## 1zafea2022003

## Source details

**Canonical URL:** [1zafea2022003](https://www.imf.org/-/media/files/publications/cr/2022/english/1zafea2022003.pdf)

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---

### Executive summary
- Major finding: "The financial system has thus far weathered the shock of COVID-19, but risks continue to loom amidst a weak macroeconomic  outlook.  The pandemic crisis hit South Africa hard, as nonresident capital outflows  accelerated,  and the domestic and global slowdown precipitated a"
- Real output contracted by 6.4 percent in 2020.
- A brief period of liquidity stress was managed with new central bank facilities and a lowering of liquidity requirements.
- Banks proved resilient thanks to sound capital and liquidity buffers.
- Pension and investment funds have assets under management of almost 140 percent of GDP.
- Banks account for about12  0 percent of GDP, with the five largest banks accounting for almost   90 percent of banking sector assets.
- Pandemic-related expenditures and underperforming SOEs raised public sector indebtedness and sovereign risk.

### Macroeconomic context and scenarios
- Key macro series (Table 2, selected rows; values preserved exactly):
  - Real GDP: 2018 1.5, 2019 0.1, 2020 -6.4, 2021 5.0, 2022 2.2, 2023 1.4
  - Real GDP per capita: 2018 0.0, 2019 -1.3, 2020 -7.8, 2021 4.1, 2022 0.6, 2023 -0.1
  - Unemployment rate (percent of labor force, annual average): 2018 27.1, 2019 28.7, 2020 29.4, 2021 33.4, 2022 34.3, 2023 36.1
  - Gross government debt (percent of GDP): 2018 51.6, 2019 56.3, 2020 69.4, 2021 68.8, 2022 72.3, 2023 74.9
  - Current account balance (billions of U.S. dollars): 2018 -13.1, 2019 -10.6, 2020 6.6, 2021 11.9, 2022 -3.8, 2023 -6.3
  - Gross reserves (billions of U.S. dollars): 2018 51.6, 2019 55.1, 2020 55.5, 2021 60.0, 2022 59.8, 2023 58.7
  - Repo rate (percent, end-period): 2018 6.8, 2019 6.5, 2020 3.5, 2021 3.5
- Adverse scenario characteristics:
  - Adverse scenario entails adverse domestic, external and pandemic related shocks in 2021 and 2022.
  - Monetary policy in the adverse scenario remains accommodative amid some capital outflows.1/
  - In the WEO baseline, the repo rate and the 10-year sovereign yield remain constant from 2021 onward, respectively at 8.7 percent and 3.5 percent. The bilateral USD-r and exchange rate depreciates by 7 per cent by 2026.
  - Asset prices experience a significant shock resulting from capital outflows and a weak domestic economy.
  - Adverse scenario used in solvency stress tests captures four risk channels: (i) resurgence of the COVID-19 pandemic; (ii) de-anchoring of inflation expectations in the United States; (iii) protracted domestic uncertainty amidst reduced policy space and worsening confidence; and (iv) an intensification of the sovereign–financial sector nexus.

### Banking sector: solvency stress testing — key findings
- Coverage and parameters:
  - Tests covered the six largest banks as of December 2020, using a Common Equity Tier 1 (CET1) hurdle rate of 4.5 percent.
  - Horizon: three-year simulations (2021–2023).
- Baseline outcome:
  - Capitalization could improve by more than 200 basis points (bps), driven by improving net interest income; some reduction in risk-weighted assets (RWA) in 2021; declining provisioning costs; and modest losses on sovereign exposures.
- Adverse outcome:
  - Capitalization could decline by 250–340 bps.
  - Aggregate capital shortfall of 0.6–0.8 percent of GDP by 2023.
  - One bank breaching minimum requirements.
- Drivers and sensitivities:
  - Drivers: reduced net interest income as NPLs increase; elevated loan loss provisions; losses on sovereign exposures.
  - Concentration risk: combined default of banks’ five largest private sector exposures as of December 2020 could erode up to 10 percent of bank capital.
  - Counterfactuals: (i) stripping moderating policy effects implies additional recapitalization needs of 0.3 percent of GDP by 2023; (ii) 1/3 migration of restructured exposures to NPLs implies additional recapitalization needs of 0.15 percent of GDP by 2023; (iii) modeled deposit-pricing response would reduce computed capital shortfall by 0.1 percent of GDP in 2023.
- Tier 1 capital ratio (T1R) path (WEO baseline):
  - Dec-20 12.6%
  - Dec-21 13.6%
  - Dec-22 14.3%
  - Dec-23 14.8%
- Adverse model results (selected):
  - Model A T1R: Dec-20 12.6%, Dec-21 13.1%, Dec-22 12.3%, Dec-23 10.1%
  - Model B T1R: Dec-20 12.6%, Dec-21 12.8%, Dec-22 11.7%, Dec-23 9.2%
  - Necessary Recapitalization (% of GDP) Model A: Dec-23 0% (earlier years 0%); Model B: Dec-23 0.8% (Dec-22 0.04%)
- Caution: stress test results subject to substantial uncertainty; credit risks may evolve differently than historical patterns.

### Banking sector: liquidity stress testing — key findings
- Funding and ratios:
  - Loan-to-deposit ratio and ratio of liquid assets to liquid asset requirements improved in 2020; liquidity coverage ratios (LCR) remain above SARB’s requirements.
  - All banks met the Basel LCR requirements at the onset of the pandemic, though some saw ratios decline below the Basel requirement consistent with regulatory flexibility afforded by the PA.
  - Under the PA’s regulatory parameters, all banks meet the NSFR threshold; two banks’ NSFR are slightly below 100 percent if Basel III parameters are applied.
- Cash-flow analysis:
  - Aggregate banking system faces a small net funding gap of some 2 percent of assets at 1–7 days maturity under the baseline, concentrated in 2 banks.
  - Under a severe scenario, the funding gap widens to about 10 percent at these maturities.
  - Two banks show modest net funding gaps at longer maturities as well.
- Vulnerabilities:
  - Wholesale funding and NFC deposits may be less stable in idiosyncratic concerns.
  - Currency breakdown suggests multiple banks vulnerable to USD-related funding pressures, although FX exposures are relatively small.
  - Under more severe stress on outflows, the overnight funding gap becomes large even after use of the counterbalancing capacity and a small funding gap appears at maturities above the one-month horizon.

### Nonbank financial sector risks
- Insurance sector:
  - Solvency ratios remain high; capital ratios remain well above regulatory minima.
  - Vulnerabilities: inclusion of sizeable future profits in Tier 1 capital, high lapse and surrender rates, substantial exposure to equities.
  - Impact of IFRS 17 adoption should be carefully monitored.
- Investment funds:
  - AuM continue to grow.
  - Money market funds (MMFs) experienced over 90 billion Rand inflows during 2020; MMFs exposures to government and public entity paper rose sharply—reaching almost 20 percent at end-2020.
  - MMFs are vulnerable to large redemptions (briefly observed at pandemic onset).
- Pension funds:
  - Private pension funds faced modest valuation declines during 2020; portfolios of the Public Investment Company (PIC) proved more resilient.

### Macrofinancial linkages: households and corporates
- Households:
  - Household debt to GDP: 2018 43.3, 2019 43.8, 2020 44.3, 2021 45.0
  - Household finances improved as real disposable income recovers from COVID-related decline.
  - Debt-related vulnerabilities concentrated among lower-income households; indebtedness low in absolute terms but relatively high relative to income.
  - Recommendation: establish a central credit register to support better credit risk monitoring.
- Corporates:
  - Corporate debt at 40 percent of GDP as of Q4-2020.
  - Baseline: firms with ICR<1 would represent 30–35 percent of outstanding corporate debt in 2021 and 2022.
  - Adverse scenario: almost 40 percent of firms, accounting for more than 40 percent of the debt stock in 2022, would remain vulnerable with an ICR<1.
  - Corporate default ratio has declined below 3 percent; corporate NPLs in banks’ balance sheets have remained relatively stable.
  - Corporate stress test mapping: under the adverse scenario, inflow of NPLs would amount to 4 percent of Tier one capital in 2021, 2.9 percent in 2022 and 2.4 percent in 2023 (benchmarking to median Moody’s KMV).

### Interconnectedness and contagion
- System structure and exposures:
  - Financial system is large and complex: banks account for about12  0 percent of GDP, five largest banks account for almost   90 percent of banking sector assets.
  - Nonbanks (pension funds, insurance products, investment funds) channel domestic savings and act as important liquidity providers to banks.
  - Banks’ reliance on funding from insurers is high by global standards; funding from investment funds ranks among highest for emerging market peers.
  - Money market funds: almost 90 percent of total assets concentrated within large banks.
- Domestic contagion:
  - Inter-bank and inter-insurance exposures have increased since the last FSAP.
  - D-SIBs identified as primary source of potential domestic contagion; capital erosion largely stemming from one bank.
  - Smaller banks are more vulnerable to cascading shocks than larger institutions.
- Cross-border exposures:
  - Foreign banking sector claims increased almost nine times since last FSAP, with exposures to SSA region accounting for almost 30 percent (vis-a-vis 20 percent in 2014).
  - Contribution of SSA to total revenues for South African banking sector increased to 15 percent, up from 10 percent in 2014.
  - Claims on South African parents (accounting for 10–30 percent of host countries’ GDP in some cases) pose risks to financial stability in host jurisdictions.

### Capital flows
- Capital flows have become increasingly volatile since the last FSAP.
- Nonresident portfolio debt flows predominantly in local currency, making them highly sensitive to domestic macro weaknesses and external shocks.
- Drop in foreign participation ahead of March 2020 sovereign credit rating downgrade was absorbed by domestic investors; SARB’s purchases in secondary market partly enabled domestic banks to absorb primary debt issuances.
- Capital-flows-at-risk analysis: drivers vary by flow type; nonresident portfolio equity flows and direct investment flows more sensitive to domestic fundamentals; nonresident portfolio debt flows primarily driven by external risk appetite.

