## EXECUTIVE SUMMARY AND KEY RECOMMENDATIONS ## Source details **Canonical URL:** [EXECUTIVE SUMMARY AND KEY RECOMMENDATIONS](https://www.imf.org/-/media/files/publications/cr/2022/english/1zafea2022007.pdf) ## Other formats - [Markdown version](/-/media/files/publications/cr/2022/english/1zafea2022007.pdf.md) - [Structured JSON version](/-/media/files/publications/cr/2022/english/1zafea2022007.pdf.json) --- ### Introduction and scope - Prepared by Aldona Jociene, the IMF, and Katia D’Hulster, the World Bank. - Targeted assessment of selected aspects of banking supervision and regulation in South Africa under the South Africa Financial Sector Assessment Program (FSAP). - Findings and recommendations based on regulatory framework and supervisory practices as at March 2020, informed by field meetings in February–March 2020 and later virtual meetings on COVID-19 response. - Review focused on selected Basel Core Principles (BCP) and themes including: powers, independence and governance (CP 1, 2); cooperation and consolidated supervision (CP 3, 12, 13); supervisory approach, tools, and techniques (CP 8, 9); corrective and sanctioning powers (CP 11); banks’ corporate governance (CP 14); credit risk, problem assets, and provisions (CP 17, 18); concentration risk, large exposures, and transactions with related parties (CP 19, 20); liquidity risk (CP 24). ### Institutional change: Twin peaks and the Prudential Authority (PA) - Twin peaks model created the Prudential Authority (PA) within the South African Reserve Bank (SARB) responsible for safety and soundness, and the Financial Sector Conduct Authority (FSCA) responsible for market conduct. - PA operates as an independent supervisor but further strengthening of PA’s independence and accountability and clearer articulation of its mandate are recommended. - PA operates with staff seconded from SARB; developing position papers to articulate risk tolerance and balance of safety and soundness with ancillary functions (financial inclusion and competition). ### COVID-19 regulatory and supervisory response - Timely regulatory relief measures included: - allowing banks to dip into capital conservation buffers; - reduction of the liquidity coverage ratio to 80 percent; - reduction of Pillar 2A capital requirements; - temporary dividend restrictions; - changes to treatment of restructured loans aligned with international guidance. - Supervisory monitoring intensified; PA developed a roadmap and phased exit strategy. - Recommendation: proactive supervisory stance and capital preservation measures, especially for more vulnerable banks, during unwinding stage. ### Main findings — prudential framework and supervisory practices - Prudential framework - South Africa has a robust prudential regulatory framework, but several areas could be strengthened. - PA priorities include effective implementation of the Basel III post-crisis reforms. - PA encouraged to fully incorporate revised BCBS corporate governance principles into regulatory framework. - Align Regulations Relating to Banks on related parties, large exposures, loan restructuring and problem assets with current BCBS standards; PA conducting gap analysis. - Supervisory approach - PA prudential oversight should become more intrusive with greater focus on governance and risk management. - Need for better structured, more intrusive, comprehensive supervision and detailed supervisory methodologies to assist supervisors with bank ratings. - Strengthen on-site supervision and expand PA cadre of experienced risk specialists. - Conglomerates and perimeter - PA expanding regulatory and supervisory perimeter to financial conglomerates; supervisory tools and practices must evolve (prudential reporting, stress testing, corporate governance, ICAAP). - Supervisory communications and guidance - PA should regularly issue guidance on good practice and supervisory expectations; thematic reviews and supervisory understanding currently not sufficiently shared with industry. - PA began publishing supervisory outcomes in its Annual Reports. - External audit quality - Heavy historical reliance on external auditors requires urgent oversight of external audit quality in banks. - IRBA oversees audit quality but lacks bank audit experts and scope limited to statutory audits (excludes regulatory audit activities). - PA and IRBA must collaborate and find funding to implement independent oversight of bank audit quality. - Recommend performing an Accounting and Auditing ROSC to obtain an independent assessment. - Preventative and early intervention frameworks - PA uses qualitative and quantitative tools (monthly trigger reports, heat maps, Management Information Reports (MIRs), industry analysis, risk matrices, recovery plans) but lacks a formalized supervisory intervention framework combining quantitative triggers with qualitative aspects. - Develop and test early warning indicator frameworks and contingency plans for weak banks. - Supervisory powers and statutory intervention - Power to place a bank under official control through a curator will be removed with the Financial Sector Law Amendment Bill (FSLAB), creating a gap in capacity to address stress events where board and management cannot remediate. - Recommendation: retain power to place banks under official control (temporary administrators or statutory managers) as a basic intervention tool. - Resources and funding - Increase staff resources for bank supervision and diversify funding sources to ensure PA can discharge responsibilities. - Financing through levies and special fees important for autonomy; proposed levies should cover the full operational costs of the PA. - Consider special fees under “user pays” for conglomerate supervision and banks using internal models. - Consider building a contingency fund to cover enforcement actions. - Regulatory cooperation and coordinating bodies - FSR Act prescribes mandatory cooperation and establishes four coordinating bodies with extensive and overlapping memberships but no formal powers. - Recommend review membership and responsibilities to streamline membership and better align responsibilities. - One evaluation body consists solely of cabinet members, risking politicization of supervisory processes. - Assess need for number of coordinating bodies and whether all require legal basis in FSR Act. - Increase transparency by formalizing meeting discussions or publishing a record of actions taken. ### Key recommendations (selected, with timing and responsibility) - Update the Regulations on corporate governance, related parties, large exposures, loan restructuring and problem assets to ensure closer alignment with the current BCBS standards. - Responsible Authorities: PA - Timing: ST - Further strengthen and refine ongoing bank supervision practices and procedures for intrusive assessment of governance and risk management. - Responsible Authorities: PA - Timing: ST - Strengthen on-site supervision, make greater use of risk specialists, and develop specialists for banks’ governance assessment. - Responsible Authorities: PA - Timing: I - Work on a collaborative solution and find funding to implement independent oversight of bank external audit quality. - Responsible Authorities: PA, IRBA - Timing: I - Develop a framework for balancing PA’s primary objective of safety and soundness with supporting mandate of financial inclusion and competition. - Responsible Authorities: PA - Timing: ST - Increase the PA’s human resources, its funding and the diversity of its funding sources. - Responsible Authorities: PA, NT - Timing: ST - Review legislation to further strengthen PA’s operational independence and accountability. - Responsible Authorities: PA, NT - Timing: MT - Revisit the FSR Act to mitigate politicization risks from the cooperation evaluation body composed of cabinet members and establish formal disclosure framework for coordinating bodies; streamline membership and mandates. - Responsible Authorities: All regulators, NT - Timing: ST - Maintain the power for the PA to temporarily take control of weak banks, without ministerial involvement, as a pre-resolution supervisory instrument (temporary administrator, or statutory manager). - Responsible Authorities: PA, NT - Timing: MT - Remove the 30-day notice for suspending registration or restricting activities of a bank or controlling company. - Responsible Authorities: PA, NT - Timing: MT - Perform an Accounting and Auditing ROSC to obtain an independent assessment of the quality of the accounting and audit profession. - Responsible Authorities: NT - Timing: ST - Timing key: I = Immediate, with results less than 1 year; ST = Short Term, with results 1–2 years; MT = Medium Term, with results 3–5 years. ### Banking sector structure — key statistics and features - Total financial sector assets of about 300 5 percent of Gross Domestic Product (GDP) (December 2020). - Banking sector assets account for 44 percent of total financial sector assets. - Banks’ assets as a proportion of GDP is 132 percent. - Number of banks: 31 banks. - Five large banks account about 90 percent of total banking sector assets. - 4 mutual banks and 5 cooperative banks operate in the country. - International presence: 13 branches of international banks operate in South Africa (their assets account for 6 percent of total banking sector assets). - Expansion in sub-Saharan Africa: the four large banks have more than 40 subsidiaries in many sub-Saharan African countries. ### Capital, liquidity and funding profile entering COVID-19 - Aggregated total capital adequacy ratio of the banking sector was 16.2 percent as at December 2020. - Average banking sector Liquidity Coverage Ratio (LCR) was around 142 percent at the end of 2020. - Deposits make up the largest source of bank funding (more than 70 percent). - Retail deposits account for less than a fifth of total funding. - Banks’ foreign-currency liabilities remain well below 8 percent of total liabilities. ### COVID-19 policy measures and unwinding timeline (selected facts) - April 2020: PA allowed banks to utilize capital conservation buffer and reduced Pillar 2A minimum capital requirements (systemic risk add-on) from 1 to 0 percent. - PA reduced the LCR requirement from 100 to 80 percent. - COVID-19 restructures peaked at 12.1 percent of corporate and retail credit exposures in July 2020, then decreased to 2.1 percent in April 2021. - Banks required to reinstate the Pillar 2A capital buffer by January 2022. - Gradual withdrawal of temporary LCR relief: - January 1, 2022—90 percent - April 1, 2022—100 percent - PA withdrew relief measure for restructured credit exposures from April 1, 2022. ### Supervisory approach, tools, and implementation status - PA implementing unified supervisory framework based on four pillars: licensing, ongoing supervision, enforcement, and resolution; framework risk-based, proportional, forward-looking, outcome-focused and integrated. - PA developing Risk Framework covering inherent risk, risk management, corporate governance and business model assessment, ratings and tolerance of risk, and supervisory judgment application. - Four interim supervisory guidelines approved in December 2019 covering supervisory planning, off-site analysis, appointment of independent reviewers and governance and culture reviews. - On-site supervision intensity reduced after PA establishment due to dissolution of on-site review team; PA drafting on-site supervision guidelines and encouraged to increase on-site depth and specialist deployment. ### Supervisory engagement, ratings, and escalation - Current risk-rating methodology: quantitative ratios weighting 70 percent; assessment of corporate governance, management and staff, compliance, AML/CFT, internal audit issues weighting 30 percent. - Recommendation: supervisory intensity should be differentiated by ratings of individual risk components rather than driven mainly by overall rating. - PA lacks a structured intervention framework with quantitative and qualitative triggers and indicative response actions. - Recommendation: develop formal early warning indicators (EWIs), a structured intervention framework, contingency plans, and regular testing of capacity for dealing with bank stress. ### Credit risk, audit quality, collateral and restructurings - Credit risk is main driver of banks’ risk profile; PA considerably relies on external auditors for review of credit risk management and provisioning. - External auditors’ application of IFRS 9 shows divergence across banks; principles-based IFRS 9 allows high degree of management discretion. - IFRS 9 guidance and PA-directives: Guidance note 3 (2016) and Directive 5 (2017); Directive 7/15 defines distressed restructuring with minimum reclassification periods that are shorter than Basel guidance. - Recommendations (selected): - Align Regulations on restructuring with Basel Guidelines “Prudential Treatment of Problem Assets”. - Extend observation period for restructured exposures to one year in accordance with Basel Guidelines “Prudential Treatment of Problem Assets”. - Amend asset quality definitions for standardized banks to remove impact of collateral value on classification. - Develop prudential standard on collateral valuation and requirements for external valuation, appraiser independence, back-testing, and enforceability. - Perform an Accounting and Auditing ROSC and establish independent oversight of bank audits. - Assess IFRS 9 skills in second and third line of defense in small banks and consider additional requirements while skills build up. ### Concentration risk, large exposures, and related-party transactions - Regulations: individual investments/loans exceeding 10 percent of capital and reserves require board/committee permission; private sector nonbank exposures exceeding 25 percent of capital and reserves require prior written approval of PA. - Several banks have exceeded the 25 percent single-name concentration limit; excess portion attracts 1250 percent risk weighting. - New BCBS large exposure framework in force January 1, 2019 and expected implementation April 1, 2022; PA Regulations do not yet include new “control relationship” and “economic interdependence” definitions. - Related-party definitions and scope in Regulations outdated and inconsistent with BCP 20 and FSR Act/BA terminology; gaps include scope of transactions covered, governance prescriptions, and depth of supervisory review. - Recommendations (selected): - Implement BCBS large exposure framework including connected counterpart requirements and interbank caps. - Expand definitions of “related party” and “related-party transactions” to align with BCP 20 and ensure consistency across FSR Act, BA and Regulations. - Clearly prescribe governance requirements and conduct independent verification of related-party controls and reporting. ### Liquidity risk supervision and metrics - Banks subject to LCR and NSFR on solo and consolidated basis; Regulation 26 and Directive 8/2017 detail calculations. - LCR reporting daily to PA; average sector LCR around 140 percent at end-2019 and around 142 percent at end-2020. - NSFR implementation not fully