Supervision Department
13 July 2006
The 2005 annual report of the bank supervision department highlights four
key messages namely:
1. The use of information and communication technology systems by banks has
increased dramatically in the past number of years, a trend that is likely not
only to continue but to grow. Therefore, some thoughts on the importance of
such systems for the future viability and sustainability of banks are
highlighted.
2. During 2005, mortgage advances showed the strongest growth of the various
types of credit. As house prices have risen, lending innovations, such as a
wider array of loan products being offered to borrowers, have allowed more
borrowers to obtain larger mortgages for varying purposes than in the past. In
view of the innovative products, there has been some concern that banks
mortgage-loan portfolios may be vulnerable to a possible rise in interest rates
and in some markets, a decrease in house value. Therefore, the Bank Supervision
Department continuously encourages the implementation and maintenance of sound
risk-management practices by banks, in order for them to keep pace with such
risks as the banking cycle turns which were explained in detail in the 2004
Annual Report.
3. In 2005, the South African banking industry saw regulatory approval being
granted for the acquisition of a majority shareholding in ABSA Group Limited
(ABSA), a bank controlling company, by Barclays Bank plc United Kingdom (UK)
(Barclays). The transaction resulted in the first international ownership of
one of the larger South African banks. In view of the importance of the
transaction to the South African financial system, some thoughts on the
implications of the transaction for the economy of South Africa and its banking
system are highlighted.
4. Taking into account the ongoing developments in banks, bankers are urged
to take note of the need for proper succession planning and ongoing training of
directors, to enable them to meet the demands placed on them.
In chapter 1 of the report, the issues discussed include the following:
* Overview of trends in the South African banking sector
During 2005, the South African banking system remained stable, and in general,
banks were sound and continued to benefit from South Africaâs economic
health.
Banks were well capitalised and the average risk-weighted capital-adequacy
ratio for the banking system as a whole was 13,3 per cent at the end of
December 2005.
Growth in the total balance sheet remained strong throughout 2005. By the
end of December 2005, the total assets of banks comprising, amongst other
things, money, loans and advances, investment and trading position and
non-financial assets had increased by 12 per cent (measured over a period of
twelve months), to a level of R1 677,5 billion (December 2004: R1 489,4
billion).
Mortgage advances showed the strongest growth of the various types of
credit. At the end of 2005, the five largest banks (one of which is
internationally owned) represented about 89,6 per cent of the total banking
sector, whereas small local banks constituted 2,2 per cent of total
banking-sector assets and other international banks constituted 8,6 per cent of
the banking sector.
Total non-bank deposits increased by 21,1 per cent over the 12-month period
ended 31 December 2005 (December 2004: 20,5 per cent). The composition of
non-bank deposits remained largely unchanged during 2005.
Profitability indicators, however, declined somewhat during 2005. By the end
of December 2005, the average return on net qualifying capital and reserves
smoothed was 14,4 per cent, down from 14,7 per cent in December 2004, whereas
the return on assets smoothed decreased from 1,2 per cent in December 2004 to
1,1 per cent in December 2005. The efficiency of the banking sector also
started showing signs of a decline during the year under review, weakening from
63,9 per cent in December 2004 to 66,3 per cent in December 2005.
Throughout 2005, South African banks maintained adequate levels of
liquidity. In December 2005, banks liquid assets amounted to 119,7 per cent of
the liquid assets required to be held, compared to a level of 116,8 per cent in
December 2004. Besides banks experiencing strong asset growth in their core
products, gross amounts overdue also improved during 2005, from 1,8 per cent in
December 2004 to 1,5 per cent in December 2005. Banksâ provisioning against
these non-performing loans was adequate.
* Progress with implementation of Financial Sector Charter
During 2005, the Charter Council envisaged by the Financial Sector Charter set
up offices in Johannesburg and the Charter Council Principal Officer, Mr Enoch
Godongwana, was appointed in October 2005. The ten Charter Council committees
tasked with addressing the challenges of implementing the principal commitments
made in terms of the Charter met regularly throughout 2005, and most committees
completed their work.