### Climate change risk analysis
- Physical risks:
  - Severe droughts are principal physical risk; several banks have relatively large exposures to drought-sensitive sectors in affected provinces.
  - Difference-in-difference econometric analysis suggests banks assign significantly higher PDs (about 5 percentage points on average) to sectors more vulnerable to water shortages in affected provinces.
- Transition risks:
  - Technological transition to green energy: incremental increases in expected default frequency and defaulted debt from permanently higher electricity prices.
  - Carbon tax increase scenario (absent pass-through) estimating higher production costs.
  - "A rapid carbon price increase to a mid-point estimate needed to stabilize emissions could, under severe assumptions, result in a doubling of corporate debt at risk."
- Recommendations: enhance data gathering and analysis, finalize green taxonomy, enhance disclosure, and consider issuing ‘green’ sovereign bonds.

### Financial oversight, regulation, and supervisory recommendations
- Institutional architecture:
  - SARB is the designated macroprudential authority; the Governor—advised by FSOC and SARB’s FSC—is the main decision-maker.
  - Twin Peaks model: Prudential Authority (PA) within SARB handles prudential regulation; Financial Sector Conduct Authority (FSCA) handles market conduct.
- Key supervisory recommendations and timing (ST = short term 0–6 months; MT = medium term 6 months–2 years; NT = near term):
  - Further strengthen analytical tools, including for solvency and liquidity stress testing and climate risk analysis; incorporate results in risk-based supervision (SARB, PA MT).
  - Continue to broaden the macroprudential toolkit and close data gaps (SARB MT).
  - Consider carefully calibrated measures to alleviate sovereign–financial nexus (SARB, NT MT).
  - Continue safeguarding supervisory agencies’ operational independence; further strengthen resourcing and enhance coordination (PA, FSCA, NCR NT MT).
  - Pursue more structured, intrusive, and comprehensive (risk-based) supervision, with greater focus on governance and credit, liquidity and other significant risk management (PA, FSCA ST).
  - Develop a rigorous framework for early intervention in banks (PA MT).
  - Scrutinize insurers’ capital calculations, review products with high lapse and surrender rates, conduct industry-wide stress tests, and analyze impact of IFRS 17 adoption (PA, FSCA MT).
  - Enact COFI bill; develop and implement conduct supervision framework (NT, FSCA MT).
  - Fast-track adoption of the NPS Act, while buttressing supervision of fintechs (NT, FSCA, ST).
  - Implement a consistent, multi-sectoral regulatory framework for cyber resiliency (SARB, PA MT).
  - Improve climate risk oversight (SARB, PA MT).
  - Improve implementation of the risk-based approach to AML/CFT and bring all sectors covered by the FATF standards under the AML/CFT framework (NT, PA MT).
  - Adopt and operationalize the new resolution and deposit insurance legislation; following adoption, step up crisis preparedness through resolvability assessments, resolution planning, and recurrent simulations (NT, SARB ST).
  - Extend SARB’s ELA guidance to temporary liquidity support for solvent banks (SARB MT).
  - Improve the repo market by establishing collateral interoperability; harmonizing regulatory treatments of different types collateral and repos; and promoting wide-spread use of repos under the Global Master Repo Agreement (GMRA) (NT, SARB, PA, FSCA ST).
  - Enable provision of payment services by nonbanks; foster retail payment instrument interoperability and open banking standards; improve credit information environment; strengthen secure transaction framework; finalize taxonomy of ‘green’ economic activities and start monitoring flows; finalize guidelines on climate-related financial disclosures (various authorities ST/MT as listed).

### Crisis management, liquidity management, and safety nets
- Priority actions:
  - Adopt and operationalize draft amendments to designate SARB as resolution authority, introduce new resolution powers, and establish a deposit insurance scheme (DIS).
  - After adoption: operationalize resolution manual, DIS payout capabilities, ascertain ‘single customer view’ deposit data, undertake resolvability assessments, resolution planning, and recurrent simulation exercises.
  - Finalize loss-absorbing requirements for systemic banks; consider a mechanism for temporary public funding sourced from National Treasury with strict preconditions.
  - To strengthen DIS funding: consider determining a funding target for the (nonrepayable) ‘equity’ tranche to be met via ex ante industry contributions.
- Liquidity management improvements:
  - Develop the repo market by improving collateral management, harmonizing regulatory treatments, and promoting use of classic repo under GMRA.
  - Fully aligning SABOR with international best practice will improve market integrity.
  - Move National Treasury liquidity to a SARB settlement account to reduce contagion risk.
  - SARB’s ELA framework should be extended to liquidity support for solvent banks and legal underpinnings of lender-of-last-resort function strengthened over the medium term.

### Financial sector development, inclusion, and market improvements
- Financial inclusion and access:
  - Approximately four in five adults have a bank account.
  - Utilization of accounts and digital payments is much lower than account ownership.
  - Less than four percent of SMEs have a credit line.
  - Estimates of the credit gap between supply and demand vary between 9 and 15 percent of GDP.
  - Recommended priorities: reform secured transactions framework; improve credit bureau reporting; establish a national credit bureau; use alternative data for creditworthiness; enable nonbanks to provide payment services; use sandbox to target inclusion challenges.
- Market development:
  - ETP for government bonds can improve pricing transparency and support a more developed yield curve.
  - Repo and money market improvements: improve interoperability between SARB and Strate; introduce additional NBFIs as repo participants; enhance collateral management; harmonize tax treatment of repos; introduce T-bill market-making requirement for primary dealers.
  - Support green investments via credible climate and energy plans, National Climate Finance Strategy, disclosures and green taxonomy.

### Risk Assessment Matrix (selected entries)
- Global risks:
  - Resurgence of the COVID-19 pandemic — Likelihood: High — Impact: High/Medium
  - Rising yields and risk premia due to a de-anchoring of inflation expectations — Likelihood: Medium — Impact: High/Medium
  - Cyber attacks — Likelihood: Medium — Impact: High
- Domestic risks:
  - Intensification of the sovereign-financial institutions nexus — Likelihood: Medium — Impact: High/Medium
  - Protracted domestic uncertainty amidst reduced policy space and worsening confidence — Likelihood: High — Impact: High
  - Higher frequency and severity of natural disasters related to climate change and transition risks — Likelihood: Medium — Impact: Medium

### Key financial soundness indicators (selected, values preserved exactly)
- Regulatory capital to risk weighted assets: 2018 16.1, 2019 16.6, 2020 16.6, 2021 17.3
- Tier 1 capital (of which): 2018 14.9, 2019 15.6, 2020 15.7, 2021 16.4
- Nonperforming loans to total of loans: 2018 3.7, 2019 3.9, 2020 5.2, 2021 5.2
- Return on assets: 2018 1.7, 2019 1.5, 2020 0.6, 2021 0.9
- Return on equity: 2018 19.8, 2019 17.6, 2020 7.7, 2021 11.8
- Liquid assets to total assets: 2018 15.6, 2019 15.0, 2020 15.2, 2021 15.8
- Residential real estate price growth (as of September, 2021): 3.8 (2018), 3.5 (2019), 2.5 (2020), 4.3 (2021)

_Italic: Source: EXECUTIVE SUMMARY and selected chapters, appendices, and figures from the provided IMF content unit 1zafea2022003._

### EXECUTIVE SUMMARY ___________________________________________________________________________ 7

### EXECUTIVE SUMMARY ___________________________________________________________________________ 7

### Major finding
- "The financial system has thus far weathered the shock of COVID-19, but risks continue to loom amidst a weak macroeconomic  outlook.  The pandemic crisis hit South Africa hard, as nonresident capital outflows  accelerated,  and the domestic and global slowdown precipitated a"

### Background
- Sections listed: BACKGROUND (page 10)
  - A. Macrofinancial Context
  - B. Financial System Structure

### Systemic Risk Assessment
- Sections listed: SYSTEMIC RISK ASSESSMENT (page 12)
  - A. Key Risks, Assessment Methods, and Scenarios
  - B. Bank Solvency Stress Tests (page 16)
  - C. Bank Liquidity Stress Tests (page 16)
  - D. Nonbank Risk Analysis: Insurers, Fund Managers, and Pension Funds (page 17)
  - E. Macrofinancial Linkages: Households and Corporate Sector (page 18)
  - F. Interconnectedness (page 18)
  - G. Capital Flows (page 19)
  - H. Climate Change Risk Analysis (page 20)
- Box: 1. How Vulnerable Are Smaller Banks? (page 13)
- Figures referenced for systemic assessment: Figures 4, 5, 13, 14, 15, 16, 17, 18, 19, 20 (pages as listed in the source)

### Financial Sector Oversight
- Sections listed: FINANCIAL SECTOR OVERSIGHT (page 21)
  - A. System-Wide Oversight and Macroprudential Policies
  - B. Systemic Liquidity Management

### Financial Supervision and Regulation
- Sections listed: FINANCIAL SUPERVISION AND REGULATION (page 22)

### Crisis Management and Financial Safety Nets
- Sections listed: CRISIS MANAGEMENT AND FINANCIAL SAFETY NETS (page 24)

### Financial Sector Development
- Sections listed: FINANCIAL SECTOR DEVELOPMENT (page 25)
  - A. Competition and Efficiency (page 25)
  - B. Financial Inclusion and Access to Finance (page 26)
  - C. Market Development (page 26)