compliant with Basel III; ASF factor of 35 percent assigned to certain short-term rand funding from financial corporate customers (excluding banks). - Recommendations include formalizing externally facilitated liquidity simulations for large banks and smaller banks with elevated liquidity risk, and articulating risk tolerance for funding concentration by peer group. ### Domestic regulatory cooperation and governance of coordinating bodies - FSR Act imposes mandatory cooperation among PA, SARB, FSCA, NCR, and FIC and requires MOUs published and reviewed every three years; PA had signed and published MOUs with SARB, FSCA, NCR and FIC at assessment time. - FSR Act establishes four cooperation bodies: Financial System Council of Regulators (FSCR), Financial Stability Oversight Committee (FSOC), Financial Sector Contingency Forum (FSCF), and Financial Sector Inter-Ministerial Council (FSMC), with overlapping memberships and no formal powers. - Concerns: prescriptive framework, overlapping mandates, potential resource inefficiencies, and politicization risk via FSMC composition. - Recommendations: - Review and streamline membership and mandates of coordinating bodies. - Develop independent evaluation criteria for cooperation effectiveness and disclose records of actions taken (at least for FSOC and FSCR). ### Selected implementation status (2014 FSAP recommendations extract) - CP1: Objectives clarified in FSR Act; prudential and joint standards introduced. - CP2: Progress on CEO fixed term and removal basis but public disclosure of reasons for removal should be prescribed. - CP3, CP12, CP13, CP18, CP20, CP23, CP28, CP29: Various ongoing improvements noted; further work required on on-site supervision (CP9), intervention powers (CP11), and conglomerate supervision (CP3/12/13). _Italic: Source: 1zafea2022007 - EXECUTIVE SUMMARY AND KEY RECOMMENDATIONS (Technical Note, FSAP assessment as of March 2020)._ ### EXECUTIVE SUMMARY AND KEY RECOMMENDATIONS ___________________________________________ 5 ### EXECUTIVE SUMMARY AND KEY RECOMMENDATIONS ### Introduction - This Technical Note was prepared by Aldona Jociene, the IMF, and Katia D’Hulster, the World Bank. - The review is a targeted assessment of selected aspects of banking supervision and regulation in South Africa conducted under the South Africa Financial Sector Assessment Program (FSAP). - Findings and recommendations are based on the regulatory framework and supervisory practices in place as at March 2020, informed by field meetings in February–March 2020 and later virtual meetings on COVID-19 response. - The review focused on selected Basel Core Principles for Effective Banking Supervision (BCP) and themes including: - powers, independence and governance (CP 1, 2); - cooperation and consolidated supervision (CP 3, 12, 13); - supervisory approach, tools, and techniques (CP 8, 9); - corrective and sanctioning powers (CP 11); - banks’ corporate governance (CP 14); - credit risk, problem assets, and provisions (CP 17, 18); - concentration risk, large exposures, and transactions with related parties (CP 19, 20); - liquidity risk (CP 24). ### Institutional change: Twin peaks and the Prudential Authority (PA) - The implementation of a twin peaks model created the Prudential Authority (PA) within the South African Reserve Bank (SARB) responsible for safety and soundness, and the Financial Sector Conduct Authority (FSCA) responsible for market conduct. - Motivation for twin peaks: increase robustness of financial sector regulation and supervision, reinforce financial stability, improve customer protection, and enhance regulator cooperation. - In practice the PA operates as an independent supervisor but further strengthening of PA’s independence and accountability and clearer articulation of its mandate are recommended. - The PA operates with staff seconded from SARB and benefits from SARB staff credibility, professionalism, and integrity. - The PA has been developing position papers to articulate risk tolerance and balancing of safety and soundness with ancillary functions of financial inclusion and competition. ### COVID-19 regulatory and supervisory response - To deal with the COVID-19 crisis, the PA provided timely regulatory relief to enable continued credit extension and preserve financial stability. - Measures included: allowing banks to dip into capital conservation buffers, reduction of the liquidity coverage ratio to 80 percent, reduction of Pillar 2A capital requirements, temporary dividend restrictions, and changes to the treatment of restructured loans in line with international guidance. - Supervisory monitoring was intensified and flexibility was provided where necessary. - The PA has been working on a roadmap and phased exit strategy from extraordinary measures; assessors recommend a proactive supervisory stance and capital preservation measures, especially for more vulnerable banks, during the unwinding stage of interventions. ### Main findings: prudential framework and supervisory practices - Prudential framework: - South Africa has a robust prudential regulatory framework for banks, but several areas could be strengthened. - PA priorities include effective implementation of the Basel III post-crisis reforms. - PA is encouraged to fully incorporate the revised BCBS corporate governance principles for banks into its regulatory framework. - Align Regulations Relating to Banks (Regulations) on related parties, large exposures, loan restructuring and problem assets with current BCBS standards and guidance; PA has been working on gap analysis. - Supervisory approach: - PA prudential oversight should become more intrusive with greater focus on governance and risk management. - Develop better structured, more intrusive, and comprehensive supervision to prioritize assessment of corporate governance and risk management effectiveness. - Develop more detailed supervisory methodologies to assist supervisors with bank ratings. - Strengthen on-site supervision and expand PA cadre of experienced risk specialists. - Conglomerates and perimeter: - PA is expanding regulatory and supervisory perimeter to financial conglomerates and is on track for framework implementation, but supervisory tools and practices must evolve for conglomerates (prudential reporting, stress testing, corporate governance, ICAAP). - Supervisory communications and guidance: - PA should regularly issue guidance on observed good practice and supervisory expectations; current thematic reviews and supervisory understanding are not sufficiently shared with industry. - PA began publishing supervisory outcomes in its Annual Reports. - External audit quality: - Heavy historical reliance on external auditors requires urgent oversight of external audit quality in banks. - Audit quality pressures have risen following the failure of two smaller banks and corporate scandals (including VBS). - IRBA oversees audit quality but lacks bank audit experts and its scope is limited to statutory audits (excludes regulatory audit activities). - PA and IRBA must collaborate and find funding to implement independent oversight of bank audit quality. - An Accounting and Auditing ROSC should be performed to obtain an independent assessment of the accounting and audit profession. - Preventative and early intervention frameworks: - PA uses qualitative and quantitative tools (monthly trigger reports, heat maps, Management Information Reports (MIRs), industry analysis, risk matrices, recovery plans) but lacks a formalized supervisory intervention framework that combines quantitative triggers with