Access standards for entry-level products across all financial industries
were finalised and approved by the Charter Council. Key indicators include
physical access, appropriateness, affordability, fair value, simplicity and
non-discrimination. Almost two million Mzansi accounts had been opened since
the launch of the product by the four major banks and the Post Bank in November
2004 and a money-transfer facility was launched in September 2005. Banks will
however, be required to enhance the Mzansi offering with affordable debit-order
facilities.
As regards definitions, measurements and targets, agreement had largely been
reached by December 2005. The Charter may however, have to be aligned in this
regard to the Codes of Good Practice published by the Department of Trade and
Industry.
All five big banks entered into black economic empowerment (BEE)
shareholding transactions, funded by structured finance and various hedging
transactions. The debt incurred by the BEE participants in the transactions is
to be repaid primarily from the share-dividend flow. Since the banks are
adequately capitalised to absorb any potential loss, default by any party would
have only a limited effect on a bankâs capital adequacy ratio.
* Barclays/ABSA transaction
A majority shareholding in ABSA Group Limited (ABSA), a controlling company,
was acquired by Barclays Bank plc (UK) (Barclays) in 2005. The transaction
resulted not only in the first international ownership of one of the larger
South African banks, but also in the receipt of the largest single foreign
direct investment in South Africa to date. The transaction also affirmed South
Africaâs position as an attractive and stable financial centre.
In view of the importance of the transaction to the South African financial
system, the Bank Supervision Department made a recommendation in terms of the
Banks Act to the Minister of Finance only after extensive consultation with
local and international stakeholders and after consideration of a multitude of
aspects. Of particular importance in the latter regard were the implications
for the economy of South Africa and its banking system, the implications of, as
well as arguments for and against, international ownership of a domestic bank
and considerations relating to the existing four-pillar policy.
* Evaluation of progress with South Africaâs economicâpolicy framework by
the International Monetary Fund
During May 2005, the International Monetary Fund evaluated the progress made
with various aspects of South Africaâs economic-policy framework. The
International Monetary Fund (IMF) directors noted that indicators of the South
African banking system's health were favourable and sound. In particular, it
was noted that most of the recommendations of the IMF/World Bank Financial
Sector Assessment Program, including legislation on anti-money laundering and
countering of terrorist financing, had been implemented and that enhancements
to the regulatory and supervisory framework would further strengthen the
financial sector's resilience to adverse shocks. The South African authorities
were encouraged to facilitate access to banking services for the whole
population and to speed up implementation of the Financial Sector Charter, as
well as the introduction of a regulatory framework for institutions providing
basic banking services.
* Succession planning for senior executives and training of directors
In the report, banks are urged to take note of the need for proper succession
planning and ongoing training of directors, particularly non-executive
directors. In line with the recommendation of the 2003 Myburgh Report on the
Standard of Corporate Governance in the five largest banks, the Banks Act was
amended to incorporate a requirement that banks establish a directorâs affairs
committee, consisting of non-executive directors only and with responsibility
for corporate governance and succession planning. Although succession planning
by banks has become more formalised, banks have to focus on updating the
succession plans for all senior executives. Banks also have to pay increased
attention to relevant training to equip newly appointed non-executive directors
properly to discharge their duties and responsibilities.
Chapter two focuses on important regulatory and supervisory developments,
both locally and abroad. These include the following:
* New Basel Capital Accord (Basel II)
Good progress was made during 2005 with preparations for the implementation of
Basel II on 1 January 2008. The Bank Supervision Department established a
dedicated project team, which includes quantitative analysts and risk
specialists, to drive the implementation of Basel II. Each risk specialist has
been assigned dedicated responsibility for a specific risk area or aspect of a
particular risk area. These responsibilities include, amongst other things,
provision of technical guidance on model validation and minimum criteria for
the use of more advanced approaches by banks. The risk specialists will also
lead onsite visits to banks to assess the quality of banksâ risk management
and, in the case of banks intending to use an advanced approach, the models,
methodologies and related controls used by such banks.
The previously established Accord Implementation Forum met on a regular
basis during 2005, resulting in a substantial increase in the number of
position papers issued. Proposed amendments to both the Banks Act and the
Regulations relating to Banks necessitated by Basel II were also circulated for
comment.