### Authorities' Views
- Section listed: AUTHORITIES' VIEWS (page 27)

### Figures (selection as listed)
- 1. Macroeconomic Context (page 10)
- 2. Market Developments (page 11)
- 3. Financial System Structure (page 12)
- 4. Bank Sovereign Nexus (page 14)
- 5. Macroeconomic Scenarios (page 15)
- 6. Macroprudential Policy (page 21)
- 7. Macroeconomic Context (page 28)
- 8. Temporary Measures to Offset the Impact of COVID-19 (page 29)
- 9. South Africa and Peer Countries: Financial Soundness Indicators (page 30)
- 10. Insurance Sector Developments (page 31)
- 11. Nonfinancial Corporate Sector (page 32)
- 12. Household Sector (page 33)
- 13. Growth-at-Risk (page 34)
- 14. Solvency Stress Tests (page 35)
- 15. Bank Stress Testing Sensitivity Analysis (page 36)
- 16. Bank Liquidity Stress Tests (page 37)
- 17. Domestic Interconnectedness (page 38)
- 18. Cross-Border Interconnectedness (page 39)
- 19. Capital Flows (page 40)
- 20. Climate Risks (page 41)
- 21. Banking Sector Competition and Efficiency (page 42)
- 22. Financial Inclusion and Access to Finance (page 43)

### Tables (selection as listed)
- Table 1. Key Recommendations (page 9)
- Table 2. Selected Economic Indicators, 2018–23 (page 44)
- Table 3. Financial Soundness Indicators, 2018–21 (page 45)

### Appendices (selection as listed)
- I. Stress Testing Matrix (page 46)
- II. Risk Assessment Matrix (page 55)
- III. Corporate Sector Stress Test (page 56)
- IV. Managing the Sovereign-Financial Sector Nexus (page 58)
- V. Twin Peaks Implementation (page 59)
- VI. Status Recommendations 2014 FSAP (page 60)

### Glossary (selected acronyms preserved verbatim)
- AML/CFT Anti-Money Laundering and Combating the Financing of Terrorism
- AUM Assets Under Management
- CET1 Common Equity  Tier 1
- CIS Collective Investment  Schemes
- DBSD Department of Small Business Development
- DIS Deposit Insurance Scheme
- D-SIBDomestic Systemically Important Bank
- ELAEmergency Liquidity  Assistance
- ESGEnvironmental,  Social and Governance
- ETPElectronic Trading Platform
- EWIEarly Warning Indicator
- FATFFinancial  Action  Task  Force
- FDIForeign Direct Investment
- FICFinancial  Intelligence  Center
- FMAFinancial  Markets Act
- FMIFinancial  Market Infrastructure
- FSAPFinancial  Sector Assessment Program
- FSBFinancial  Stability  Board
- FSLABFinancial  Sector  Laws  Amendment  Bill
- FSCFinancial Stability  Committee
- FSCAFinancial  Sector  Conduct  Authority
- FXForeign Exchange
- GaRGrowth-at-Risk
- GDPGross Domestic Product
- GEPFGovernment Employees’ Pension Fund
- ICRInterest Coverage Ratio
- IFRSInternational  Financial  Reporting  Standards
- IFWGInter-governmental  Fintech  Working Group
- IMFInternational  Monetary Fund
- JSEJohannesburg Stock Exchange
- LCRLiquidity  Coverage Ratio
- LGDLoss Given Default
- MMMoney Market Fund
- MSMEMicro, small, and medium-sized enterprises
- NBFINonbank Financial  Institution
- NCRNational Credit Regulator
- NDCNationally Determined Contribution
- NGFSNetwork for Greening the Financial  Sector
- NPL Nonperforming Loan
- NPS National Payment System
- NSFR Net Stable Funding  Ratio
- NT 
- ODP Over-the-counter Derivatives Providers
- PA Prudential Authority
- PD Probability of Default
- PIC Public  Investment  Company
- RAM Risk Assessment Matrix
- RBA Risk-Based Approach
- RWA Risk-Weighted Assets
- SACCRA South  African Credit and Risk Reporting Association
- SAM Solvency Assessment and Management framework
- SARB South  African Reserve Bank
- SME Small and Medium-Sized Enterprises
- SOE State-Owned  Enterprises
- SSA Sub-Saharan Africa
- TCFD Task Force on Climate-related Financial Disclosures
- USD United States Dollar
- WB World Bank
- WEO World Economic Outlook

*Source: EXECUTIVE SUMMARY (pages and headings as listed in the supplied IMF content unit).*

### 6.4 percent GDP real output  contraction in 2020. A brief period of liquidity  stress was managed with

### 1zafea2022003 - 6.4 percent GDP real output  contraction in 2020. A brief period of liquidity  stress was managed with

### Macroeconomic and immediate pandemic impact
- Real output contracted by 6.4 percent in 2020.
- A brief period of liquidity stress was managed with new central bank facilities and a lowering of liquidity requirements.
- Banks proved resilient thanks to sound capital and liquidity buffers.
- Asset management and pension assets saw falling valuations, but redemption pressures quickly dissipated as markets stabilized.
- Pandemic-related expenditures and underperforming SOEs raised public sector indebtedness and sovereign risk.
- The flexible exchange rate, favorable composition of government debt (long maturity and mainly in local currency), and a resilient banking system acted as shock absorbers.

### Key financial system structure and exposures
- The financial system is large and complex: banks account for about12  0 percent of GDP, with the five largest banks accounting for almost   90 percent of banking sector assets.
- Pension and investment funds have assets under management of almost 140 percent of GDP.
- Nonbanks (pension funds, insurance products, investment funds) channel domestic savings and act as important liquidity providers to banks.
- Banks have low exposures to foreign currency assets; pension, investment funds and life insurances are by rule dedicated to rand investments.
- Interconnectedness: major banks are affiliated with insurers and fund managers; bank-affiliated insurers underwrite a substantial proportion of private pension assets.

### Sovereign–financial nexus and corporate/household vulnerabilities
- Lack of fiscal reform, looming fiscal contingencies from underperforming SOEs, and pandemic-related expenditures intensified the sovereign–financial system nexus.
- Domestic banks increased holdings of sovereign debt as nonresident investors reduced their holdings; as of November 2021 domestic banks held around 20 percent of all outstanding domestic sovereign bonds, up from around 17 percent at end-2019. Insurance companies held another 7 percent (6 percent at end-2019).
- Corporate debt at 40 percent of GDP as of Q4-2020; rising leverage, risk concentrations, and relatively high obligations in foreign currency raise concerns.
- Corporate default ratio has declined below 3 percent; corporate NPLs in banks’ balance sheets have remained relatively stable.
- Household finances experienced severe strain in 2020 with aggregate disposable income dropping and employment reaching its lowest point in the past decade; retail portfolio default ratios approached levels observed during the global financial crisis but have since stabilized.

### Banking and insurance resilience and stress testing
- Banks and insurers appear well-capitalized and liquid in the baseline but may face significant capital erosion under a modeled adverse scenario.
- A medium-term adverse stress scenario would cause a significant decline in capital although most banks would remain sufficiently capitalized.
- Under stress, banks could face some liquidity gaps, particularly at very short maturities, highlighting importance of close monitoring and development of domestic repo and money markets.
- The solvency stress test used April 2021 WEO forecasts as baseline and an adverse scenario capturing four risk channels: (i) resurgence of the COVID-19 pandemic; (ii) de-anchoring of inflation expectations in the United States; (iii) protracted domestic uncertainty amidst reduced policy space and worsening confidence; and (iv) an intensification of the sovereign–financial sector nexus.
- Insurance sector: capital ratios remain well above regulatory minima but concerns arise from inclusion of substantial future profits in capital, high lapse and surrender rates, and substantial exposure to equities. Tepid business growth and guaranteed-return products could generate additional pressures if low interest rates persist.

### Financial oversight, prudential policy, and regulatory recommendations
- Financial sector oversight is strong, with implementation of the “twin peaks” regulatory structure and strengthened risk-based supervision; however, the environment calls for stepped up intrusiveness in prudential supervision and full implementation of the market conduct framework.
- Recommendations and implementation timing (ST = short term 0–6 months; MT = medium term 6 months–2 years):
  - Further strengthen analytical tools, including for solvency and liquidity stress testing and climate risk analysis; incorporate results in risk-based supervision (SARB, PA MT).
  - Continue to broaden the macroprudential toolkit and close data gaps (SARB MT).
  - Consider carefully calibrated measures to alleviate sovereign–financial nexus (SARB, NT MT).
  - Continue safeguarding supervisory agencies’ operational independence; further strengthen resourcing and enhance coordination (PA, FSCA, NCR NT MT).
  - Pursue more structured, intrusive, and comprehensive (risk-based) supervision, with greater focus on governance and credit, liquidity and other significant risk management (PA, FSCA ST).
  - Develop a rigorous framework for early intervention in banks (PA MT).
  - Scrutinize insurers’ capital calculations, review products with high lapse and surrender rates, conduct industry-wide stress tests, and analyze impact of IFRS 17 adoption (PA, FSCA MT).
  - Enact COFI bill; develop and implement conduct supervision framework (NT, FSCA MT).
  - Fast-track adoption of the NPS Act, while buttressing supervision of fintechs (NT, FSCA, ST).
  - Implement a consistent, multi-sectoral regulatory framework for cyber resiliency (SARB, PA MT).
  - Improve climate risk oversight (SARB, PA MT).
  - Improve implementation of the risk-based approach to AML/CFT and bring all sectors covered by the FATF standards under the AML/CFT framework (NT, PA MT).
  - Adopt and operationalize the new resolution and deposit insurance legislation; following adoption, step up crisis preparedness through resolvability assessments, resolution planning, and recurrent simulations (NT, SARB ST).
  - Extend SARB’s ELA guidance to temporary liquidity support for solvent banks (SARB MT).
  - Improve the repo market by establishing collateral interoperability; harmonizing regulatory treatments of different types collateral and repos; and promoting wide-spread use of repos under the Global Master Repo Agreement (GMRA) (NT, SARB, PA, FSCA ST).
  - Enable provision of payment services by nonbanks; foster retail payment instrument interoperability and open banking standards; improve credit information environment; strengthen secure transaction framework; finalize taxonomy of ‘green’ economic activities and start monitoring flows; finalize guidelines on climate-related financial disclosures (various authorities ST/MT as listed).