qualitative aspects. - Early warning indicator frameworks and contingency plans for weak banks need to be developed and tested. - Supervisory powers and statutory intervention: - The power to place a bank under official control through a curator will be removed with the Financial Sector Law Amendment Bill (FSLAB), creating a gap in the PA’s capacity to address stress events where board and management cannot remediate (including fraud or managerial misconduct). - The power to place banks under official control (temporary administrators or statutory managers) should be retained as a basic intervention tool. - Resources and funding: - Continued efforts needed to increase staff resources for bank supervision and diversify funding sources to ensure PA can discharge responsibilities. - Financing through levies and special fees is important for autonomy; proposed levies should cover the full operational costs of the PA. - Consider special fees under “user pays” for conglomerate supervision and banks using internal models. - Consider building a contingency fund to cover enforcement actions. - Regulatory cooperation and coordinating bodies: - The FSR Act prescribes mandatory cooperation and establishes four coordinating bodies with extensive and overlapping memberships but no formal powers. - Recommendation to review membership and responsibilities to streamline membership and better align responsibilities. - One evaluation body consists solely of cabinet members, risking politicization of supervisory processes. - Assess need for number of coordinating bodies and whether all require legal basis in the FSR Act. - Increase transparency by formalizing meeting discussions or publishing a record of actions taken. ### Key recommendations (Table 1) - Update the Regulations on corporate governance, related parties, large exposures, loan restructuring and problem assets to ensure closer alignment with the current BCBS standards. - Responsible Authorities: PA - Timing: ST - Further strengthen and refine ongoing bank supervision practices and procedures specifically pertaining to better structured, intrusive, and comprehensive assessment of banks’ corporate governance and credit, liquidity and other significant risk management arrangements. - Responsible Authorities: PA - Timing: ST - Strengthen on-site supervision, make greater use of risk specialists for this function, and develop specialists for bank’s governance assessment. - Responsible Authorities: PA - Timing: I - Work on a collaborative solution and find funding to implement independent oversight of bank external audit quality. - Responsible Authorities: PA, IRBA - Timing: I - Develop a framework for balancing the PA’s primary objective of safety and soundness with its supporting mandate of financial inclusion and competition. - Responsible Authorities: PA - Timing: ST - Increase the PA’s human resources, its funding and the diversity of its funding sources. - Responsible Authorities: PA, NT - Timing: ST - Review the legislation to further strengthen the framework of the PA’s operational independence and accountability. - Responsible Authorities: PA, NT - Timing: MT - Revisit the FSR Act to prevent the risks of political influence on the supervisory process though the cooperation evaluation body composed of cabinet members and establish a formal framework for disclosure of meeting discussions and a record of actions taken by the domestic coordinating bodies and streamline their membership and mandates. - Responsible Authorities: All regulators, NT - Timing: ST - Maintain the power for the PA to temporarily take control of weak banks, without ministerial involvement, as a pre-resolution supervisory instrument (temporary administrator, or statutory manager). - Responsible Authorities: PA, NT - Timing: MT - Remove the 30-day notice for suspending registration or restricting activities of a bank or controlling company. - Responsible Authorities: PA, NT - Timing: MT - Perform an Accounting and Auditing ROSC to obtain an independent assessment of the quality of the accounting and audit profession. - Responsible Authorities: NT - Timing: ST - Timing key: I = Immediate, with results less than 1 year; ST = Short Term, with results 1–2 years; MT = Medium Term, with results 3–5 years. _Italic: Source: 1zafea2022007 - EXECUTIVE SUMMARY AND KEY RECOMMENDATIONS (Technical Note, FSAP assessment as of March 2020)._ ### 4. The team wishes to thank the authorities and private sector participants for their excellent ### BANKING SECTOR STRUCTURE ### Cooperation and acknowledgements - The team thanks the authorities and private sector participants for their cooperation and for providing a self-assessment of compliance with the 2012 Basel Core Principles and responses to a complementary questionnaire. - Authorities provided a wide range of supporting documents on supervisory practices and assessments; the team benefited from inputs and exchanges with supervisors and market participants. - The team thanks PA staff for professionalism, cooperation, and extensive support facilitating the mission’s work. ### Structure of the note - The note is divided into two main parts: - First chapter: banking sector structure. - Remaining part: review and main findings. ### Banking sector size, composition and concentration - South Africa’s financial sector described as large, well developed and sophisticated. - Key statistics and structure: - Total financial sector assets of about 300 5 percent of Gross Domestic Product (GDP) (December 2020). - Banking sector assets account for 44 percent of total financial sector assets. - Banks’ assets as a proportion of GDP is 132 percent. - Nonbank financial sector (insurance companies, pension funds and collective investment schemes) continues to grow. - Number of banks: 31 banks. - Five large banks account about 90 percent of total banking sector assets. - Four of the five large banks provide full-scale banking services; a fifth focuses on corporate and private banking. - New entrants: a few digital banks have started activities. - Other institutions: 4 mutual banks and 5 cooperative banks operate in the country. ### Cross-sectoral and cross-border linkages - Cross-sectoral linkages: - Large banks hold significant shareholdings in large insurers; insurers have significant shareholdings in large banks. - Bank-affiliated insurers underwrite a substantial proportion of private pension fund assets. - Some banks own asset management companies offering unit trusts. - These linkages require comprehensive group-wide supervision. - Cross-border linkages: - Shareholders of large South African banks have ownership links with many foreign countries; certain banks are indirectly owned by U.K. financial institutions. - One of the largest 5 banks is dual listed on the Johannesburg Stock Exchange (JSE) and London Stock Exchange and has a parallel structure where the U.K. holding company oversees the group’s non-African operations. - International presence: 13 branches of international banks operate in South Africa (their assets account for 6 percent of total banking sector assets). - Expansion in sub-Saharan Africa: the four large banks have more than 40 subsidiaries in many sub-Saharan African countries. - Cross-border operations are a relatively small part of consolidated balance sheets but are systemically important in some host jurisdictions (e.g., Botswana, Lesotho, Malawi, Mauritius, Namibia and Swaziland), underscoring the importance of effective home-host coordination. ### Capital, liquidity and funding profile entering COVID-19 - Capital