Are Banks Safer Now than During the Global Financial Crisis?

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:

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.

Investors 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:

As investors in banks ourselves, we undertake stringent analysis of banks and believe that this approach, which combines both macro (system-wide) and micro (bank-specific) factors to form a differentiated view on each bank within the broader South African banking system, enables investors, as best as possible within an ever-changing environment, to make informed decisions about where to place their funds.

Ultimately, whilst banks remain highly cyclical, highly complex, highly geared entities, they are now also more highly regulated than ever. While this of course is a positive development for investors, they must remain aware and alert to the ever-changing landscape, as they would for any other sector. This will enable them to make informed decisions and ensure appropriate protections and risk-adjusted returns for themselves or their clients.