EXECUTIVE SUMMARY AND OVERALL ASSESSMENT
South Africa's financial sector operates in a challenging economic environment. Despite remarkable progress since the end of apartheid in 1994, South Africa still has one of the world's highest unemployment and income inequality rates.
Slow economic growth since 2008 has further aggravated unemployment, real disposable income is stagnant, and households are heavily indebted. As a result, banks are increasingly exposed to credit risk, while households and firms are vulnerable to a rise in interest rates. The large fiscal and current account deficits, a weak growth outlook, the reliance of banks on money market funds (MMFs) for short-term wholesale funding, and banks' active trading in the over-the-counter (OTC) derivatives market make South Africa susceptible to contagion and sudden stops of capital flows. This susceptibility and potential for spillovers have been exacerbated by the significant concentration and interconnections in the financial system, and the substantial expansion of South African banks into sub-Saharan Africa. These vulnerabilities became apparent in August 2014. African Bank, a boutique lender catering mainly to low-income households, was placed under curatorship after record losses from unsecured lending. Although its small size would have suggested no systemic implications, its problems are a reminder that asset quality can quickly deteriorate in a weak economy and even small institutions can entail systemic risk due to high interconnectedness. Relatively high capital buffers as well as sound regulation and supervision have helped mitigate the risks. Banks and insurers are well capitalized and profitable. The South African Reserve Bank (SARB) is a proactive supervisor, with a high level of compliance with international standards on effective banking supervision. The SARB's decisive action in placing African Bank under curatorship limited contagion. Its proposed bail-in of senior unsecured creditors to share in the burden of resolution is also welcome and a step in the right direction of reducing the "too big to fail premium" for the large banks. Overall, financial sector risks and vulnerabilities are elevated but manageable. Stress tests (ST) confirm the capital resiliency of banks and insurance companies to severe shocks but illustrate a vulnerability to liquidity shortfalls. Some banks have difficulty meeting Basel's requirement to hold enough high quality liquid assets (HQLA) to survive a stress scenario lasting 30 days without assistance from the SARB. They face even bigger challenges meeting a more stringent requirement to hold a minimum amount of stable funding over a one year horizon. Although these requirements will be gradually phased in, African Bank's experience highlights the importance of ensuring the large banks maintain adequate liquidity. Given significant downside risks to the economy, strong regulation and supervision are essential to ensure financial sector resilience. The outlook for lackluster growth amid an uncertain global environment requires intensifying scrutiny on asset quality. Remaining gaps in the supervisory and regulatory framework should also be closed. The FSAP recommends the following actions: • Reduce systemic liquidity risk by introducing deposit insurance and variable net asset value (NAV) for MMFs.
SOURCE International Monetary Fund (IMF)
