Share

African Bank too inclusive to fail

THE RESCUE of African Bank by the South African Reserve Bank (Sarb) once again demonstrates the difficulty of allowing a financial institution to fail and to let all the messy consequences play out unhindered. This is of course not a problem peculiar to South Africa, as illustrated so starkly by the 2008 international financial crisis.


An important part of the crisis was the realisation that some financial institutions, in particular banks, may be too big to fail (TBTF), while others, though not as big, may be too interconnected to fail.

The systemic risk to the financial system would be just too big and the resultant consequences for the real economy just too dire to turn a blind eye to what could be an unfolding train smash.

The result has been either a structured rescue operation involving healthy institutions in the financial sector, usually with the insolvent institution being merged with a solvent peer, or the injection of capital from public funds into ailing institutions.

It is fair to say that the TBTF problem is still not fully resolved in spite of an avalanche of financial sector reforms in the wake of the crisis. A recent speech by Stanley Fischer, deputy governor of the US Federal Reserve, provides an overview of the progress with financial sector reform to date, including TBTF. He concludes that a great deal of progress has been made in dealing with this issue, but “we should never allow ourselves the complacency to believe that we have put an end to TBTF”.

The new measures adopted to deal with TBTF include the requirement for systemically important financial institutions to adopt so-called “living wills” or contingency plans in which they set out how they will unwind their operations in an orderly manner in the event of bankruptcy, without causing havoc in the financial system.

In a recent move, US regulators rejected the “living wills” committed to by 11 large banks and much to their ire sent them back to the drawing board. The regulators in effect acknowledged that large banks still cannot be wound down in an orderly bankruptcy process.

Whether large banks will ever be able to draw up satisfactory “living wills” is a moot point. It will unavoidably depend on wide-ranging assumptions, including on how other institutions whose cooperation is essential in the winding-down process will behave. If we ever get to the point where such a “living will” is put to the test, success will not be guaranteed.

South Africa of course has its own too-big-to-fail challenge. It is unthinkable that one of the big four banks could be allowed to declare bankruptcy without systemic consequences and a major disruption to real economic activity. No plans dealing explicitly with this problem are known, but the best way of dealing with TBTF remains proper regulation and supervision, viz. preventing the problem from arising in the first place.

However, one should perhaps avoid giving too much weight to the TBTF problem in South Africa. After all, the South African banking system has a long history of stability in spite of its highly concentrated nature. It shares this characteristic with other highly concentrated banking systems, e.g. in Australia and Canada. In fact, research conducted by Beck, Demirgüç-Kunt and Levine (2003) indicates that more concentrated banking systems with high levels of competition are less likely to suffer crises.

This leads to the question as to why the Sarb decided to bail out African Bank.

READ: African Bank is open for business - curator

To begin with, African Bank was certainly not too big or too connected to fail - its bankruptcy would hardly have posed a threat to financial stability. The share prices of other banks (with the exception of Capitec, which shares African Bank’s exposure to unsecured lending) hardly budged when the news of African Bank’s predicament broke, and interbank money-market rates remained stable.

The final paragraph of the remarks by the Sarb governor at the announcement of the rescue plan perhaps offers a clue. To quote: “Notwithstanding the challenges facing African Bank, government’s policy of financial inclusion is appropriate and important. This requires sound practices, appropriate lending relating to affordability and an increased effort to provide greater access to finance for entrepreneurs as well as small and medium enterprises.”

This lends a new dimension to the reasons why rescuing a failing financial institution may have merit. To too-big-to-fail and too-interconnected-to-fail we must apparently now add too-inclusive-to-fail. What this means for South Africa’s further financial development only time will tell.

It likewise implies an extension of the problem of moral hazard, viz. the encouragement of risky behaviour by financial institutions because they know they will be bailed out in the event of trouble.

The terms of the African Bank resolution are in fact lopsided in so far as the taxpayer will bear the cost if the collection against the bad lending book turns out to be worse than the 41% allowed for, while a clawback arrangement will see the bank getting the benefit if performance exceeds expectations. In other words, heads the taxpayer loses, tails the good bank wins!

At the end of the day any interference in the bankruptcy process undermines the efficient functioning of a market economy. Business people and investors should face the full consequences of their decisions, whether positive or negative. If this principle is not honoured, with the state interfering according to its judgement, it turns private entities into semi-public ones.

- Fin24

* Jac Laubscher is Group Economist of Sanlam. Opinions expressed are his own.

References

1. Stanley Fischer: “Financial Sector Reform: How Far Are We?” Martin Feldstein Lecture. National Bureau of Economic Research. 10 July 2014.
2. Thorsten Beck, Asli Demirgüç-Kunt, and Ross Levine: “Bank Concentration and Crises”. National Bureau of Economic Research. Working Paper 9921. August 2003.
3. Remarks by the Governor of the South African Reserve Bank, Gill Marcus. Press Conference August 10th, 2014: African Bank.

We live in a world where facts and fiction get blurred
Who we choose to trust can have a profound impact on our lives. Join thousands of devoted South Africans who look to News24 to bring them news they can trust every day. As we celebrate 25 years, become a News24 subscriber as we strive to keep you informed, inspired and empowered.
Join News24 today
heading
description
username
Show Comments ()
Rand - Dollar
18.87
+0.3%
Rand - Pound
23.85
+0.2%
Rand - Euro
20.38
+0.2%
Rand - Aus dollar
12.31
+0.2%
Rand - Yen
0.12
+0.2%
Platinum
908.05
0.0%
Palladium
1,014.94
0.0%
Gold
2,232.75
-0.0%
Silver
24.95
-0.1%
Brent Crude
87.00
+1.8%
Top 40
68,346
0.0%
All Share
74,536
0.0%
Resource 10
57,251
0.0%
Industrial 25
103,936
0.0%
Financial 15
16,502
0.0%
All JSE data delayed by at least 15 minutes Iress logo
Company Snapshot
Editorial feedback and complaints

Contact the public editor with feedback for our journalists, complaints, queries or suggestions about articles on News24.

LEARN MORE
Government tenders

Find public sector tender opportunities in South Africa here.

Government tenders
This portal provides access to information on all tenders made by all public sector organisations in all spheres of government.
Browse tenders