July 30, 2018

IMF publishes its staff report and selected issues report under the 2018 Article IV consultation with South Africa. Directors welcomed the introduction of the Twin Peaks approach, which strengthens financial sector oversight and cross-agency coordination. They took positive note that the banking system remains sound, but stressed that continued vigilance will be important in light of pockets of vulnerabilities in small and medium-sized banks. Directors welcomed the authorities’ continued efforts to upgrade stress-testing capabilities.

The staff report states that the banking sector is large, highly concentrated, and well capitalized. As of the end of 2017, banking sector assets corresponded to around 110% of GDP, with more than 90% accounted for by the five largest banks. On average, capital adequacy is above regulatory requirements and profitability, while having declined moderately amid weak economic growth, remains strong. The non-performing loan (NPL) ratio edged higher to 3.2% and the liquidity ratio exceeds the regulatory requirement. Medium-size and smaller banks have higher NPLs and capital than large five banks do. The operations of medium-size and small banks appear more sensitive to economic activity, notably if growth remains low for a protracted period, as they target riskier customers. These banks have lower asset quality compared to large banks and, although accompanied by larger holdings of equity capital, appear to have some pockets of vulnerabilities. While in isolation these banks are small, the broader banking system could be affected negatively through confidence effects, triggering vicious macro-financial feedback loops.

The recognition of contagion risk prompted the SARB to take a firm action when African Bank’s balance sheet conditions deteriorated in 2014. SARB also took a firm action when VBS Mutual Bank faced liquidity shortages in March 2018. Staff welcomed the ongoing initiatives to further buttress financial sector stability. The new Financial Sector Regulation Act lays the foundation of the Twin Peaks model of financial regulation and confers on the SARB an explicit statutory mandate to enhance and protect financial stability. Putting in place a deposit insurance scheme will help stem the potential contagion from a localized event. Upgrading the stress testing framework and conducting it at least annually will help identify potential bank vulnerabilities. The authorities view the transition to the new Twin Peaks model as a way of further strengthening the financial stability framework. The envisaged resolution framework will allow failed small and medium-size banks to exit the system, thus limiting depositors’ losses without a negative impact on financial stability. SARB intends to expand stress tests (produced in cooperation with IMF capacity development) to include insurance companies.

The selected issues report highlights that the financial sector is large and highly integrated with other sectors of the economy. Overall, the large and highly concentrated banking sector is well-capitalized and profitable. Capital adequacy is above regulatory requirements, and profitability remains strong. However, a further slowdown in growth could result in an increase in the share of non-performing loans, thereby feeding into bank balance sheets. However, there are pockets of vulnerabilities within the sector. On average, banks outside the top 5 hold equity capital of around 15% of unweighted assets—nearly twice the level observed among Top 5 banks. However, NPLs among the smaller banks are also significantly higher than among the Top 5, with some smaller banks reporting NPLs of above 20% of loans. Notably, the balance of capital ratios and NPLs for a couple of medium-size and small banks is near that observed for African Bank when it was moving toward curatorship in 2014. Public Investment Corporation (PIC) constitutes a major part of the South African financial sector. Managing a significant share of pension fund assets in South Africa, the government-owned PIC is also the largest asset manager on the African continent, with more than R2.1 trillion of assets under management as of the end of 2017. Of these, close to 90% are those of the Government Employees Pension Fund (GEPF).

 

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Keywords: Middle East and Africa, South Africa, Banking, Article IV, NPLs, IMF

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