and liquidity buffers prior to and during COVID-19: - Aggregated total capital adequacy ratio of the banking sector was 16.2 percent as at December 2020. - Average banking sector Liquidity Coverage Ratio (LCR) was around 142 percent at the end of 2020. - Funding composition and risks: - Deposits make up the largest source of bank funding (more than 70 percent). - Wholesale funding primarily from nonbank financial institutions and non-financial corporates in similar proportion. - Retail deposits account for less than a fifth of total funding. - Households prefer non-deposit products (pension funds, insurance products, unit trusts); providers of these products invest some funds in bank deposits, increasing interconnectedness. - Authorities consider liquidity risk mitigated by exchange control restrictions that help maintain domestic currency–denominated funding within the rand system. - Funding is largely sourced domestically; banks’ foreign-currency liabilities remain well below 8 percent of total liabilities. ### Regulatory and supervisory response to COVID-19 (Box 1 and Box 2 highlights) - Objectives: PA provided regulatory relief aligned with other authorities’ fiscal, monetary and financial stability actions to stabilize the economy; response was timely but needs to remain proactive during unwinding. - Temporary capital and liquidity relief: - In April 2020 the PA allowed banks to utilize their capital conservation buffer and reduced Pillar 2A minimum capital requirements (the systemic risk add-on) from 1 to 0 percent. - PA reduced the LCR requirement from 100 to 80 percent. - In April 2020 and March 2021 some banks temporarily reported ratios < 100 percent but the temporary 80 percent requirement was not breached. - The PA noted the temporary LCR reduction appears to have achieved objectives of providing stability and predictability in banks’ liquidity management. - Restriction on capital distributions: - PA recommended banks pause distribution of dividends on ordinary shares and cash bonuses to executive officers and material risk takers during 2020. - Several banks paid dividends in 2020; majority had declared dividends before PA guidance issued. - In February 2021 the PA relaxed guidance, shifting responsibility to banks’ boards of directors to consider capital distributions prudently under the Banks Act 1990 (Act No.94 of 1990, as amended). - Considering weak macro outlook, further capital preservation measures are advisable, especially for banks with pre-existing weaknesses; a case-by-case approach on capital distribution can be considered to avoid penalizing well-capitalized banks. - Treatment of restructured loans and IFRS 9 guidance: - April 2020 guidance on treatment of COVID-19 related restructured credit exposures provided temporary relief on minimum capital requirements for corporate and retail credit exposures to enable banks to continue extending credit. - Classification limited to borrowers in good standing before COVID-19 and expected to remain up-to-date after relief period. - PA has been working with banks and auditors to align impact under IFRS 9 and regulatory capital. - At this stage PA does not expect restructurings under this guidance to have a material impact on NPV of cash flows as relief is for limited period (3-6 months). - COVID-19 restructures peaked at 12.1 percent of corporate and retail credit exposures in July 2020, then decreased to 2.1 percent in April 2021. - PA must ensure banks timely recognize all defaulted restructured exposures from a prudential perspective. - Recommendation: banks and PA should consider more extensive and regular public disclosure on COVID-19 restructured loans covering magnitude, trends and risk profile. - Unwinding COVID-19 policy interventions: - PA developed a roadmap and phased exit strategy to ensure stability going forward. - Banks required to reinstate the Pillar 2A capital buffer by January 2022. - Gradual approach for withdrawal of temporary liquidity measure with revised minimum LCR requirements: - January 1, 2022—90 percent - April 1, 2022—100 percent - PA decided to withdraw the relief measure for restructured credit exposures from April 1, 2022. - While uncertainty remains high, continued restrictions on capital distributions are advisable; fund staff recommends proactive supervisory stance challenging banks’ capital projections and ensuring banks can meet capital requirements under a broad range of scenarios. - Supervisory reprioritization and enhanced monitoring (Box 2): - PA reprioritized supervisory work, intensifying supervisory monitoring, suspending lower-priority reviews, extending implementation timelines for certain regulatory reforms, and using flexibility in operational requirements (e.g., extended submission timelines for external audit reports, Pillar 3 disclosures). - On-site reviews were replaced by desktop reviews and virtual meetings; credit risk received heightened attention. - Operational resilience (business continuity, disaster recovery, cybersecurity) became high priority. - PA introduced additional reporting to monitor LCR, Net Stable Funding Ratio (NSFR), COVID-19 restructured credit exposures and operational risk metrics; at the height of turmoil banks provided additional quantitative and qualitative information daily, weekly, and later monthly. - PA surveyed 10 banks on collateral valuations and considered independent credit analyses by audit firm experts in some banks. - PA deepened cooperation and coordination with FSCA, SARB and National Treasury; bi-monthly meetings with SARB and National Treasury; SARB conducted a top-down solvency stress test of the 6 largest banks and developed a new liquidity stress metric. ### Main findings — Powers, Independence and Governance - Institutional reform and twin peaks model: - Implementation of twin peaks model changed supervisory architecture; on April 1, 2018 two new regulatory authorities started operating: - Prudential Authority (PA): a juristic person within SARB administration, responsible for prudential regulation and supervision of banks, insurance companies and market infrastructures (MIs). - Financial Sector Conduct Authority (FSCA): standalone entity with mandate for financial sector conduct regulation and supervision. - Financial Sector Regulation Act (FSR Act) provided legal framework for PA and FSCA; gave SARB explicit mandate to protect and enhance financial stability; obliged SARB to seek concurrence of PA and FSCA on licensing matters; introduced PA power to regulate and supervise financial conglomerates; empowered PA to collect supervisory levies and special fees; and addressed some FSAP 2014 recommendations. - High societal expectations that institutional supervisory reform will strengthen supervision, consolidate regulation across industries, and enhance cooperation among financial sector regulators. - PA organizational structure and governance: - PA integrated BSD of SARB, Insurance Prudential Supervision teams of erstwhile Financial Services Board, and CFI Supervisory Unit of Cooperative Banking Development Agency of National Treasury. - PA organizational structure comprises a Prudential Committee (members include SARB Governor as chairman and three SARB Deputy Governors, one of whom is PA CEO) and four departments: - Financial Conglomerate Supervision Department: prudential supervision of institutions potentially designated as financial conglomerates; responsible for AML/CFT supervision within PA-regulated institutions. - Banking, Insurance and Financial Market Infrastructure Supervision Department: supervises other banks (including cooperative and mutual banks), small and medium sized insurance companies, MIs and cooperative financial institutions. - Risk Support Department: provides specialized regulatory and supervisory support on credit, Asset and Liability Management (ALM), operational, market and insurance risk, and quantitative and actuarial support. - Policy, Statistics and Industry Support Department: develops and maintains regulatory and supervisory framework, provides industry analysis, enforcement, and technical support on capital and accounting issues. - Governance: Prudential Committee oversees management and administration; daily operations managed by CEO, Heads of Departments and Divisional Heads; PA Management Committee (MANCO) supports CEO; CEO established six advisory and decision-making panels (Policy, Licensing, Designation, Restructuring and Expansion, Regulatory Action, Risk and Capital) which recommend to CEO; PA developed Regulatory Action Blueprint setting comprehensive decision-making framework. - Implementation progress and objectives: - PA has integrated bank and insurance supervision, prepared regulatory framework for financial conglomerates, and implemented strategic priorities in PA Regulatory Strategy 2018-2021. - Achievements: integrated supervisory teams for large financial groups, roadmap for harmonizing regulatory framework (governance, licensing), continued work on secondary legislation for financial conglomerates (designation criteria, prudential standards on governance, intragroup exposures, audit, capital and risk concentration), aligning regulations with Basel III post-crisis reforms, and establishing close cooperation with other national regulators. - Primary objective of PA in legislation includes “to promote and enhance the safety and soundness of financial institutions that provides financial products and securities services.” - PA rolling out new supervisory framework and drafting internal operating procedures to guide supervision and risk tolerance; stated aim to maintain a regulatory and supervisory environment with an acceptably low probability of institutional failure. *South Africa — INTERNATIONAL MONETARY FUND* ### 17. The PA’s broader mandated responsibilities (to support financial inclusion and sustainable ### 17. The PA’s broader mandated responsibilities (to support financial inclusion and sustainable competition) ### Mandate and ancillary functions - The FSR Act mandates the PA to perform ancillary functions to help achieve its primary objectives. - The PA Regulatory Strategy 2018–2021 notes the PA’s role to enhance financial sector transformation, financial inclusion, and sustainable competition. - In support of ancillary responsibilities, the PA, including National Treasury, is exploring steps towards a greater tiering of the financial sector—supported by a proportional supervisory and regulatory framework—to allow for a wider range of participants and greater potential for innovative technologies to help to improve access and efficiencies in the financial sector. - The PA recognizes the need for collaboration with the SARB in monitoring fintech developments that may facilitate financial inclusion. - The PA is in the process of developing its policy on how to operationalize these ancillary functions in support of its objectives. ### Supervisory powers and constraints - The Banks Act (BA), FSR Act and Regulations provide the PA with a broad range of supervisory tools to take timely corrective actions or intervene in banks for: - non-compliance with laws or Regulations; - unsafe and unsound practices; and/or - activities that pose risks to banks or to the banking system at large. - The PA can issue directives to a bank, a controlling company, an eligible institution or a bank’s auditor as a non-financial sanction or require them to: - cease or refrain from engaging in specified activities; - perform necessary actions; and - provide documents and information. - Under the FSR Act, additional enforcement tools have been introduced, including the imposition of administrative penalties on individuals. - The PA has raised concerns about banks’ operations in prudential meetings and has followed up through feedback letters and established a decision-making mechanism (a dedicated unit and panel) to impose corrective and sanctioning measures on banks. - Notable constraints in the corrective-action toolkit: - Obligation to give 30 days prior notice in suspending registration or restricting activities of a bank. - Need to gain the prior concurrence of the FSCA in respect of specific matters as set out in the FSR Act. - Requirement to give prior notice in suspending registration (license) or restricting activities of a bank or a controlling company. ### Operational independence and accountability - The PA operates within the administration of the SARB; the SARB’s independence is enshrined in the Constitution of the Republic of South Africa (reference to Section 224). - Advantages of the SARB–PA arrangement: - Appointment of the PA CEO by the Governor (in terms of section 36(1) of the FSR Act, with the concurrence of the Minister of Finance), without scope for political interference. - Enhanced accountability through oversight by SARB’s Governor and deputy Governors (through the Prudential Committee). - PA operates with staff seconded from the SARB and receives accommodation, facilities, use of assets, financial resources, and other services from the SARB (in line with sections 50 and 51 of the FSR Act). - A Memorandum of Understanding (MoU) exists between the PA and SARB; cooperation in financial stability, resolution, recovery plans, etc. - SARB powers to mitigate systemic risks: - After consulting with the PA, the SARB can give directions to the PA regarding specific systemically important financial institutions or such institutions generally, on matters including solvency, leverage ratios, liquidity, risk management, and recovery and resolution planning. - Recommendation: ensure SARB directions are clearly confined to the SARB’s core mandate and do not infringe the PA’s microprudential mandate. - Potential tensions and recommendations for operational autonomy: - The PA relies on SARB seconded staff, receives financial support from the SARB for operational costs (only staffing costs expected to be funded by levies), and has strong SARB representation in decision-making bodies—this can dilute PA accountability for its mandate. - Authorities should strive to evolve to a model where the levies cover the totality of the PA’s budgeted expenditure to ensure more financial autonomy and mitigate potential tensions. - Appointment and dismissal of the PA CEO: - FSR Act sets requirements for the PA CEO, who must be a SARB Deputy Governor (other than the Deputy Governor responsible for financial stability). - The CEO is appointed by the Governor with the concurrence of the Minister of Finance (MOF); the Governor must agree in writing on the individual’s performance assessment measures (these performance measures are not disclosed). - Term of office: no longer than 5 years with possibility of re-appointment for one further term. - Dismissal: - Governor can remove the CEO if the individual becomes a disqualified person; legislation does not require public disclosure of reasons in such cases. - Alternatively, Governor with concurrence of MOF may remove the CEO if an independent inquiry finds stipulated issues; MOF must submit the inquiry report to the National Assembly at which point the report becomes publicly available. - PA–FSCA