### Financial safety nets, liquidity management, and market functioning
- Completing and operationalizing the bank resolution framework and establishing the new deposit insurance scheme—while strengthening its financing arrangements—is imperative.
- Practices for liquidity management can be strengthened: repo market liquidity and functioning would be improved with changes in treatment of collateral; fully aligning SABOR with international best practice will improve market integrity; moving National Treasury liquidity to a SARB settlement account will reduce contagion risk.
- SARB’s ELA framework could be extended to provision of liquidity support to solvent banks facing idiosyncratic shocks; over the medium term, the legal underpinnings of the SARB’s ‘lender-of-last-resort’ function should be strengthened.
- The impact of capital flow volatility is mitigated by the flexible exchange rate, low levels of foreign currency exposures, and prudential limits on foreign investments, but these features deepen interconnectedness and vulnerability to cross-sectoral contagion.

### Financial inclusion, fintech, and climate-related financial risks
- Main financial inclusion challenges: reaching the “last mile” of unbanked adults, increasing the use of digital financial services and MSME access to finance, and addressing persistently high levels of credit impairment.
- Policy actions to support inclusion and competition: encourage fintech solutions, embed regulatory frameworks for fintech including payment providers and crypto assets, amend the National Payment System Act, and adopt the Conduct of Financial Institutions (COFI) bill.
- The Financial Inclusion Implementation Strategy Policy should prioritize: enhanced credit information systems, establishing a national credit bureau, improving the secure transactions framework, and promoting payment systems interoperability.
- Climate stress tests indicate non-negligible implications of transition and physical risks over the medium term; enhance data gathering and analysis, finalize green taxonomy, enhance disclosure, and consider issuing ‘green’ sovereign bonds.

*Source: 1zafea2022003 - 6.4 percent GDP real output  contraction in 2020. A brief period of liquidity  stress was managed with*

### Appendix II). To gauge liquidity  risks, the FSAP conducted cash flow analyses and assessed banks’

### 1zafea2022003 - Appendix II). To gauge liquidity  risks, the FSAP conducted cash flow analyses and assessed banks’

### Macroeconomic scenarios
- Adverse scenario entails adverse domestic, external and pandemic related shocks in 2021 and 2022.
- Monetary policy in the adverse scenario remains accommodative amid some capital outflows.1/
- In the WEO baseline, the repo rate and the 10-year sovereign yield remain constant from 2021 onward, respectively at 8.7 percent and 3.5 percent. The bilateral USD-r and exchange rate depreciates by 7 per cent by 2026.
- Asset prices experience a significant shock resulting from capital outflows and a weak domestic economy.
- Figures referenced: Real GDP growth (WEO Baseline vs Adverse scenario); Annual GDP Growth time series; Interest rates and exchange rate projections (NEER depreciation, Repo rate, 10 year sovereign yield); Asset price growth (House Price Growth, Stock Price Growth).

### B. Bank solvency stress tests — key findings
- Tests covered the six largest banks as of December 2020, using a Common Equity Tier 1 (CET1) hurdle rate of 4.5 percent.
- Horizon: three-year simulations.
- Baseline scenario:
  - Capitalization could improve by more than 200 basis points (bps), driven by improving net interest income; some reduction in risk-weighted assets (RWA) in 2021; declining provisioning costs; and modest losses on sovereign exposures.
- Adverse scenario:
  - Capitalization could decline by 250–340 bps.
  - Aggregate capital shortfall of 0.6–0.8 percent of GDP by 2023.
  - One bank breaching minimum requirements.
- Drivers of capital erosion: reduced net interest income as NPLs increase; elevated loan loss provisions; losses on sovereign exposures (fair value through profit or loss or through other comprehensive income).
- Sensitivity analyses of real estate, sovereign spreads and portfolio concentrations indicate further loss potential in worsening environments.
- Concentration risk: combined default of banks’ five largest private sector exposures as of December 2020 could erode up to 10 percent of bank capital (Figure 15).
- Pandemic-policy counterfactuals:
  - Three counterfactual experiments: (i) adjusted PD calculations to strip out moderating effect of pandemic policies; (ii) simulated migration of 1/3 of remaining stock of COVID-19 restructured exposures to nonperforming loans; (iii) lower deposit rates offered by banks experiencing large declines in net income to improve spreads.
  - First two counterfactuals imply additional recapitalization needs of 0.3 and 0.15 percent of GDP, respectively, by 2023.
  - Modeled deposit-pricing response would reduce computed capital shortfall by 0.1 percent of GDP in 2023.
- Caution: stress test results subject to substantial uncertainty; credit risks may evolve differently than historical patterns.7

### C. Bank liquidity stress tests — key findings
- Large banks have been well-funded since COVID-19 outbreak, though some funding-profile vulnerabilities exist.
- Loan-to-deposit ratio and ratio of liquid assets to liquid asset requirements improved in 2020; liquidity coverage ratios (LCR) remain above SARB’s requirements.
- Deposit growth steady, driven by call deposits; banks’ net open foreign exchange (FX) positions largely unchanged. Short-term liabilities increased as a share of total liabilities.
- Wholesale funding and NFC deposits may be less stable in idiosyncratic concerns; prudential limits on foreign investments limit capital flight risks.
- LCR analysis:
  - All banks met the Basel LCR requirements at the onset of the pandemic, though some saw ratios decline below the Basel requirement consistent with regulatory flexibility afforded by the PA.9
  - Simulations with larger shocks than Basel envisages would result in some banks having LCR ratios below the Basel threshold.
  - Currency breakdown suggests multiple banks vulnerable to USD-related funding pressures, although FX exposures are relatively small.
- Cash flow analysis:
  - Aggregate banking system faces a small net funding gap of some 2 percent of assets at 1–7 days maturity under the baseline, concentrated in 2 banks.
  - Under a severe scenario, the funding gap widens to about 10 percent at these maturities.
  - Two banks show modest net funding gaps at longer maturities as well.
- Net stable funding ratio (NSFR):
  - All banks meet NSFR threshold under the PA’s regulatory parameters.
  - Two banks’ NSFR are slightly below 100 percent if Basel III parameters are applied.10

### D. Nonbank risk analysis: insurers, fund managers, and pension funds
- Insurance sector:
  - Pandemic impact muted; investment losses and elevated lapse and surrender rates caused sharp fall in life insurers’ profitability in H1 2020, but profitability stabilized as capital markets recovered.
  - Solvency ratios remain high; inclusion of sizeable future profits from existing policies into Tier 1 capital poses a vulnerability.
  - Solvency benefited from higher yields on South African government bonds, reducing value of long-term insurance liabilities.
  - Impact of IFRS 17 on insurance sector solvency ratios should be carefully monitored.11
- Investment funds:
  - Assets under management (AuM) continue to grow.
  - Money market funds (MMFs) experienced over 90 billion Rand inflows during 2020; MMFs vulnerable to large redemptions (briefly observed at pandemic onset).
  - MMFs exposures shifted: exposures to financial institutions declined significantly during 2020; exposures to government and public entity paper rose sharply—reaching almost 20 percent at end-2020.
- Pension funds:
  - Private pension funds faced modest valuation declines during 2020; portfolios of the Public Investment Company (PIC) proved more resilient.12

### E. Macrofinancial linkages: households and corporate sector
- Households:
  - Household finances improved as real disposable income recovers from COVID-related decline.
  - South Africa’s household debt ratio remains elevated relative to emerging market peers; significant wealth inequality may mask pockets of vulnerability.
  - National Income Dynamics Study data signal debt-related vulnerabilities for lower-income households: indebtedness low in absolute terms but relatively high relative to income (Figure 12).
  - Interest rate reductions and loan restructurings helped alleviate COVID-19 impact; pressures may re-emerge as policies normalize or if pandemic resurges.
  - Recommendation: a central credit register could help inform financial stability analysis and support better credit risk monitoring by banks.
- Corporates:
  - Scenario-based stress tests of publicly listed corporates and Eskom indicate:
    - Baseline: firms with interest coverage ratios (ICR) <1 would represent 30–35 percent of outstanding corporate debt in 2021 and 2022.13
    - Adverse scenario: almost 40 percent of firms, accounting for more than 40 percent of the debt stock in 2022, would remain vulnerable with an ICR<1.
  - Large corporate vulnerabilities could translate into significant credit risks for the banking system (Appendix III).

### F. Interconnectedness
- Sectoral contagion risks limited except in most extreme scenarios, despite increased interconnectedness.
- Inter-bank and inter-insurance exposures have increased since the last FSAP.
- Simulations of cascading defaults identify D-SIBs as primary source of potential domestic contagion; capital erosion largely stemming from one bank.
- Smaller banks are more vulnerable to cascading shocks than larger institutions (Figure 17).
- Spillovers within insurance sector concentrated in a few institutions; multi-round failures generate modest capital losses. Life insurers generally more impacted than non-life insurers.
- Cross-sectoral linkages:
  - Banks’ reliance on funding from insurers high by global standards; funding from investment funds ranks among highest for emerging market peers.
  - Money market funds: almost 90 percent of total assets concentrated within large banks.
  - In the adverse scenario, cross-sectoral exposures led to multiple rounds of cascading defaults and indirect spillovers, substantially increasing magnitude of spillovers.
  - Most cross-sectoral exposure resides in large banks, making them more vulnerable to shocks from rest of financial system.14
- Regional exposures:
  - Foreign banking sector claims increased almost nine times since last FSAP, with exposures to SSA region accounting for almost 30 percent (vis-a-vis 20 percent in 2014).
  - Contribution of SSA to total revenues for South African banking sector increased to 15 percent, up from 10 percent in 2014, increasing susceptibility to inward spillovers.
  - Claims on South African parents (accounting for 10–30 percent of host countries’ GDP in some cases) pose risks to financial stability in host jurisdictions, underscoring importance of robust buffers (Figure 18).

