supervision department
26 June 2007
The 2006 Annual Report of the bank supervision department highlights five
key messages namely:
1. All financial institutions are equally concerned about disruptions to
business continuity, a State of continued, uninterrupted operation of a
business. Therefore, some views on business disruptions and business continuity
planning are highlighted in the introductory section of the report.
2. In 2006, the Basel Committee on banking supervision published a revised
version of the document titled core principles for effective banking
supervision commonly referred to as the core principles. Banking supervisors as
well as the International Monetary Fund (IMF) and World Bank use the core
principles to assess the quality of a banking supervisory system, identify any
weakness that may exist and to determine the way in which the major sources of
risk to such systems are being managed. The bank supervision department
(department) performed a self assessment of compliance with the revised core
principles.
3. The department continued to monitor corporate governance practices of
banks during 2006 focusing mainly on the induction and development of
directors. It was found that banks' induction and training programmes diverged
significantly and therefore the department encouraged banks to make use of a
director development programme that was introduced by a local tertiary
institution.
4. All parties involved in and impacted by the implementation of the new
Capital Accord (Basel II) on 1 January 2008 have intensified their preparation
efforts. Legislation required for effecting Basel II implementation is at an
advanced stage and will be considered for approval during 2007.
5.
The department is of the opinion that all banks have made good progress in the
implementation of anti money laundering and combating the finance of terrorism
measures. The department continued to foster a close working relationship with
the financial intelligence centre in the interest of ensuring a high level of
value added by the banking industry to the attainment of international best
practice requirements.
Chapter 1 of the report discusses, inter alia, the following issues:
Overview of trends in the South African banking sector
During 2006, the South African banking system remained stable and banks were
adequately capitalised with the banking sector capital adequacy ratio remaining
in excess of the minimum requirement of 10 percent. The capital adequacy ratio
decreased from 12,7 percent in December 2005 to 12,3 percent in December
2006.
Total balance sheet growth remained strong during 2006 but eased towards the
end of the year. By the end of December 2006, total banking sector assets had
increased by 23,7 percent (measured over 12 months) to a level of R2 075,1
billion (December 2005: R1 677,5 billion). The five largest banks constituted
89,7 percent of the total assets of all banking institutions as at the end of
December 2006 (December 2005: 89,6 percent).
Non-bank deposits remained the main source of funding for the banking sector
and constituted 65,2 percent of total liabilities (2005: 65,7 percent). Total
non bank deposits increased by 22,9 percent (measured over 12 months) amounting
to R1 353,2 billion, compared to the 21,1 percent growth in December 2005 (R1
101,5 billion). The composition of non bank deposits remained fairly stable
during 2006.
Profitability ratios improved throughout 2006. By the end of December 2006,
a return of 18,3 percent on net qualifying capital and reserves (12 month
smoothed average) was reported, compared to 15,2 percent in December 2005.
Return on assets (12 month smoothed average) amounted to 1,4 percent at the end
of December 2006 (December 2005: 1,2 percent). The banking sector's efficiency
ratio displayed steady improvement, breaking the 60 percent level to end the
year under review at 58,9 percent (December 2005: 66,3 percent).
The banking sector maintained an adequate amount of liquid assets during
2006, exceeding the statutory liquid asset requirement. In December, the
average daily amount of liquid assets held by banks represented 111,2 percent
of the statutory liquid asset requirement compared to 119,7 percent in December
2005.
Non-performing loans continued to decrease during 2006. This decrease
should, however, be seen against the backdrop that gross over dues in respect
of mortgages deteriorated from R6,1 billion in December 2005 to R6,9 billion in
December 2006. This deterioration was offset by an improvement in the gross
over dues in respect of other loans and advances. Expressed as a percentage of
total loans and advances, gross over dues improved from 1,5 percent in December
2005 to 1,1 percent in December 2006. In terms of the minimum regulatory
requirements, provisioning by banks remained adequate.
Development of bank directors
During 2006, the department continued to monitor the corporate governance
practices of banks and focused mainly on the induction and development of
individual directors. Notwithstanding the uniqueness of individual banks'
operations, the department is of the view that directors of all banks should be
exposed to homogenous development programmes that will equip them to perform
their fiduciary duties. However, following an analysis of all banks' induction
and training programmes it was clear that these programmes diverged
significantly.
The department brought the above mentioned findings to the attention of the
Banking Association South Africa (BASA) which agreed to pursue the matter. A
local tertiary institution, as requested by the BASA, developed a director
development programme consisting of three courses namely: introductory course,
Banking Board Leadership Programme and Bank Board Leadership Forum.
The introductory course aims to familiarise participants with the regulatory
environment in which banks operate and introduce key concepts and principles.
