Braking the bank

RESERVE BANK governor Gill Marcus last week revealed that the bank had made a loss of about R1bn in the 2009/2010 financial year.

It was no coincidence that this revelation coincided with a demand from some private shareholders of the Bank for bigger dividends.

What the loss illustrates is that it makes no sense at all for the Reserve Bank to have private shareholders.

SA's Reserve Bank is one of only a handful in the world to have private shareholders. The situation dates back to the 1920s, when the bank was founded, and when it was thought that private stakeholders would help stave off too much intervention from government.

The shares have a nominal value of R1 and the dividend is 10c a share - never more, even if the bank makes a big profit.

But the bank's loss in the most recent fiscal year is a telling reminder of the truth of what Marcus wrote in a recent letter to shareholders.

She wrote: "Profit making should never be a motive for holding shares in the bank. The bank is neither designed nor expected to maximise profits. The fixed dividend paid and the limited voting rights available to private shareholders underline the fact that the bank - like its counterparts in other countries - is a public entity that acts in the public interest."

It's important to note that the bank's loss was incurred in the process of buying foreign exchange in the currency market. The bank does this when the rand is strong and it tries to "lean against the wind" of an appreciating currency. It also buys forex to add to its forex reserves (currently about $38bn), which are supposed to be an insurance against future possible bouts of massive dollar demand in the local currency market.

How is the loss incurred? It's fairly complicated, and there's nothing that the bank can do, when it's buying currency, to avoid the loss, which is footed by the taxpayer.

The process is that the bank sells rands into the currency market in exchange for dollars. The extra liquidity that is pumped into the money market as the rands flow in puts downward pressure on interest rates, threatening to render the repo rate meaningless and fattening banks' margins.

The Reserve Bank has to take this liquidity out of the market. It does so by issuing debentures (bonds), on which it has to pay interest.

Let's say it pays an interest rate of 6% to 7%. This is much higher than the interest it earns on the foreign exchange it has acquired, because the interest rate paid on dollars and euros is close to zero.

The loss is incurred as a result of this interest rate gap.

The bank can avoid the loss if the government issues bonds instead of the bank issuing debentures to take the liquidity out of the money market.

However, for the taxpayer the effect is the same - there's an interest bill to pay. It's easier to hide on the Reserve Bank's income statement, especially as the bank has made profits in the past (when government picked up the interest bill relating to currency intervention.)

This R1bn loss was incurred on minimal intervention by the Reserve Bank.

Those who call for Reserve Bank intervention to weaken the rand almost without exception never consider the possibility of losses for the taxpayer that may be incurred when sterilising the liquidity inflows into the money market.

This "sterilisation of intervention", as it is known, is easy to ignore, as it's a technical issue.

The key point about the Reserve Bank loss is that it was incurred as a result of the bank acting in the country's interest. It's not in SA's interest for the rand to be too strong; last week the Bureau for Economic Research said that rand strength would curb SA's economic growth this year.

So, in trying to curb rand strength, the Reserve Bank was acting in the country's interests. The bank was also acting in the country's interest by building up forex reserves.

Its income statement may have taken a hit, but its balance sheet looked better (forex reserves are a central bank asset.)

Absolute disgrace

A small group of vociferous Reserve Bank shareholders last week demanded an extraordinary annual general meeting of shareholders where a number of proposals would be discussed. This included that the Reserve Bank declared a capital distribution of 10% of its net profits from the financial period ending 31 March 2010.

For the dividend to increase from 10c/share, new legislation would be necessary. It's a safe bet that the law won't change to accommodate these avaricious shareholders who don't seem to understand the function of a central bank.

The letter from the shareholders was emailed to the media by a German shareholder of the Bank, Michael Dürr. He claims that the Reserve Bank is discriminating against foreign shareholders by not allowing them to vote.

But I'm sure I'm not alone in saying that it would be an absolute disgrace if foreign shareholders of the central bank have a say in pushing the bank towards acting in a way that wouldn't be in the national interest.

The Reserve Bank incurred a loss while acting in the national interest, as is its duty - and this went against foreign shareholders' interests.

If government can do so cheaply, it should get rid of these noisy, greedy Reserve Bank shareholders as soon as possible.

- Fin24.com