance • SARB will remain the lender of last resort (LOLR) • Natural tendency to want effective oversight of banks • Proximity of supervision helps with rapid decision-making so crucial in a crisis – Saambou was a case in point • An effective DIS would enhance supervision and increase crisis resolution options • Without proper DIS it would be difficult for SARB to part with supervision function

26. SA Country-specifics Existence of complex financial groups • Integrated financial conglomerates not prevalent • Little evidence of regulatory arbitrage • But: Insurance companies tend to control the banks • If conglomerates increase, this will be a compelling argument to unify prudential supervision • But: The other country specifics dictate that the single prudential regulator should be in the SARB (as in Bank of Ireland and Monetary Authority of Singapore)

27. SA Country-specifics The role of state and foreign-owned banks • State-owned banks not a feature • Role of foreign-owned banks is small • Hence, relatively more power for supervisor • Increases risk of removing supervision from SARB • Scarce regulatory resources • Political and bureaucratic tensions

28. Rationale for a functional approach Alternative approaches • Current environment: - Systemic: SARB/FinStab - Prudential: SARB/BSD for banks, FSB for rest - Conduct: FSB • Single regulator environment: - Systemic: SARB/FinStab - Prudential: SFSR for all • Conduct: SFSR for all • Possible alternative: - Systemic: SARB/FinStab - Prudential: SARB/BSD for all • Conduct: FSB for all

29. Rationale for a functional approach Merits at a glance • Single regulator: • Potentially more effective conglomerate supervision • Less regulatory arbitrage • Politically expedient/more suited to transformation? • Perceived as more modern and accountable • Functional split: • More effective for stability objectives • Less risk in a crisis • Less cost of duplication • Superior integration of monetary and regulatory objectives

30. Rationale for a functional approach • Any model can work in good times • However, in a crisis • Availability of ready information • Depth of knowledge, intimate understanding of nuances • Cooperation is key • Formal arrangements • Relationships and goodwill • Single regulator only one part of safety net

31. Transitional and other pragmatic issues • How to select the best structure • Remove emotive issues and biases • Split the decision into components: • Integrate or separate? • Placement? • How to manage the transition • Big bang vs gradual • Policy clarity vs planned and phased implementation • Need for certainty

32. Conclusion • SA on the international radarscreen • Complicated by need to maintain systemic stability yet ensure broader delivery of services • Functional split seems best but single peak model can work • Form not so important as the substance of: • Cooperation • Change management • A common (NT and SARB) position paper is required