The second course will provide participants with a broad understanding of risk
management in banks at governance level and will endeavour to equip them with
the skills to apply their knowledge in the fulfilment of their statutory and
fiduciary duties. The final course is aimed at instilling a deeper
understanding of the principles covered in the first two courses by focusing on
"real life" experiences and the development of "best practice" approaches.
The department believes that the development programme will meet the needs
of both new and experienced directors. The programme is sufficiently
comprehensive for new directors to be provided with a solid foundation to
comfortably enter the banking arena and for experienced directors to stay
abreast of current developments in the banking system. For these reasons, the
department, by way of Banks Act Circular 9/2006, encouraged the chairpersons of
banks to utilise the programme to ensure that proposed directors have a basic
understanding of banking. Furthermore, it was emphasised that this development
programme should be considered supplementary to internal induction and
development programmes and not as an alternative thereto.
International supervisory interaction
As in previous years, the department continued to interact with other global
national supervisors. Meetings were held with host supervisors in Argentina,
Mauritius and Namibia and the department was invited to attend a seminar hosted
by the supervisory authority in Indonesia.
The department maintained its participation in the working streams, seminars
and training events of the Basel Committee which are viewed as particularly
important. Furthermore, representatives of the department also participated in
events organised by the IMF and World Bank.
International Conference of Banking Supervisors (ICBS)
In October 2006, the department attended the International Conference of
Banking Supervisors (ICBS) hosted by the National Banking and Securities
Commission, Mexico, in the city of Merida in Mexico. The ICBS is held
biennially and is aimed at promoting co-operation among national supervisory
authorities and enables these authorities to exchange views on current issues
of common concern. A range of topics were discussed at the 2006 ICBS including
the following: the main changes to the updated core principles for effective
banking supervision, corporate governance of banks, governance and
accountability of financial supervisors, risk based supervision and several
topics related to the new Basel Capital Accord (Basel II).
Proliferation of credit in South Africa
Members of the public lately have been exposed to a proliferation of new
names linked to banking services. These developments could prove to be
confusing to the public as banking names are now being linked to retail
outlets, cellular telephone service providers and other such companies. These
new names that have entered the banking market might cause uncertainty in the
mind of the public as to the origin and soundness of such initiatives. They are
portrayed as being stand alone initiatives whereas they are undertaken as joint
ventures with or as divisions that are currently registered banking
institutions. From a supervisory point of view, the department ensures that the
risk management pertaining to such joint ventures or divisions of banking
institutions is of the highest standard and in so doing, endeavours to ensure
that these business initiatives and the proliferation of banking services will
not dilute the public's trust in the banking system.
2006 International Monetary Fund Article IV consultation
Following its 2005 Article IV consultation, the IMF commended the South
African authorities for their continued implementation of sound macroeconomic
and financial policies. In 2006, the Article IV discussions with the IMF were
held in Pretoria and Cape Town. The IMF staff report was once again very
supportive of the strategies and policies implemented to address social
concerns while preserving macroeconomic stability. Furthermore, the view was
expressed that the banking sector was sound and well regulated while noting
also the progress made in improving access to banking services for the poor and
aligning banking regulations with international standards.
Chapter two focuses on important regulatory and supervisory developments,
both locally and abroad. These include the following:
Core principles for effective banking supervision
The Basel Committee on banking supervision published a revised version of
the document titled core principles for effective banking supervision, commonly
referred to as the core principles. Banking supervisors as well as the IMF and
World Bank use the Core Principles to assess the quality of a banking
supervisory system, identify any weakness that may exist and to determine the
way in which the major sources of risk to such systems are being managed.
Following the publication of the original core principles in 1997,
significant developments have taken place in both banking regulation and in the
manner in which banks conduct their business. Issues that particularly have
come to the fore are risk management, corporate governance and anti-money
laundering concerns. Furthermore, the numerous compliance assessments that have
been performed have identified some shortcomings in the core principles. In
this light, the Basel Committee initiated the process of revising the core
principles at the end of 2004 culminating in the publication of the revised
version in October 2006.
During the first half of 2006, the department performed a self assessment of
compliance with the revised core principles. The core principles had at that
stage not been endorsed for publication and therefore the department monitored
all further amendments throughout the assessment process. This exercise was
facilitated by the department having served as a member of the working group
responsible for revising the core principles. The key objectives of the self
assessment process were to benchmark the South African banking supervisory
system against the core principles, conduct a comprehensive gap analysis and
develop an action plan for eliminating the shortcomings that were identified. A
project team continues to meet on a monthly basis to assess the progress made
in implementing the action plans. The ultimate objective for the department is
to obtain a favourable rating when it is next assessed by the IMF and World
Bank.