In order to assess banks readiness for Basel II, the Bank Supervision
Department analysed the results of the gap analyses and self-assessments
performed by banks, as well as the results of the fourth quantitative impact
study, aimed at assessing the possible impact of Basel II on the level of
banking capital. Problems identified are receiving ongoing attention, and
substantial progress was made during 2005. From a supervisory perspective, a
major challenge will be to balance the supervisory requirements of Basel II
with the available resources.
* Review of corporate governance in South African banks
Following the review of corporate governance in the five largest South African
banks in 2003, the Bank Supervision Department undertook a similar review of 14
other South African banks, including two mutual banks. The general findings
were similar to those of the 2003 review, but a number of concerns were
highlighted in the final report. These concerns related to the compliance
function, director selection, training, board monitoring of management and
unresolved issues, transformation within boards, effectiveness of directorsâ
affairs committees and segregation of duties. The Department is engaging with
the banks to ensure that these areas of concern are addressed.
* Interaction with other supervisors
The Bank Supervision Department continued to interact with other supervisors,
both locally and abroad, in fulfilling its regulatory and supervisory
responsibilities. Interaction with the Basel Committee on Banking Supervision
continued to be of particular importance at the international level, and at the
regional level, the Department continued to participate in the activities of
the SADC (Southern African Development Community) Subcommittee of Bank
Supervisors. Attendance of courses on bank supervision and training of staff
received particular attention so as to ensure that the Departmentâs skills base
is constantly improved.
* Alignment of South African Accounting Statements with International
Financial Reporting Standards
For financial years commencing on or after 1 January 2005, listed banks have to
prepare their consolidated financial statements in accordance with
International Financial Reporting Standards (IFRS), which also includes
International Accounting Standards. Although conversion to IFRS is compulsory
for the consolidated financial statements of listed banks, the statements of
other banks may continue to be prepared in accordance with South African
Statements of Generally Accepted Accounting Practice (SA GAAP). As part of the
process of bringing SA GAAP in line with IFRS, the Accounting Practices Board
in South Africa has reissued all SA GAAP statements and interpretations when
there were differences between these standards and those issued by the
International Accounting Standards Board (IASB). Consequently, all differences
in wording between the affected statements and interpretations were removed,
except when effective dates differed.
All listed banks in South Africa have spent a substantial amount of time and
effort on ensuring that their figures accord with IFRS and have reported the
effect of conversion from âoldâ GAAP in their opening balance sheet.
* Monitoring of banks compliance with anti-money-laundering
legislation
At a meeting during the earlier part of 2005, all banks had to give feedback to
the Bank Supervision Department on their progress with the further
implementation of know-your-client (KYC) procedures and the verification of
clients, consistent with the deadlines of the conditions of exemption from the
provisions of section 21(2) of the Financial Intelligence Centre Act, 2001
(FICA).
The Registrar of Banks also requested the five big banks to call for an
independent auditing firm to undertake physical verification of the
client-verification data that the banks had submitted in terms of Banks Act
Circular 10/2004. This verification was intended to give the Director of the
Financial Intelligence Centre (FIC) and the Minister of Finance comfort from an
external source that all data that had been submitted to the Department were
reliable. Further guidance on compliance with Financial Intelligence Centre Act
(FICA) by banks was subsequently issued by the FIC. A subsequent verification
review in October 2005 showed that substantial improvements had been made.
* Combating of illegal deposit-taking
The Bank Supervision Department is responsible for the administration of the
Banks Act, 1990, in terms of which the Registrar of Banks is tasked with,
amongst other things, controlling deposit taking of persons not registered as
banks or mutual banks. During 2005, three new inspections of unregistered
deposit-takers, together with 30 inspections carried over from 2004, were
undertaken. The Department also forwarded information to other regulatory
bodies to ensure that they were informed of possible contraventions by
unregistered persons.
* Deposit insurance
South Africa does not have an explicit deposit-insurance scheme (DIS) at
present. During 2000, the Minister of Finance requested the Bank Supervision
Department to participate in a joint project with the National Treasury to
investigate the requirements necessary to implement a South African DIS
(SADIS). A work group, consisting of members of the National Treasury, the
Department, the Banking Association of South Africa and others, was established
in order to research the issues and to make proposals on the establishment of
SADIS.