concurrence requirement and related risks: - The FSR Act requires the PA to seek concurrence of the FSCA on licensing matters; the PA may not issue, vary, suspend, revoke or grant an exemption on a license without agreement of the FSCA. - Practical challenges: different mandates and objectives between PA and FSCA, no dispute resolution mechanism prescribed in the FSR Act, tight deadlines for FSCA decisions. - In practice, FSCA responses in concurrence have included conditions that relate to financial conduct matters not within PA responsibility. - Authorities noted concurrence of the FSCA may only be necessary for a transitional period until FSCA establishes its own licensing process. - Unclear practical outcomes: whether loss of one license would automatically result in loss of the other license, and how diverging views about issuance or revocation would be handled. - Ministerial (MOF) involvement: - Some MOF powers remain; ministerial involvement was reduced since FSAP 2014 but still exists and can bring non-prudential considerations into prudential decision making. - Recommendation: consider further limiting the MOF’s involvement by reducing cases requiring approval or concurrence (e.g., acquisitions of more than 49 percent in a bank or controlling company). - Specific criteria and circumstances for exclusion from application of the Banks Act by Minister’s power should be prescribed in the Act. - State-owned company application example: in 2019 Banks Act was amended to allow a state-owned company to apply for PA authorization to establish a bank; to date only the Post Bank has applied. - Prudential standards and Parliament involvement: - FSR Act introduces prudential standards that do not require ministerial approval; all Regulations currently in force will be converted to prudential standards. - PA must submit prudential standards to Parliament through National Treasury for at least 30 days while Parliament is in session (urgent prudential standards: at least seven days). - Parliament cannot stop issuance of secondary legislation, but PA must consider Parliamentary deliberations. - Recommendation: consider providing the PA with sufficient delegated powers, clearly circumscribed to the prudential sphere, to issue prudential standards without Parliament involvement. - Transparency and accountability: - PA published its Regulatory Strategy 2018–2021 as required by the FSR Act. - PA CEO required to prepare annual financial accounts for the PA, which form part of the annual report of the SARB. - Annual report on PA activities should be submitted to the MOF for tabling in the National Assembly and publication. - In practice PA CEO participates in Parliament’s sessions; prescribing such participation in the legal framework would help strengthen accountability (reference to BCP Principle 2). ### Funding, resources, and operational capacity - Funding via levies and fees: - FSR Act provides PA power to impose levies to fund operations and charge fees for specific functions. - The draft Levies Bill sets methodology for calculation of levies to be paid by each financial institution. - Legislation requires the PA to publish, for public comment, an annual budget including an estimate of expenditure for the following two financial years and proposals for fees and levies. - Transparency requirement imposes discipline but the two-year estimate may be problematic if material changes occur requiring more intensive supervision. - Authorities encouraged to set levies to meet the PA’s budgeted expenditure in full to buttress financial autonomy. - Additional funding considerations: - PA supervisory model relies on independent reviewers for detailed supervisory work; high cost borne by the bank may lead to delayed intervention or supervisory forbearance, particularly for smaller banks with poor profitability. - Recommendations: - Mobilize additional funding sources to mitigate risk of delayed intervention. - Under a “user pays” model, consider introducing special fees (FSR Act provides this power) to cover supplementary supervision of financial conglomerates and banks using internal models. - Consider building a special contingency fund to cover legal enforcement proceedings. - Staff resources: - PA acknowledges increasing supervisory demands and burdens on staff. - PA not experiencing major difficulties attracting and retaining high-caliber staff, benefiting from SARB’s reputation. - Challenges remain in attracting risk analysts, quantitative experts and data scientists. - Turnover rate relatively low but several vacancies observed. - Need to establish effective training program for junior staff for skills, qualifications and succession planning. - Continued regulatory evolution and mounting vulnerabilities underscore importance of boosting operational capacity through staffing increases and investments in specialized skillsets. ### Recommendations (condensed) - Develop an operational definition of the PA’s primary objective for banking supervision and clearly articulate the PA’s tolerance for risk. - Develop a framework for balancing the PA’s primary objective of safety and soundness with its supporting mandate of financial inclusion and competition. - Strengthen human resources to ensure the quality and comprehensiveness of banking supervision. - Review the legislation to further safeguard the independence of the PA, while maintaining an effective accountability framework: - i. Review relevant provisions of FSR Act to require public disclosure of reasons for removal of the PA CEO and performance assessment measures of the CEO. - ii. Clearly prescribe the PA accountability and operational independence framework in legislation; review the legislation to further limit cases that require MOF involvement (approval, concurrence); review relevant provisions of FSR Act to remove the requirement that the PA must receive the concurrence of the FSCA on licensing matters. - iii. Ensure directives given to the PA by the SARB do not encroach on the PA’s microprudential responsibilities. - iv. Further strengthen funding support of the PA to enhance its operational effectiveness. *Source: IMF Financial Sector Assessment—chapter content as provided.* ### 31. The FSR Act imposes mandatory cooperation between the regulators—namely the PA, the ### 31. The FSR Act imposes mandatory cooperation between the regulators—namely the PA, the ### Domestic regulatory cooperation and MOUs - The FSR Act imposes mandatory cooperation between the regulators—namely the PA, the SARB, the FSCA, the National Credit Regulator (NCR), and the Financial Intelligence Centre (FIC). - Cooperation and collaboration extend to the making of regulatory instruments, taking joint enforcement actions, and conducting inspections and investigations. - The FSR Act includes a requirement to implement MOUs, and a legal requirement for the MOUs to be published and reviewed every three years. - At the time of the assessment the PA had signed and published MOUs with the SARB, the FSCA, the NCR and the FIC. - PA-FSCA joint standards work is ongoing; regulators have released standards on: - fit and proper person requirements for significant owners, - margin requirements, - requirements relating to central counterparty license applications. ### PA–SARB cooperation and information sharing - The PA and the SARB cooperate very closely on financial stability related issues, including recovery planning. - SARB staff sit on many PA decision-making bodies, such as the Prudential Committee which consists of the Governor, the CEO and other Deputy Governors. - The