### G. Capital flows
- Capital flows to South Africa have become increasingly volatile since the last FSAP.
- Trends reflect interplay between higher-than-average sensitivity to external shocks and a deep domestic investor base that offsets volatility.
- Nonresident portfolio debt flows predominantly in local currency, making them highly sensitive to domestic macro weaknesses and external shocks.15
- Drop in foreign participation ahead of March 2020 sovereign credit rating downgrade, exacerbated by pandemic, was absorbed by domestic investors; SARB’s purchases in secondary market partly enabled domestic banks to absorb primary debt issuances.
- Capital-flows-at-risk analysis:
  - Drivers of flows vary significantly by type of capital flow.16
  - Nonresident portfolio equity flows and direct investment flows more sensitive to domestic fundamentals, with higher impact during surges.
  - Nonresident portfolio debt flows primarily driven by external risk appetite.17
  - Flows to sovereign bond market more affected by global risk aversion shocks while flows to the corporate...

*Source: IMF staff calculations; content excerpted from the FSAP Appendix II material.*

### Chapter 3  of  the Global Financial Stability Report, April 2020.

### 1zafea2022003 - Chapter 3 of the Global Financial Stability Report, April 2020

### Climate Change Risk Analysis
- Climate change poses potential negative impacts on the banking sector due to South Africa’s arid climate, geographical position, and high dependence on fossil fuel production and consumption, exposing the financial sector to physical and transition risks.
- Physical risks:
  - Severe droughts are the principal physical risk; several banks have relatively large exposures to drought-sensitive sectors in affected provinces.
  - Insurance companies face increased underwriting risks, though underwriting risks “appear manageable due to the relatively small and geographically diversified exposures of insurers.”
  - Difference-in-difference econometric analysis suggests banks already assign significantly higher PDs (about 5 percentage points on average) to sectors more vulnerable to water shortages in affected provinces.
- Transition risks:
  - Risks arise from technology shifts and policy dimensions given high carbon emissions and a large carbon pricing gap.
  - Stress tests used two scenarios:
    - A technological transition to green energy estimating incremental increases in expected default frequency and defaulted debt from permanently higher electricity prices.
    - A carbon tax increase scenario (absent any pass-through to end users) estimating higher production costs.
  - Results indicate a shift from coal-based energy production could contribute to sustained price hikes that squeeze NFCs’ margins and increase credit risks.
  - “A rapid carbon price increase to a mid-point estimate needed to stabilize emissions could, under severe assumptions, result in a doubling of corporate debt at risk.”

*Italic: Source — Chapter 3 of the Global Financial Stability Report, April 2020.*

### System-Wide Oversight and Macroprudential Policies
- Institutional arrangements:
  - The South African Reserve Bank (SARB) is the designated macroprudential authority; the Governor—advised by the interagency Financial Stability Oversight Committee (FSOC) and SARB’s internal Financial Stability Committee (FSC)—is the main decision-maker.
  - SARB’s hard powers are mostly limited to systemically important financial institutions as identified by the Governor; designation of an event as ‘systemic’ may be required to attain wider authority, which can create stigma and unintended side-effects.
  - Recommendation: Ensure SARB has adequate powers without needing a systemic designation to improve macroprudential use and reduce adverse market reaction.
- Monitoring and toolkit:
  - SARB’s monitoring capacity is well-advanced, relying on macrofinancial indicators, stress tests, analytical tools, and a published Risk and Vulnerabilities Matrix in the Financial Stability Review (FSR).
  - Data gaps limit analysis of tail risks and calibration of borrower-based tools due to limited access to micro data.
  - The macroprudential toolkit for nonbanks lags international peers; the toolkit for banks is broadly sufficient.
  - Consider adoption of measures to alleviate the sovereign-financial nexus to strengthen system resilience.

### Systemic Liquidity Management
- SARB’s liquidity framework:
  - The framework functions well; SARB monitors financial market developments closely and has the ability and track record to manage system-wide liquidity needs.
  - Opportunities: develop the repo market by improving collateral management, moving toward more favorable regulation, and wider use of classic repo under the Global Repo Master Agreement.
  - Planned revisions of SARB’s overnight benchmark interest rate should be completed “as soon as practicable.”
- Emergency Liquidity Assistance (ELA):
  - SARB has new internal guidance for liquidity support to banks that have become (or are expected to become) non-viable.
  - Additional guidance is needed for extension of liquidity to solvent but temporarily illiquid banks outside of resolution, including strengthened capacity for solvency and viability assessments.
  - Legal changes are advisable to fully align legislation with best practices.
- Government cash management:
  - A gradual migration of National Treasury’s operational rand liquidity balances from the largest banks to SARB would reduce risks; outstanding balances reinforce too-big-to-fail, generate competitive distortions, and can undermine asset allocation.
  - Distributing cash balances among a larger group of banks is not recommended due to cash management complications.

### Financial Supervision and Regulation
- Regulatory architecture:
  - Since 2018, the Twin Peaks model reformed supervisory architecture: Prudential Authority (PA) within SARB handles prudential regulation and supervision of banks, insurance companies, and market infrastructures; Financial Sector Conduct Authority (FSCA) handles market conduct and prudential supervision of pension schemes and investment funds; National Credit Regulator (NCR) regulates consumer credit.
  - AML/CFT responsibilities are discharged through the Financial Intelligence Center Act, mandating supervisory bodies to ensure compliance.
- FSAP findings and supervisory recommendations:
  - Banking:
    - The regulatory framework is strong; enhanced capital and liquidity standards proved fortuitous during the COVID-19 crisis.
    - The PA should: (i) pivot to a more structured and intrusive approach with recalibrated on-site/off-site supervision, more risk specialists, and greater focus on governance, credit, liquidity and other significant risks; (ii) reduce reliance on external auditors; (iii) introduce a structured framework for early intervention; and (iv) clarify supervisory expectations to influence industry behavior.
  - Insurance:
    - Introduction of SAM and group-wide supervision are key milestones.
    - Concern: discount rates for insurance liabilities under SAM are calibrated from sovereign bond yields without credit risk adjustments.
    - Recommendations: enhanced monitoring, industry-wide stress testing, impact studies of IFRS 17 adoption, stronger focus on investment risks for life insurers’ high equity exposure, greater scrutiny of the quality of capital resources, and attention to potential liquidity risks from high lapse and surrender rates.
  - Fund management:
    - Reforms underway, with the Conduct of Financial Institutions (COFI) Bill envisaged as cornerstone.
    - Potential improvements: conflict-of-interest rules for investment fund managers, accounting and disclosure requirements, capital requirements and risk management for OTC Derivatives Providers.
    - Adoption of Conduct of Business Standards should bolster conduct supervision and close regulatory gaps.
  - Pensions:
    - Legal framework and supervisory approach need updating to address long-standing governance problems.
    - Needs: detailed regulations (e.g., valuation, use of derivatives), stronger risk-based supervision, improved governance, and investment policies grounded in best interests of policyholders.

### Fintech, Cyber Resilience, and Climate-related Supervision
- Fintech:
  - SARB is championing legal reforms to allow nonbank fintechs to issue e-money, offer payment services, enable nonbank payment service providers to access central bank settlement services (subject to risk management), and transfer regulatory powers to SARB.
  - Interim measures are needed to enhance monitoring and supervision of fintech, focusing on data collection and monitoring developments outside the regulatory perimeter.
- Cyber resilience:
  - Recommend development of a cross-sectoral cybersecurity framework based on binding prudential standards, increased onsite examination frequency, and allocation of resources to ensure consistency in cyber risk management.
  - Amendments to the NPS Act are needed to formally adopt CPMI-IOSCO Principles for Financial Market Infrastructures (FMI) and establish SARB’s oversight powers.
  - Service providers should be assessed against the CPMI-IOSCO Assessment Methodology for Oversight Expectations Applicable to Critical Service Providers.
- Climate change risks:
  - Since joining NGFS in 2019, SARB has increased focus on climate risks; further efforts should expand climate risks in stress testing and supervision.
  - Recommendations: issue guidelines on climate risk management, governance, and disclosure; integrate climate change risks in supervisory dialogue, onsite inspections, and supervisory ratings.

### AML/CFT
- South Africa has a solid legal framework but needs more proactive pursuit of money laundering (ML) and terrorist financing (TF) and improved implementation of a risk-based approach.
- Historical context: a sustained period of “state capture” undermined key AML/CFT agencies and generated substantial corruption proceeds.
- Recommendations: improve application of a risk-based approach by businesses and supervisors, strengthen market entry controls, and extend sectoral coverage to virtual assets service providers.

### Crisis Management and Financial Safety Nets
- Pending reforms:
  - Draft amendments published in 2018 aim to strengthen the framework for failing banks by designating SARB as resolution authority for banks and systemically important nonbank financial institutions, introducing new resolution powers, and establishing a deposit insurance scheme (DIS).
  - Authorities should: (i) prioritize adoption of the legislation and operationalize it (e.g., resolution manual, DIS payout capabilities, ascertain ‘single customer view’ deposit data); (ii) advance preparedness through resolvability assessments, resolution planning for systemically important institutions, and recurrent simulation exercises; and (iii) finalize loss-absorbing requirements for systemic banks.
  - Given bail-in challenges, authorities are advised to establish a mechanism for temporary public funding to facilitate resolution, sourced from National Treasury and subject to strict preconditions that minimize moral hazard.
  - To strengthen DIS funding structure, consider determining a funding target for the (nonrepayable) ‘equity’ tranche to be met via ex ante industry contributions.
- Cross-border considerations:
  - The D-SIB’s pan-African footprint sets a high bar for cross-border cooperation.
  - Authorities should promote close cooperation on recovery and resolution planning, expand memoranda of understanding with crisis management protocols, and initiate cross-border crisis management exercises.
  - Authorities should ensure framework conditions for effective cross-border cooperation (information exchange, obligations to consider cross-border impact of resolution actions, processes to give effect to foreign resolution measures).