The Work Group has held numerous meetings and developed a number of
discussion and position papers over the years. The Work Group has also done
comprehensive research on DISs in other jurisdictions and has come to the
conclusion that each DIS was designed and implemented according to the specific
needs and requirements of the particular jurisdiction. Proposals on SADIS,
therefore are being developed to serve the purposes and interests of South
Africa, as well as to incorporate the international best-practice principles
and procedures available in order to attain that goal.
Issues requiring final resolution before a proposal is made to the Minister
relate to, amongst others, the legal nature of a possible SADIS, its functions,
roles and responsibilities, its funding and governance, basis of participation
in and membership of SADIS, reimbursement of depositors and failure resolution,
claims and recoveries.
* Liquidity-risk and market-risk management by South African banks
During 2005, the Bank Supervision Department undertook targeted reviews of
banks management of liquidity risk. Generally, the banks had liquidity
strategies, policies and procedures, standards and limits in place. The
Department communicated identified weaknesses or concerns to the banks
concerned and is monitoring progress with the rectification of deficiencies on
an ongoing basis.
The Regulations relating to Capital Adequacy Requirements (âCARâ) for Banks
Trading Activities in Financial Instruments require banks to report their
market-risk exposure and to determine their capital adequacy using one of a
number of methods, which vary in complexity. The simplified method is suited to
banks with âvanilla-typeâ trading books and few systems supporting their
trades. The building-block method is suited to banks with significant exposures
and which manage their risk internally with relatively manual processes and
systems. The internal model (IM) approach permits banks that are using
sophisticated risk-management systems not only to manage their risk and report
their exposure, but also to calculate their capital adequacy.
In order to assess the operational risks associated with the IM approach and
to review the multiplication factor used to determine a bankâs capital charge
more regularly, the Department is increasing the frequency of its onsite
reviews of trading banks. This will enable the Department more rapidly to
adjust the capital-charge requirements of banks using the IM approach via the
multiplication factor under both adverse and favourable results.
* Growth in mortgage loans
By the end of December 2005, South Africa had recorded mortgage-lending growth
of 28,6 per cent (measured over a period of 12 months), compared to growth of
25,6 per cent in December 2004. Factors leading to this growth included,
amongst other things, lower and variable mortgage-interest rates, a lower level
of inflation, lower income-tax rates and an increase in the real disposable
income of households, as well as in increase in speculative buying, also known
as the buy-to-let boom. As the regulator of banks, the Bank Supervision
Department will continue to ensure that banks risk-management processes are
appropriate for the high growth in mortgages.
* Supervision of representative offices
The Bank Supervision Department undertakes both onsite and offsite oversight,
in order to establish whether a representative office (RO) of a foreign banking
institution adheres to the applicable legislation. The onsite supervisory
function entails annual visits to all registered ROs operating in the Republic,
whereas the offsite supervisory function includes analysis of the quarterly
returns submitted by ROs and evaluation of the annual internal control reports
submitted by the ROs chief representative officers. During 2005, advisory
services to network customers, advice on offshore private-banking investment
and correspondent banking were the main areas business of the ROs operating in
South Africa.
* Information and communication systems
The information and communication systems used by the Bank Supervision
Department have evolved into sophisticated and efficient analytical tools over
the years. A number of controls are in place when the Department captures and
processes the DI returns submitted by banks, and the Department has developed
approximately 1 000 reports and graphs, for use in the analysis of banks.
Additional analytical requirements, resulting partly from the impending
implementation of the new Basel Capital Accord, however, have necessitated
upgrading of the Departmentâs database and technology.
Chapter three highlights developments in the South African bank-regulatory
framework, as follows:
* Proposed amendments to the Banks Act, 1990, and the Regulations
thereto
A first draft of proposed amendments was approved by the Standing Committee for
the Revision of the Banks Act, 1990, during November 2005 and was circulated to
all banks, for comment, and a second draft was circulated at the end of January
2006. The proposed amendments to the Banks Act are aimed mainly at addressing
the prescriptions of the new Capital Accord (Basel II), although some other
necessary amendments are also proposed. The prescriptions contained in Basel II
have also necessitated a complete revision of the Regulations relating to
Banks.