New Basel capital accord
During 2006 all parties involved in and affected by the activities of the
Accord Implementation Forum (AIF) intensified their efforts to prepare for
Basel II implementation on 1 January 2008. A second draft of the proposed
amendments to the regulations relating to banks (proposed regulations) was made
available by the department to the AIF forums from the end of January 2006. The
proposed regulatory returns were subjected to a variety of tests, which
highlighted areas for improvement and further refinement. A comprehensive third
draft of the proposed regulations was made available in October 2006, where
after further updated modules were released until the end of November 2006. It
is anticipated that the Minister of Finance will consider for approval the
proposed regulations during the latter part of 2007, which will enable the
implementation of Basel II on 1 January 2008.
During the year, the department requested locally incorporated banks
targeting the advanced approaches for credit and/or operational risk and other
specially selected smaller banks to take part in Quantitative Impact Study 5
(QIS 5). The purpose of QIS 5 was, inter alia, to obtain relevant information
pertaining to the impact of implementing Basel II, assess the state of
preparedness for Basel II implementation and develop guidance on relevant
issues pertaining to Basel II. Banks that did not participate in QIS 5
conducted formal field tests of the proposed statutory returns for credit risk
and financial information. The purpose of the field tests was to assist the
department in assessing the level of preparedness for the implementation of the
new regulatory framework and to ensure that the objectives set for the proposed
regulations could be met and that they would facilitate the implementation of
Basel II.
Apart from the quality of resources, supervisors worldwide continue to face
many challenges in ensuring that the implementation of Basel II can be effected
in a manner that is appropriate in their respective countries, while at the
same time ensuring that the objectives of the Basel II framework are
achieved.
Review of compliance with the Financial Intelligence Centre Act (FICA),
2001
During 2006 the department performed a review similar to that conducted at
the five largest banks during 2005, of the remaining banks and selected
branches of foreign banks to verify compliance with the requirements of the
FICA. The Department is of the view that banking institutions have made good
progress in the implementation of anti money laundering and combating the
finance of terrorism measures. As part of its ongoing monitoring and
supervision in this regard, the department proposed that the role of the
internal audit function of banks be extended to include FICA requirements.
Combating of illegal deposit taking
The department is primarily responsible for the regulation and supervision
of registered banks in the Republic of South Africa. It neither registers nor
supervises investment schemes. The Banks Act, however, provides that no person
may conduct the "business of a bank" unless such a person is a public company
and is registered as a bank. Sections 81 to 84 of the Banks Act, 1990 afford
the department certain powers to control the activities of unregistered
persons. During the year under review, the department investigated
approximately 40 such unregistered businesses or investment schemes.
Market-risk management by South African banks
During 2006, the department conducted in-depth reviews on banks following
the internal model approach (IMA) to calculate the capital requirement for
market risk. These reviews were part of the process of annual IMA approval and
re-assessment of the value at risk (VaR) multiplication factor. Accompanying
the task of annual and new approvals for this approach is a strategy for
increased frequency of on-site reviews that the Department has begun to
deploy.
Liquidity risk management
Due to the growth in long dated assets, i.e. mortgage loans, which were
mainly being funded by short term funding the department continued to focus on
liquidity risk management during the year under review. This asset growth had
resulted in a general increase in liquidity risk especially in the short term
maturity mismatch of banks. At the annual meetings held with the respective
boards of directors of the banks, the department engaged on this issue.
Supervision of financial conglomerates: Joint Forum
The Joint Forum, established under the auspices of the Basel Committee, the
International Organisation of Securities Commissions and the International
Association of Insurance Supervisors is the standard setting body in respect of
financial conglomerates. South Africa, together with two other non Joint Forum
member countries was invited to participate in a new Joint Forum working stream
on conglomerate principles in 2006. The exercise comprises stock taking of the
implementation by supervisors globally of the principles contained in the Joint
Forum's Supervision of Financial Conglomerates.
Independent regulatory board of auditors
Following recommendations made by the review panel on the accountancy
profession on which the Department served the Auditing Profession Act, 2005
(the Act) was promulgated and assented to by the President of the Republic of
South Africa in January 2006. The Act created the Independent Regulatory Board
of Auditors (IRBA) and places a duty on registered auditors to report to IRBA
instances where reportable irregularities have taken or are taking place in an
entity in respect of which they are the registered auditors. In terms of the
Act, the IRBA is required to report such continuing irregularities pertaining
to banking institutions to the department.
Chapter three highlights developments in the South African banking
regulatory framework, as follows:
* Developments relating to banking legislation
In May 2006, the standing committee for the Revision of the Banks Act, 1990
approved draft six of the proposed Banks Amendment Bill (the Bill) after which
it was submitted to the Minister of Finance for his consideration and approval
to publish for public comment. Draft seven of the Bill which incorporated
public comments and subsequent comments from the November standing committee
meeting, was submitted to the Minister of Finance in order to initiate the
parliamentary process during 2007. The Bill is intended to be effective from 1
January 2008.