### Financial Sector Development
- Competition and efficiency:
  - Market concentration and high entry barriers result in sizable costs for end-users; digital banks have contributed to some price convergence but transaction costs remain relatively high.
  - Initiatives to increase competition and contestability include promoting cooperatives and mutual banks under proportionate regulatory frameworks, and considering ‘Open Banking’ reforms and limited banking business permissions (e.g., payment services) under simplified oversight—without diluting safeguards for financial stability.
- Capital markets and infrastructure:
  - Amendments to the FMA are important to improve capital market competition and support nonbank financing.
  - Development of the Electronic Trading Platform (ETP) for government bonds has improved pricing transparency and price formation.

*Italic: Source — Chapter 3 of the Global Financial Stability Report, April 2020.*

### introduction of  a deposit  insurance  system  demonstrate  their commitment  to implement  the IADI  Core Principles  f

### 1zafea2022003 - introduction of  a deposit  insurance  system  demonstrate  their commitment  to implement  the IADI  Core Principles  f

### Financial inclusion and access to finance
- Approximately four in five adults have a bank account.
- Utilization of accounts and digital payments is much lower than account ownership.
- The share of bank lending to small and medium enterprises (SME) continues to decline; less than four percent of SMEs have a credit line.
- Estimates of the credit gap between supply and demand vary between 9 and 15 percent of GDP.
- Recommendations to expand access to finance:
  - Reform the secured transactions framework.
  - Reduce persistently high rates of credit impairment through improved credit bureau reporting.
  - Use innovations in creditworthiness assessments using alternative data.
  - Implement fintech measures from the authorities’ “vision” document, including:
    - Use of the sandbox to call for solutions to specific inclusion challenges.
    - Enabling nonbanks to provide payment services (as proposed by SARB).

### Market development and market efficiency
- The ETP could provide a platform for market making to increase trading volumes and support a more developed yield curve to derive a reliable and low ‘risk-free’ price-reference for non-government bonds.
- Measures to improve domestic repo and money markets:
  - Improve interoperability between settlement systems operated by SARB and Strate.
  - Introduce additional NBFIs as participants to the repo market.
  - Enhance the collateral management system.
  - Improvements in the issuance strategy for treasury bills.
  - Harmonization of the tax treatment of buy/sell and classic repos.
  - Introduce T-bill market-making requirement for primary dealers.
- To support green investments, authorities should:
  - Provide clarity on credible, long-term climate and energy plans.
  - Advance work on a National Climate Finance Strategy.
  - Foster transparency through climate risk disclosures and a green taxonomy.
  - Stimulate the use of green finance instruments.
  - Implement NT’s National Disaster Risk Finance strategy.

### Authorities' views and financial safety net priorities
- Authorities welcomed FSAP engagement and noted alignment with their risk outlook and reform priorities.
- Authorities highlighted progress since the last FSAP and implementation of global reform agenda items and domestic priorities including financial inclusion and market development.
- Authorities reported the financial sector remained resilient and profitable during COVID-19.
- Outstanding COVID-19 restructured exposures declined to below 1 percent of total exposures (vis-à-vis about 12 percent in July 2020).
- Priorities for further strengthening:
  - Cybersecurity.
  - Climate risk.
  - Market conduct.
  - Introduction of a modern resolution regime and a deposit insurance scheme.
  - Modernizing payment systems to provide safe and competitive financial services.

### Macroeconomic context (selected messages from figures and tables)
- Per-capita GDP growth has consistently lagged other emerging markets.
- Government debt is projected to sharply deviate from international peers if key reforms are not undertaken.
- Labor participation rates continue to deteriorate.
- South Africa is noted as one of the most unequal societies in the world (Gini Index comparisons shown).
- Table 2: Selected economic indicators, 2018–23 (selected rows; values preserved exactly)
  - Real GDP: 2018 1.5, 2019 0.1, 2020 -6.4, 2021 5.0, 2022 2.2, 2023 1.4
  - Real GDP per capita: 2018 0.0, 2019 -1.3, 2020 -7.8, 2021 4.1, 2022 0.6, 2023 -0.1
  - Unemployment rate (percent of labor force, annual average): 2018 27.1, 2019 28.7, 2020 29.4, 2021 33.4, 2022 34.3, 2023 36.1
  - Gross government debt (percent of GDP): 2018 51.6, 2019 56.3, 2020 69.4, 2021 68.8, 2022 72.3, 2023 74.9
  - Current account balance (billions of U.S. dollars): 2018 -13.1, 2019 -10.6, 2020 6.6, 2021 11.9, 2022 -3.8, 2023 -6.3
  - Gross reserves (billions of U.S. dollars): 2018 51.6, 2019 55.1, 2020 55.5, 2021 60.0, 2022 59.8, 2023 58.7
  - Repo rate (percent, end-period): 2018 6.8, 2019 6.5, 2020 3.5, 2021 3.5
  - Notes: 3/ Central government. 4/ As of September, 2021. 5/ As of October 19, 2021.

### Temporary measures to offset the impact of COVID-19
- Monetary policy operations:
  - Policy rate cut by a cumulative 275 bps to 3.5 percent during March-December 2020.
  - Replacement of SARB’s end-of-day discretionary supplementary facilities with Intraday Overnight Supplementary Repurchase Operations, offered at the repo rate and allocated on a pro rata basis.
  - Standing Facility borrowing rate adjusted to the repo rate less 200 bps; lending rate lowered to the repo rate.
  - Additional offerings of longer-term refinancing operations with 91-day maturities at the repo rate plus 30 bps; maturities extendable to 364 days if necessary.
  - SARB lending to commercial banks at the repo rate plus 50 bps to support the government’s Loan Guarantee Scheme.
  - New SARB program to purchase government securities in the secondary bond market, across the yield curve.
- Prudential Authority temporary measures:
  - Temporary changes to the treatment of restructured loans in good standing before COVID-19.
  - Temporary capital and liquidity relief (e.g., reduced Pillar 2A capital requirements, clarified criteria to draw down capital conservation buffers, lowered the liquidity coverage ratio from 100 to 80 percent).
  - Temporary guidance on dividend distribution and cash bonuses (revised in February 2021).
  - Guidance on the application of IFRS 9 during the pandemic.
- Support to vulnerable borrowers:
  - Multiple support schemes including the COVID-19 Loan Guarantee Scheme, working capital investment and revolving credit facility backed by the Khula Credit Guarantee, various loan funding facilities and a temporary credit moratorium for MSME.

### Insurance sector developments (Figure highlights)
- Solvency ratios remain high and stable.
- Substantial exposure to equities poses a risk to life insurers; asset allocation to non-linked products shows notable equity shares.
- Life insurers are suffering from high lapse rates.
- Risk-free rates are substantially higher than international comparators.
- Life insurers rely extensively on future profit.

### Banking sector stress tests and scenarios
- Under the April 2021 published WEO projections, with dividend payout ratios at their 2020 value, capital buffers would gradually reach 14.8 percent as provisions decline steadily.
- Tier 1 capital ratio (T1R) path (WEO baseline):
  - Dec-20 12.6%
  - Dec-21 13.6%
  - Dec-22 14.3%
  - Dec-23 14.8%
- Under the adverse scenario, bank capitalization would decline by 2.5-3.4 percentage points by 2023 depending on the magnitude of interest rate risks.
- Counterfactual experiments suggest pandemic policies protected bank capital, while forbearance could cause some additional capital needs.
- Model A and Model B adverse outcomes (selected figures):
  - Model A T1R: Dec-20 12.6%, Dec-21 13.1%, Dec-22 12.3%, Dec-23 10.1%
  - Model B T1R: Dec-20 12.6%, Dec-21 12.8%, Dec-22 11.7%, Dec-23 9.2%
  - Necessary Recapitalization (% of GDP) Model A: Dec-23 0% (earlier years 0%); Model B: Dec-23 0.8% (Dec-22 0.04%)
- Sensitivity analysis highlights:
  - An additional shock of 200 bps to sovereign spreads would further deplete bank capital and generate additional recapitalization needs.
  - An additional shock of 5 percentage points to real estate values has modest impact on capital ratios.
  - A combined default of the top private sector exposures would cause a loss of 10 percent of bank capital at end-2020.

### Liquidity stress tests and funding vulnerabilities
- Three of the largest banks saw their LCR ratios decline during the pandemic, with two having used temporary easing of the LCR requirement below 100 percent.
- Two banks are vulnerable to wholesale funding shocks that exceed run-off rates envisaged under Basel requirements.
- Under baseline assumptions, the cash flow analysis for the six largest banks reveals a small funding gap at the overnight horizon after use of the counterbalancing capacity.
- Under more severe stress on outflows, the overnight funding gap becomes large even after use of the counterbalancing capacity and a small funding gap appears at maturities above the one-month horizon.
- Under the Prudential Authority’s regulatory parameters, all banks meet the NSFR; under Basel parameters, two banks narrowly miss the 100 percent requirement.

### Domestic and cross-border interconnectedness and contagion risks
- The system is highly interconnected, with exposures to insurers being the highest across major EMs and AEs.
- Large banks have significantly higher exposures to insurers.
- MMFs are highly vulnerable to banking sector shocks; 90% of assets in top-5 banks (MMF portfolio composition).
- Big banks are a source of outward contagion, while smaller banks are highly vulnerable to such shocks.
- Cross-border exposures have risen sharply; banks’ footprint in Sub-Saharan Africa is increasing.
- Market analysis suggests Latin America accounts for the larger part of inward spillovers.
- Inward spillovers can be materially contained by shoring up buffers.

