Are South African banks at risk of their own crisis? Examining the threats – Katzenellenbogen - Biznews

In certain ways all banking crises are the same. There is a run on the bank as depositors rush to withdraw their cash and big lenders refuse to extend any more credit. It is all brought on by an erosion of confidence. While the erosion in confidence might be drawn out, the breaking point is always sudden.

This article discusses the risks facing South African banks, including the possibility of a banking crisis caused by a lack of confidence in the government and the economy. It highlights the importance of effective regulation and the need to reduce the country’s budget deficit to mitigate these risks. It also discusses the potential impact of the country’s placement on a “grey list” due to money laundering and terrorist financing, as well as the risk of a collapse of the national power grid. Ultimately, the article suggests that there are increasing scenarios that could contribute to bank failure in South Africa.

Jonathan Katzenellenbogen

In certain ways all banking crises are the same. There is a run on the bank as depositors rush to withdraw their cash and big lenders refuse to extend any more credit. It is all brought on by an erosion of confidence. While the erosion in confidence might be drawn out, the breaking point is always sudden.

Paths to the breaking of confidence have been well illustrated in recent years.

The failure of Silicon Valley Bank earlier this month was the result of the bank being unable to meet the withdrawals by depositors. That was because it had a large proportion of short-term deposits, which it invested in long-term instruments like government bonds. Had it been prudent, the Bank would have insured these deposits against sudden and catastrophic withdrawal.

The collapse of Credit Suisse, Switzerland’s second largest bank was long in coming. The change in the environment brought on by the collapse of Silicon Valley Bank meant Credit Suisse became a lot more vulnerable. The reputational and financial damage from scandals at the bank, bad acquisitions, and poor management had never been resolved.

After a run on the bank’s stock price, the head of Saudi National Bank, Credit Suisse’s largest shareholder, was asked if his bank would help support the bank. His reply, “The answer is absolutely not,” was the breaking point, and forced the Swiss government into putting together a rescue package.

Part of the contagion of the refusal by the US government to bail out Lehman brothers in 2008 was the Icelandic banking and sovereign debt crisis. All three of the country’s largest private banks defaulted and the country had to go to the IMF and its Scandinavian neighbours for a bailout. Then the crisis spread to other severely indebted countries: Portugal, Ireland, Greece and Spain, also known as the PIGS.

Credit standing

These were all combined sovereign debt and banking crises. Where a country is highly indebted, a sovereign debt crisis can easily transform into a banking crisis. Banks holding large amounts of government bonds are found, as required capital and investments are wiped out by a sudden deterioration in confidence. The credit standing of large banks in any country is inextricably linked to that of the government.

South Africa has had its share of bank collapses over the past 30 years, but none went so far as to threaten the financial system. There was a spate of collapses of small banks about 20 years ago, and African Bank and VBS went under more recently.

One reason that we have avoided the collapse of larger banks and more frequent collapses of smaller banks is effective regulation. The International Monetary Fund often gives the country the credit for strong financial sector oversight and a commitment to independent supervision of banks. The Fund believes there are gaps, such as the need to focus more on governance and have less reliance on auditors.

Due to exchange controls and isolation, South African banks have managed to avoid the manias that have infected the big US and European banks. They did not make massive loans to dodgy South American countries in the 1980s, and they avoided the mania for US mortgage-backed securities in the lead up to 2008.

Ultimately, the main risk to our banks and other financial institutions may lie in the erosion of confidence in the country and the economy. It is the combined Iceland and PIGS scenario. Large holdings of government debt directly raise the financial system’s exposure to the state: sovereign risk. Banks are required to maintain certain levels of holdings in government debt to meet capital requirements, but they also invest in these bonds for good returns.

The exposure of the banks to government debt, at around 25 percent, is currently not a massive risk, but it is nevertheless one that is regularly highlighted by the Reserve Bank and the International Monetary Fund.

Extreme pressure

As the government budget deficit rises, the banks are likely to take on more public debt. If bonds were to come under extreme pressure, the banks might require more capital and that could be difficult to raise in a crisis of confidence. The banks are also exposed to local governments and state-owned enterprises, many of which are in distress, in the course of their everyday business.

The best way to reduce the risk of large holdings of public debt leading to the collapse of banks is by cutting the budget deficit. But the government will run a sizeable budget deficit of 6.5 percent of GDP this year and there is continuing pressure on spending from the bailout of Eskom, extension of social grants, and other big spending ambitions.

We have not heard anything for some time about the idea of requiring financial institutions to invest a certain portion of their assets in public debt. For example, banks and pension funds could be required to invest in new government development projects. That would expose the financial sector to even greater risk.

The placement of South Africa on a “grey list” by an international task force, due to a lax approach to money laundering and terrorist financing, has also raised the risk to our financial institutions. It could make it more difficult for the banks to raise capital offshore.

And then there is the additional risk of what a collapse of the national power grid might mean for the financial system. As a high impact event, albeit with low, but rising probability, the country’s financial institutions have been running scenarios around this, according to Business Day. The collapse of the national grid would raise the chance of national unrest, severely disrupt transport and communication networks, and it might even freeze the system of payments, raising the possibility of collapse of financial institutions.

There are an increasing number of scenarios that could feed into bank failure in South Africa.

Risks rise

The risks rise with a weak economy, the inevitable rise in defaults, the grey-listing, the large budget deficit, poor prospects for reform, and the rise of mafias and fraud. While the risks have been around for some time and might seem minimal, they could become large in a perfect storm. That is the way of many banking crises.

Then there is the problem of who would help in the event of a major bank collapse. With a large deficit the state would be highly strained in responding to a crisis of this magnitude.

The Reserve Bank would be part of the rescue plan, but there would be a big cost to pay in terms of inflation. The IMF might be required, but we would have to do what they say, which means it could take the ANC a long time to respond and for relief to be found.

The rise in risks to the banking system and the heightened costs of any ensuing bailout are largely the result of the country’s predicament. If we were in a better place, our sound system of banking regulation might allow us to become something of a financial centre.

Jonathan Katzenellenbogen is a Johannesburg-based freelance financial journalist. His articles have appeared on DefenceWeb, Politicsweb, as well as in a number of overseas publications. Jonathan has also worked on Business Day and as a TV and radio reporter and newsreader.

This article was first published on the Daily Friend.