Are Banks Safer Now than During the Global Financial Crisis?
By Melissa Moore, Investment Analyst, Futuregrowth Asset Management
The outcome of the global financial crisis of 2008 - 2010 led regulators and central banks the world over to re-look at the way banks are regulated and governed. So what exactly has changed in the South African context?
Basel III requirements
The Basel Committee on Banking Supervision now imposes the following requirements:
- The Liquidity Coverage Ratio which requires that a bank holds enough liquid assets to cover its outflows during a 90-day liquidity stress scenario (i.e. a run on the bank);
- The Net Stable Funding Ratio which aims to address the term maturity mismatch between assets and liabilities;
- Capital Adequacy Requirements to ensure that there are sufficient levels of loss-absorbing capital to take losses before senior funders and, particularly, depositors take losses; and
- The Leverage Ratio which limits the amount that a bank can gear itself.
National Credit Act
This is aimed at curbing reckless lending. More stringent regulations now govern affordability assessments that must be performed by credit providers and restrict the interest rates and fees that credit providers can charge. Banks and other credit providers are less incentivised to write excessively risky loans if they aren’t able to earn risk-adjusted returns for such business.
Bank Resolution Framework
The South African Reserve Bank is currently in the process of finalising this framework, which is intended to address ways and means to recapitalise or reorganise distressed banks before they reach a point of insolvency. The expectation is that by imposing losses on investors, rather than relying on implicit government support, the Resolution Framework should reduce the moral hazard typically associated with banks and impose discipline on investors.
The Depositor Insurance Scheme
This is envisaged as part of the new framework, and is further expected to increase the stability of the financial sector. This will ensure that the costs of failed banks are borne by the banking sector rather than by taxpayers (as banks themselves will have to fund the deposit insurance). This will hopefully also reduce the likelihood of a panicked run on a bank.
The above developments have gone a long way to bolster the regulation and supervision of banks, thereby creating a safer and more resilient financial sector in South Africa. However, banks remain geared, cyclical entities which operate in highly competitive, changeable markets.
So, how should investors approach their exposure to banks?
Rather than viewing banks as “too big to fail”, investors should endeavour to understand the complexities associated with the banking sector (both macroeconomic; structural and bank-specific) in order to assess which risks have been adequately mitigated; which risks can be priced to achieve an appropriate risk-adjusted return; or which, if any, should be avoided outright.
nvestors should not simply view all of the large South African banks as homogenous entities. Whilst there are certain overarching themes such as the macroeconomic and regulatory environment, we suggest that investors should also perform analysis at an individual bank level:
- Look at the financial performance of each bank, how its key ratios have changed over time, and how it compares to its peers within the banking sector.
- Assess whether the board has an appropriate balance of power and skill-set to govern the highly complex operations of a bank, and that it has appropriately delegated powers to suitably sized and skilled sub-committees.
- These assessments can feed into a scoring model that allows investors to quantify the degree to which, on a balance of quantitative and qualitative factors, they may prefer one bank over another.