Other legislation likely to affect the banking industry:
Other pieces of draft legislation likely to affect the banking industry, as
well as the ongoing regulation and supervision of banks by the Bank Supervision
Department, include the National Credit Bill, 2005 (which will regulate all
credit extension), proposed legislation relating to the establishment of
second-tier and third-tier banks (namely, the Dedicated Banks Bill, 2004, and
the Co-operative Banks Bill, 2004) and a proposed section in the Companies
Amendment Bill, 2005, requiring audit committees for public-interest
companies.
In chapter four and appendix six of the report, trends in the South African
banking sector, based on risk-based information submitted by banks during 2005,
are outlined under the following headings:
* Balance-sheet structure
The aggregated balance sheet of the banking sector in South Africa equalled R1
677,5 billion as at 31 December 2005, as opposed to R1 498,4 billion as at 31
December 2004 and R1 379,8 billion as at 31 December 2003. During 2005, growth
in the aggregated balance sheet accelerated until June 2005 (15,8 per cent),
but moderated to 15,3 per cent in September 2005. By the end of 2005, a growth
rate of 12 per cent had been recorded. Domestic deposits from the public, in
the amount of R1 101,5 billion, remained the main source of funding for the
banking sector and constituted 65,7 per cent of total liabilities in December
2005, compared to 60,7 per cent in December 2004. Short-term deposits remained
the largest component of total non-bank funding and accounted for 66,2 per cent
of total non-bank funding as at 31 December 2005. The sharp increase of R116,2
billion in mortgage loans, to a level of R522,4 billion, representing an
increase of 28,6 per cent, during 2005 was due, amongst other things, to South
Africa having experienced a lower interest-rate environment from June 2003, as
well increased demand for housing by the previously disadvantaged sector of the
population.
* Capital adequacy
For 2005, the average capital and reserves held by the banking sector amounted
to R130,7 billion (R116,5 billion in December 2004), and R122,5 billion (R107,5
billion in December 2004) thereof constituted qualifying capital and reserves
for purposes of assessing capital adequacy. The capital-adequacy ratio for the
banking sector in total as at the end of December 2005 was 13,3 per cent (2004:
12,7 per cent).
* Profitability
During 2005, there was a gradual decline in both the return on equity and the
return on assets, owing to a decline in net income after tax, resulting mainly
from higher operating expenses. For 2005, an after-tax return of approximately
1,1 per cent on total assets (1,2 per cent for 2004) was reported, whereas an
after-tax return of approximately 14,5 per cent was reported on net qualifying
capital and reserves (14,7 per cent for 2004).
* Liquidity risk
The average daily amount of liquid assets held by banks exceeded the statutory
liquid-asset requirement throughout 2005. For the month of December 2005, the
average daily amount of liquid assets held represented 119,7 per cent of the
statutory liquid-asset requirement, compared to 116,8 per cent for December
2004.
* Market risk
Turnover in derivatives, excluding forward contracts, generally fluctuated
during 2005. Total turnover in derivative contracts, excluding forward
contracts, increased from R475,8 billion in January 2005 to R840,7 billion in
August 2005, before declining to R728,9 billion in December 2005. Forward
contracts contributed to the largest portion of total turnover in derivative
instruments and increased from R1 442,5 billion in January 2005 to R2 172,5
billion in August 2005, but decreased to R1 346 billion in December 2005.
* Credit risk
Banks experienced enhanced asset growth in their core products during 2005, the
main products being mortgages, instalments and overdrafts, owing mainly to
favourable economic conditions. These growing credit portfolios were generally
well managed by banks, as evidenced by the level of total overdues, which
continued to decrease, from R20,4 billion in December 2004 to R20,1 billion in
December 2005.
* Currency risk
From December 2004 to December 2005, the maximum net open position in foreign
currency after hedging increased from 0,83 per cent to 1,7 per cent, but
remained well within the limit of 10 per cent of net qualifying capital and
reserves.
Appendices one to five and seven to nine of the report contain useful
administrative information.
Enquiries: Ms Samantha Henkeman
Tel: (012) 313-4669
Cell: 083 209 0570
Issued by: South African Reserve Bank
13 July 2006
Source: South African Reserve Bank (http://www.reservebank.co.za/)