### Climate risks
- Exposures to water-scarce provinces are notable; exposures to Mpumalanga and water-scarce provinces are reported as percent of credit exposures for individual banks.
- Estimated impacts of droughts on EAD-weighted PDs are shown with multiple drought scenarios.
- A sudden and large rise in the price of carbon could increase the share of corporate debt at risk as margins are compressed.
- Some heterogeneity in exposures to the coal-producing region; overall climate-sensitive sector credit risk is reflected to some extent in estimated default probabilities.

### Banking sector competition, efficiency, and financial inclusion (figures summary)
- High concentration is a persistent feature of the financial sector; market shares of assets and deposits by the top banks are above country peers.
- Bank market power (Lerner index) decreased slightly since 2016.
- Interest rates and interest rate spreads have remained stable and are in line with peer countries.
- Overheads and profit remain high, indicating persistent operational inefficiencies.
- Non-interest income and bank fees have remained higher than in peer countries.
- Financial inclusion trends (Figure 22):
  - Financial inclusion has increased since 2010 but progress has slowed in recent years.
  - Most South Africans rely on cash for common transactions.
  - Formal SMEs with credit are far below regional and income benchmarks; the share of bank lending to SMEs has declined.
  - Household and SME loan statistics show SME loans as a percent of total outstanding business loans have been declining over time.

### Financial Soundness Indicators (selected indicators, 2018–2021; values preserved exactly)
- Regulatory capital to risk weighted assets: 2018 16.1, 2019 16.6, 2020 16.6, 2021 17.3
- Tier 1 capital (of which): 2018 14.9, 2019 15.6, 2020 15.7, 2021 16.4
- Nonperforming loans to total of loans: 2018 3.7, 2019 3.9, 2020 5.2, 2021 5.2
- Return on assets: 2018 1.7, 2019 1.5, 2020 0.6, 2021 0.9
- Return on equity: 2018 19.8, 2019 17.6, 2020 7.7, 2021 11.8
- Liquid assets to total assets: 2018 15.6, 2019 15.0, 2020 15.2, 2021 15.8
- Household debt to GDP: 2018 43.3, 2019 43.8, 2020 44.3, 2021 45.0
- Residential real estate price growth (as of September, 2021): 3.8 (2018), 3.5 (2019), 2.5 (2020), 4.3 (2021)

*Source: 1zafea2022003 - introduction of  a deposit  insurance  system  demonstrate  their commitment  to implement  the IADI  Core Principles  for Effective  Deposit  Insurance   Systems.*

### Appendix I. Stress Testing Matrix

### Appendix I. Stress Testing Matrix

### Banking Sector: Solvency Risk
- Institutional perimeter
  - Institutions included: 6 largest commercial banks.
  - Market share: 92 percent of the banking system assets.
  - Data source and baseline date:
    - Sources: Supervisory data and data directly provided by the banks (regulatory and IFRS9 accounting data);
    - Baseline date: December 2020;
    - Scope of Consolidation: Solo data (domestically booked exposures).

- Channels of risk propagation / Methodology
  - Balance sheet-based approach.
  - Satellite models for macrofinancial linkages:
    - Logistic bank-sector level NPL panel regression models with macrofinancial determinants; calculations of cure and write-off rates from historical data; PDs consistent with projected NPLs and cure and write-off rates;
    - Bank level deposit rates and lending rates panel regression models with macrofinancial determinants;
    - Sovereign spreads (e.g., spread between sovereign bond yields and the repo rate) time series econometric models;
    - Feedback loops between funding costs and solvency assessed based on a bank level panel regression model;
    - Evolution of IFRS9 transition matrices based on beta-linked models from Gross, Laliotis, Leika, and Lukyantsau (2020).

- Stress test horizon
  - 3 years (2021–2023)

- Tail shocks / Scenario analysis
  - Adverse scenario with severity benchmarked based on the 5th per centile of a GaR model estimated for South Africa.
  - Macrofinancial simulations realized based on macrofinancial DSGE model by Lipinsky and Miesu, 2020, “Capital Gaps, Risk Dynamics, and the Macroeconomy,” IMF Working Paper WP/20/209, and auxiliary empirical models.
  - Scenario characterized by an L-shape path for real GDP growth, tightening of financial conditions, widening of local currency spreads, and uncertainty about the economic environment.
  - Sensitivity analysis includes two policy counterfactuals that modify credit risk estimates, larger widening of sovereign spreads, higher shocks to the real estate market resulting in higher LGDs and a concentration risk analysis.

- Risks and buffers
  - Risks/factors assessed:
    - Credit risk;
    - Interest rate risk in the banking book;
    - Market risk (interest rate, spreads, equity).
  - Behavioral adjustments:
    - Dynamic balance sheet with asset growth aligned with nominal GDP growth ensuring stable credit-to-GDP ratio;
    - Cures and write-offs and new credit production endogenously consistent;
    - Portfolio composition unchanged over time.

- Regulatory and market-based standards and parameters
  - Calibration of risk parameters:
    - TTC and Initial PiT PDs and LGDs obtained from banks at the asset class level;
    - Dynamic from model estimated PDs in line with the scenario considered (baseline scenario, adverse scenario).
  - Regulatory/accounting and market-based standards:
    - Regulatory capital ratios and IFSR9 accounting standards.

- Reporting format for results
  - Output presentation:
    - Aggregate results and contributions to evolution of capital ratios;
    - Bank by bank results.

### Banking Sector: Liquidity Risk
- Institutional perimeter
  - Institutions included: 6 largest commercial banks.
  - Market share: 92 percent of the banking system assets.
  - Data and baseline date:
    - Source: Supervisory and bank data;
    - Baseline date: December 2020;
    - Scope of Consolidation: Solo data.

- Channels of risk propagation / Methodology
  - Basel III-LCR and NSFR for all currencies and other significant currencies;
  - LCR and cash-flow test scenario with variants (severe, retail, wholesale funding);
  - Cash-flow based liquidity stress testing using contractual and behavioral (where available) cash flow data for significant currencies and in USD with assumptions about combined interaction of funding and market liquidity along with two approaches of counterbalancing capacity support and central bank support.

- Sensitivity analysis
  - Perimeter and type of analysis: Retail and funding shock.

- Risks and buffers
  - Risks:
    - Funding liquidity shock (short-term liquidity outflows);
    - Market liquidity shock (asset price shocks and fire-sales).
  - Buffers:
    - Counterbalancing capacity;
    - Central bank facilities.

- Tail shocks / Size of the shock
  - Simulated run-off rates benchmarked against LCR and NSFR which are based on historical events, statistical approach, satellite models, and IMF expert judgement;
  - Bank run and dry up of wholesale funding markets, taking into account haircuts to liquid assets;
  - Assumptions under the Cash flow analysis: all maturing assumptions are rolled over and baseline (business as usual).

- Regulatory and market-based standards and parameters
  - Regulatory standards:
    - Regulatory: haircuts and run-off rates based on regulatory parameters. For LCR, see BCBS (2013), The Liquidity Coverage ratio and Liquidity Risk Monitoring Tools Basel, January 2013 and NSFR, see BCBS (2014), “Basel III: The Net Stable funding ratio” Basel, October 2014;
    - Stressed: more severe haircuts under a X scenario and larger run-off rates to reflect more severe episodes of market and funding based on historical events;
    - For the LCR and NSFR, the hurdle is set to 100 percent;
    - For the cash-flow analysis, we consider more severe run-off rates and potentially larger haircuts than usually considered in FSAPs, in view of past volatilities of different categories of bank funding.

- Reporting format for results
  - Output presentation:
    - System wide liquidity gaps;
    - Survival period by bank, number of banks that can still meet their obligations.

### Banking and Insurance Sectors: Interconnectedness Analysis
- Institutional perimeter
  - Institutions included:
    - Interbank network: largest 15 banks ranked according to their consolidated assets;
    - Inter-insurer network: largest 20 insurers ranked according to their total assets;
    - Intra-financial sector network: banks and Insurers for the network analysis; major money market funds for the exposure analysis; and
    - Aggregate financial market data.
  - Data and starting position:
    - Domestic interconnectedness:
      - Data source: supervisory data;
      - Starting position: two snapshots: 2014 and 2019.
      - Data granularity: institutional level bilateral exposure data between all entities, including within the banking sub-sectors and the insurer sub-sectors; and across sectors including between banks, insurers and other nonfinancial sectors.
    - Cross-border interconnectedness:
      - Financial market data for equities, currencies and banking sector equities starting 2010;
      - Balance sheet information starting 2010 for the regional exposure analysis; and
      - Cross-border data at an institutional level, based on the supervisory data.

- Methodology
  - Overall framework:
    - Interbank: balance sheet-based interbank model based on an extension of Espinosa-Vega and Solé (2010):
      - extension: multiple failure thresholds are taken into consideration rather than assuming total capital loss as the only source of shock. Failure thresholds are also institution-specific, taking into account regulatory requirements and applicable buffers.
    - Market price-based spillover model by Diebold and Yilmaz (2014); and quantile regression framework for the fundamental analysis:
      - extension: analysis is also conducted to measure the role of domestic fundamentals in driving and limiting these cross-border spillovers.

- Risks and buffers
  - Risks:
    - Credit and funding losses related to interbank exposures and intra-financial exposures; and
    - Global risk aversion and Domestic Fundamental shocks.
  - Buffers:
    - Domestic interconnectedness: Institution’s own capital and liquidity buffers.
    - Banks: three thresholds are considered, ranging from the minimum CET1 ratio at 4.5 percent to the CET1 requirement plus all applicable buffers;
    - Insurers: two thresholds are considered including Minimum Capital Ratio and Solvency Capital Ratio.

- Reporting format for results
  - Output presentation:
    - Inter-financial network: a network chart based on the exposures;
    - Index of vulnerabilities and contagion—for each sector (showing institutional level data);
    - Distribution of the spillover indices based on institution size, institutional sector, and other characteristics;
    - Evolution and direction of spillovers.

