South Africa’s banks are ‘too big to fail’ – but government is drawing up a plan

South Africa’s major banks are currently ‘too big to fail’ – where the collapse of just one bank would result in devastating and far-reaching problems for the entire economic system, says Ismail Momoniat, deputy director-general for Tax and Financial Sector Policy at the National Treasury.

Momoniat presented the Financial Sector Laws Amendment Bill to parliament’s standing committee of finance on Tuesday (16 March).

Among other changes, the bill proposes a number of additional protections for the banking sector, should there be any failures by ‘systematically important’ financial institutions.

“The failure of a bank has a domino effect on other banks and financial institutions because of interconnectedness, and results in devastating far-reaching problems for the entire economic system,” he said.

Momoniat said that that governments typically do whatever they can to avoid this outcome, including bailouts. However, he warned that this often presents ‘moral hazards’ which are a major risk in such an environment.

With the protections offered by government-backed bailouts, banks may exhibit riskier behaviour, he said, where profits are privatised, but losses are socialised.

He noted that it is also in the nature of banking that no bank keeps cash to pay out 100% of its depositors. So in the event of collapse, depositors are not guaranteed to get their money back.

This leads to bank runs – depositors trying to withdraw their funds en masse – and panic. One bank’s failure then affects other banks, as they have interrelated deposits and loans.

The Financial Sector Laws Amendment Bill aims to address these issues by minimising the use of public funds and reducing moral hazard.

It proposes to do this through:

• The provision of a framework for the resolution of banks and non-bank financial institutions deemed ‘systematically important’;
• The designation of the Reserve Bank as resolution authority with commensurate powers;
• The introduction of a Deposit Insurance Scheme;
• The creation of a creditor hierarchy to ensure depositor protection in liquidation.

Deposit scheme 

The bill in its current form makes provision for the establishment of a subsidiary company of the Reserve Bank called the Corporation for Deposit Insurance.

This company will be responsible for administering the deposit insurance scheme to protect qualifying depositors’ funds up to a specified limit when a bank fails, which will be underwritten by the National Treasury.

Treasury’s presentation pointed directly to the failures of African Bank and VBS Mutual Bank, which it said demonstrated the need for additional powers during intervention, and an explicit, privately-funded deposit insurance scheme to protect vulnerable depositors.

According to the National Treasury, the deposit insurance scheme will have a number of additional advantages.

These include:

• Eliminating the risk of depositors losing funds that deprive them of their livelihood;
• Promoting the competitiveness of smaller banks;
• Improving confidence and reducing the risk of a bank run during a crisis and;
• Enhancing South Africa’s market integrity, which in turn ensures investor confidence.

The Standing Committee on Finance will now process the bill.

This will include calling on members of the public to submit written comments, holding public hearings, deliberating on the bill clause-by-clause and adopting a committee report that will be tabled in the National Assembly.

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