* Regulations relating to banks
In August 2006 draft three of the proposed amendments to the regulations
relating to banks (proposed regulations) was submitted to the Minister of
Finance for initial review and evaluation. Draft three of the proposed
regulations was also circulated to the AIF in October 2006 for further testing
and to facilitate discussion of high priority issues. The comments received
were incorporated into the proposed regulations and it is envisaged that draft
four of the proposed regulations will be available during the first quarter of
2007. The proposed regulations will be tabled at the standing committee during
2007 for approval, after which it will be finalised and submitted to the
Minister of Finance for his consideration and approval.
In Chapter four and Appendix 6 trends in the South African banking sector,
based on risk based information submitted by banks during 2006, are outlined
according to the following headings:
* Balance sheet structure
The aggregated balance sheet size of the banking sector in South Africa
amounted to R2 075,1 billion as at 31 December 2006, in comparison to R1 677,5
billion as at 31 December 2005 and R1 498,4 billion as at 31 December 2004.
During 2006 the aggregated balance sheet of the banking sector continued to
grow strongly, albeit at a slower rate, during the fourth quarter of 2006.
During 2006 the growth rate accelerated until September 2006 (27,4 percent) and
ended the year at 23,7 percent (December 2005, 12 percent). The main source of
funding in the amount of R1 353,2 billion remained domestic deposits from the
public constituting 65,2 percent of total liabilities in December 2006
(December 2005, 65,7 percent). Short term deposits remained the largest
component of total non-bank funding and accounted for 67,3 percent of total
non-bank funding as at the end of December 2006, compared to 66,2 percent as at
the end of December 2005. Total loans and advances equalled R1 735,8 billion by
the end of December 2006, as opposed to R1 353,6 billion as at the end of
December 2005, representing a growth rate of 28,2 percent. The strong growth
during 2006 was mainly due to growth in mortgage loans, followed by growth in
overdrafts and loans, instalment debtors and foreign currency loans.
* Capital adequacy
Total net qualifying capital increased by 20,3 percent from R127,4 billion
in December 2005 to R153,3 billion in December 2006. However, the total capital
requirement increased by 24,5 percent from R100,3 to R124,9 billion during the
corresponding period, resulting in the capital adequacy ratio decreasing from
12,7 percent in December 2005 to 12,3 percent in December 2006. Although the
capital adequacy ratio was lower, it remained in excess of the minimum 10
percent requirement throughout 2006.
* Profitability
Favourable economic conditions, among other things, contributed to the
improvement in banks' profitability ratios during 2006. At the end of December
2006, an after tax return of 1,4 percent on total assets (2005, 1,2 percent)
was reported, whereas an after-tax return of 18,3 percent on net qualifying
capital and reserves (2005, 15,2 percent) was reported. The banking sector's
efficiency ratio (smoothed over a 12 month period) improved from 66,3 percent
in December 2005 to 58,9 percent in December 2006.
* Liquidity risk
Throughout 2006 the average daily amount of liquid assets held by banks
exceeded the statutory liquid asset requirement. The average daily amount of
liquid assets held in December 2006 represented 111,2 percent of the statutory
liquid asset requirement, compared to 119,7 percent in December 2005.
* Derivative contracts
During 2006 forward contracts remained the main contributors to total
derivative turnover. Turnover in forward contracts amounted to R1,879 billion
in December 2006 (December 2005, R1,346 billion), while the remainder of the
turnover in derivative contracts amounted to R739,2 billion in December 2006
(December 2005, R728,9 billion).
* Credit risk
Gross over dues continued along a downward trend, tapering off from R20,1
billion in December 2005 to R18,8 billion in December 2006. Expressed as a
percentage of total loans and advances, gross amounts overdue improved from 1,5
percent in December 2005 to 1,1 percent in December 2006 as a result of strong
asset growth and a decline in gross over dues caused by favourable economic
conditions. Although total gross over dues decreased, it should be noted that
gross over dues in respect of mortgages increased from R6,1 billion in December
2005 to R6,9 billion in December 2006.
* Currency risk
During 2006 the aggregated effective net open foreign currency position
fluctuated at higher levels than in 2005, but remained well within the limit of
10 percent of net qualifying capital and reserves. In December 2006 the net
open foreign currency position amounted to 1,1 percent, compared to 1,5 percent
in December 2005.
Appendices 1 to 5 and 7 to 9 of the report contain useful administrative
information.
Contact person:
Ms Samantha Henkeman
Tel: 012 313 4669
E-mail: Sam.Henkeman@resbank.co.za
Issued by: South African Reserve Bank
26 June 2007
Source: South African Reserve Bank (http://www.reservebank.co.za/)