### Corporate Stress Test
- Institutional perimeter
  - Institutions included: 158 publicly listed firms and Eskom.
  - Market share: 78 percent of corporate debt as of end 2018.
  - Data and baseline date:
    - Sources: Datastream and Capital IQ; Moody’s KMV;
    - Baseline date: December 2019;
    - Scope of Consolidation: consolidated balance sheets.

- Channels of risk propagation / Methodology
  - Projections of balance sheets.
  - Variables projected: ICR, cash balance, total debt, ROA.
  - Model:
    - Regression models for some of the key variables (e.g., ROA) combined with accounting identities and macro projections to generate consistent projections of balance sheet and financial statements;
    - Aggregation at the country level (proportion of firm at risk, and proportion of debt among firms that are at risk).
  - Stress Test Horizon: 2020–2022
    - Projection for 2020 interpreted as a counterfactual (no policy support).

- Tail shocks / Size of the shock
  - Adverse scenario with severity benchmarked based on the 5th per centile of a GaR model estimated for South Africa.
  - Macrofinancial simulations realized based on macrofinancial DSGE model by Lipinsky and Miesu, 2020, “Capital Gaps, Risk Dynamics, and the Macroeconomy”, IMF Working Paper WP/20/209, and auxiliary empirical models;
  - Scenario characterized by an L-shape path for real GDP growth, tightening of financial conditions, widening of local currency spreads, and uncertainty about the economic environment.

- Risks and buffers
  - Risks:
    - Liquidity risks;
    - Credit risks.
  - Buffers:
    - Initial cash balance;
    - Initial equity.

- Reporting format for results
  - Output presentation:
    - Share of firms (or share of debt among firms) with ICR<1 or with borrowing needs;
    - Aggregate one year ahead expected default frequency and one year ahead expected defaults on loans by large corporates in percent of banks’ Tier one capital.

- Key simulation findings (Appendix III summary)
  - Framework: multi-year dynamic scenario-based stress test combining firm level OLS panel regressions, industry fixed effects, macrofinancial conditions, and accounting identities; last observed data point end of 2019.
  - Simulations performed for the April 2021 WEO baseline projections and for the FSAP adverse scenario.
  - Vulnerability indicators:
    - ICR defined as EBIT to interest expenses;
    - Cash balance defined as EBIT minus taxes and interest expense plus initial cash.
  - Behavioral assumptions: firms do not pay dividends; capital expenditures cover depreciation and amortization; net capital stock does not increase.
  - Mapping to default probabilities uses a matrix based on US data from Moody’s; aggregation uses each firm’s debt as a weight; benchmarking to end-2019 one-year ahead EDFs for South African corporates from Moody’s KMV using two benchmarks: mean EDF and median EDF.
  - Quantitative results:
    - Under the baseline, the share of firms with an ICR<1 would gradually decline to 17 percent, but their share of debt remains higher at around 30–35 percent.
    - Under the adverse stress test scenario, 27–38 percent of firms would have an ICR<1, accounting for 58 percent of the stock of debt in 2021 and 44 percent in 2022.
    - Mapping into expected default frequencies suggests that, under the adverse scenario, the inflow of NPLs would amount to 4 percent of Tier one capital in 2021, 2.9 percent and 2.4 percent respectively in 2022 and 2023. This estimate is based on the benchmarking to the median Moody’s KMV.

### Climate Risk Stress Tests
- Institutional perimeter
  - Institutions included:
    - 158 publicly listed firms and Eskom;
    - 6 largest commercial banks.
  - Market share:
    - 78 percent of corporate debt as of end 2018;
    - 92 percent of banking system assets.
  - Data and baseline date:
    - Corporates:
      - Sources: Datastream and Capital IQ; Moody’s KMV.
      - Baseline date: December 2019.
      - Scope of Consolidation: consolidated balance sheets.
    - Banks:
      - Source: Supervisory and bank data.
      - Baseline date: December 2020.
      - Scope of Consolidation: Solo data.

- Channels of risk propagation / Methodology
  - Sensitivity analysis shocks.
  - Model — Corporates:
    - Sensitivity analysis 1: shock to production costs derived from an increase in carbon taxes that reduced ROA, resulting in an increase in debt-at-risk (share of debt of firms with ICR<1);
    - Sensitivity analysis 2: regression analysis linking sectoral EDFs to electricity prices.
  - Model — Banks:
    - Difference-in-difference panel regressions at the bank-sector-province level;
    - Bank exposures.

- Risks and buffers
  - Risks:
    - Liquidity risks;
    - Credit risks.
  - Buffers:
    - Corporate profit margins and equity;
    - Bank capital stock.

- Sensitivity analysis
  - Perimeter and type of analysis:
    - Credit risk shock;
    - Liquidity shock.

- Tail shocks / Size of the shock
  - Statistical analysis (multiple of standard deviation);
  - Carbon price shock to mid-point estimate of carbon price consistent with temperature increase aligned with Paris agreement.

- Reporting format for results
  - Output presentation:
    - Aggregate debt-at-risk (based on ICR<1);
    - EAD-weighted aggregated Probabilities of Default.

### Appendix II. Risk Assessment Matrix (selected entries)
- Global Risks
  - Resurgence of the COVID-19 pandemic
    - Transmission: Further outbreaks leading to containment efforts and behavioral changes; disruption in economic activity, increased unemployment, risks to asset quality and bank profitability, and pressures on capital flows.
    - Likelihood: High
    - Impact: High/Medium
  - Rising yields and risk premia due to a de-anchoring of inflation expectations
    - Transmission: Fast recovery in demand combined with supply constraints leading to sustained above-target inflation and de-anchoring of expectations; front-loaded tightening of financial conditions and higher risk premia; increases in funding costs that could stress sovereigns, banks, households and leveraged firms; falling asset prices could erode financial institutions’ capital buffers.
    - Likelihood: Medium
    - Impact: High/Medium
  - Cyber attacks
    - Transmission: Cyber-attacks on critical infrastructure and financial systems triggering systemic financial instability or widespread disruptions.
    - Likelihood: Medium
    - Impact: High

- Domestic Risks
  - Intensification of the sovereign-financial institutions nexus
    - Transmission: Weakening public finances and rising debt increase sovereign exposures, valuation losses, funding cost increases, and reduced fiscal backstop value; potential large-scale financial repression could reduce private credit supply and weigh on recovery.
    - Likelihood: Medium
    - Impact: High/Medium
  - Protracted domestic uncertainty amidst reduced policy space and worsening confidence
    - Transmission: Delays in fiscal consolidation and restructuring of insolvent SOE and crisis-related spending could erode public finances, increase poverty and inequality, and raise credit risks; extensive domestic interconnectedness may generate cascading effects.
    - Likelihood: High
    - Impact: High
  - Higher frequency and severity of natural disasters related to climate change and transition risks due to highly CO2 intensive economy
    - Transmission: Physical and transition risks can reduce corporate profits, increase credit risk, decline profitability and cause valuation losses; material erosion of public finances due to climate risks could generate adverse feedback loops for the financial system.
    - Likelihood: Medium
    - Impact: Medium

*Source: Appendix I. Stress Testing Matrix (from the provided IMF content).*

### Appendix IV.  Managing the  Sovereign-Financial Sector Nexus

### Appendix IV.  Managing the  Sovereign-Financial Sector Nexus

### Risks, distortions, and recent findings
- Increasing sovereign exposures of financial institutions create potential adverse feedback loops raising risks and distortions in the form of crowding out private credit.
- Risks stemming from the nexus are reflected in the FSAP’s solvency stress test, which points to potentially large losses from sovereign exposures in the adverse scenario.
- SARB has flagged this as a key systemic risk, notwithstanding the relatively favorable currency and maturity structure of the debt profile.

### Prudential policy options to address sovereign exposures
- Structural de-risking is contingent on fiscal reforms; prudential measures can boost resilience by increasing buffers and provide disincentives against excessive risk concentrations, while avoiding unintended side-effects (e.g., excessive reduction of liquidity, bond market pressures, or other unwarranted macrofinancial dynamics).
- Options outlined (require careful calibration, phasing-in, and clear communication):
  - Increase risk-weighted assets (RWA) for sovereign exposures:
    - Given distortions associated with the preferential treatment of sovereign exposures—in line with the national discretion embedded in the Basel framework—increasing RWA arises as a natural response.
    - IRB banks have already increased RWA on their sovereign holdings and thereby hold more capital against them.
    - Authorities could introduce positive RWA for banks that apply the standardized approach.
    - Note: potential for procyclical dynamics would need to be considered (see, e.g., Véron, 2017).
  - Apply Pillar 1 or 2 capital surcharges:
    - Designed to disincentivize excessive concentrations while limiting unintended side-effects.
    - Example calibration: apply positive surcharges only above a certain threshold (to account for holdings of sovereign bonds to meet liquidity requirements), with gradual increases as exposures as a share of assets rise (see 2018 Romania FSSA and 2020 Italy FSSA).
  - Use quantitative concentration measures:
    - Concentration limits as a quantitative measure instead of a price-based one.
    - These measures would reduce concentration, but cliff effects may materialize when institutions approach the limits and may need to resort to fire sales.

### Timing, sequencing, and communication
- Introduction of prudential measures to address the sovereign-financial nexus would be optimal before there is a significant build-up of this risk in bank balance sheets.
- Measures can best be phased-in after the normalization of pandemic-related relaxation of capital requirements has been completed.
- A reasonable transition period will be needed to allow financial institutions time to adjust their balance sheets.
- A near-term announcement of envisaged measures, with the applicable transition period, can help condition behavior and thus smooth the adjustment process.
- Footnote reference: For a general discussion of the sovereign nexus, see BCBS’ Discussion paper on the regulatory treatment of sovereign exposures and IMF Departmental Paper on Managing the Sovereign Bank Nexus.

*Source: 1zafea2022003 - Appendix IV. Managing the Sovereign-Financial Sector Nexus*

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_Source: https://www.imf.org/-/media/files/publications/cr/2022/english/1zafea2022003.pdf_