PA provides regular presentations in the SARB’s Monetary Policy Committee and Financial Stability Committee. - The SARB is invited to monthly Prudential Authority Management Committee (PA MANCO) meetings and the PA’s policy Panel. - The SARB is a member of the PA’s Regulatory Action Panel. - The SARB, except the Governor and Deputy Governors, has access to all supervisory information of individual banks. - The Financial Stability Department of the SARB assists the PA in the assessment of recovery plans of systemically important banks. ### Cooperation platforms established by the FSR Act - The FSR Act establishes four cooperating bodies with extensive but overlapping memberships, without formal powers or decision responsibilities: - Financial System Council of Regulators (FSCR) - The FSCR has nine members and meets minimum twice a year. - It is a forum to facilitate cooperation and collaboration and has discussed FSAP and FATF assessment issues. - The Financial Sector Regulation Body (FSRB) established nine working groups under the FSCR umbrella. - Financial Stability Oversight Committee (FSOC) - The FSOC comprises ten members and meets at least twice a year. - It is an advisory committee to the Governor, the SARB and the MOF; mandate covers financial stability, crisis management and prevention. - Financial Sector Contingency Forum (FSCF) - The FSCF comprises 8 members including financial sector industry representatives. - Main role: identify potential financial risks, coordinate and mitigate these risks; active in crisis simulation exercises and climate risk. - Financial Sector Inter-Ministerial Council (FSMC) - The FSMC has four members but has yet to meet for the first time. ### Evaluation, transparency, and resource efficiency concerns - The FSMC has a role in evaluating cooperative and collaborative mechanisms between financial sector regulators. - The FSRB requires the FSMC to commission an independent evaluation six months after establishment of the MOUs and then every two years. - The FSRB may itself, or at the request of another regulator, commission an independent evaluation of the effectiveness of cooperation and collaboration. - No such evaluation had been performed yet at the time of the assessment. - The report highlights the importance of developing and disclosing assessment criteria as soon as possible. - Concerns identified: - The domestic cooperation framework is prescriptive, has high level of overlapping membership and some overlapping mandates. - Potential to be resource intensive; risk of regulators focusing on compliance “tick-box” formalities rather than effective cooperation. - Joint standards, inspections and enforcement may reduce industry burden but risk transferring burden to regulators. - Regular independent evaluations “on request” and overlapping memberships, particularly between the FSOC and the FSCR, raise resource-efficiency concerns. - Involvement of political actors via the FSMC, combined with lack of clarity on evaluation criteria, may create avenues for politicization of supervisory processes. - Recommendation to revisit the FSR Act to mitigate politicization risk. - Transparency recommendation: - Formalization and public disclosure of meeting discussions and records of actions taken (at least for FSOC and FSCR) to strengthen accountability and avoid perceptions of inaction. ### Consolidated and conglomerate supervision (PA practices and gaps) - Consolidated supervision - The PA regulates banks and banking groups on a consolidated basis. - Regulations prescribe Level 1 solo requirements shall apply mutatis mutandis to consolidated Level 2. - The PA collects, reviews and analyses prudential reports and statistical returns from banks on both a solo and consolidated basis, including the controlling company, and verifies reports through onsite examinations or external experts. - The PA has a dedicated consolidated supervision analyst for every large banking group. - All banking groups submit a detailed organizational chart, biannually. - Supervisors discuss issues at a consolidated level and show good understanding of group structures and impact on bank risk profiles. - Conglomerate supervision enhancements - The FSR Act enhanced PA powers in conglomerate supervision; PA can designate members as a financial conglomerate. - PA expected to have finalized its designation by November 2020. - A financial conglomerate must include both an eligible financial institution and a holding company of the eligible financial institution but need not include all group members (diverges from international practice). - PA can issue directives to holding companies requiring actions to manage or mitigate risks to the bank arising from other group members, including power to impose restructuring of the conglomerate. - PA developing designation criteria and five prudential standards: on risk concentrations, on governance, on external auditor requirements, on capital and on intragroup transactions. - Full implementation of conglomerate supervision expected to be in place by early 2022. - Identified supervisory tool and resource gaps - Need to align supervisory framework across different sectors and develop guidelines, tools, and practices to obtain holistic group-wide views, including intragroup relationships and large exposures. - Need new tools and guidance for monitoring risks from nonbanking activities of larger financial groups. - Prudential reporting forms should be expanded to Level 3 data and analysis. - Stress testing as part of the ICAAP should cover risks from insurance activities on the banking group and reputational spill-over from a parent bank. - Suggestion to consider special fees (special levies) to increase staff resources for complex group supervision and Basel II IRB modelling banks on a “user pays” basis. - PA staffing for bank supervision needs to be increased; conglomerate supervision will require additional experienced, skilled, and highly qualified staff. ### Recovery, resolution, and cross-border supervision - Recovery and resolution planning - PA has required all banks to prepare group-wide recovery plans that include material entities (banking and nonbanking), although coverage of nonbanking activities and beyond the controlling company is still sporadic. - PA plans to address resolution plans for large banks once FSLAB gives necessary mandates—the FSLAB will establish the Resolution Authority within the SARB responsible for resolution of all banks and systemically financial institutions. - The Resolution Authority is expected to contribute to development of resolution plans initially for systemically important banks and then for smaller institutions. - Cross-border cooperation and supervision - PA has strengthened cross-border supervisory activities in recent years. - A few large South African banks have expanded to other African countries and have close relationships with the U.K.; PA organized supervisory colleges for large banking groups with host country supervisors in Africa. - All African countries where a banking group has presence are invited; agendas and presentations were found substantive and comprehensive. - PA also attends supervisory colleges of foreign banks as host supervisor and holds various ad hoc meetings with foreign supervisors. - Cross-border visits by PA frontline teams include meetings with host jurisdiction supervisors and executive management of banking subsidiaries; these visits typically occur two to three times a year for large cross-border groups. - Detailed records of meetings and correspondence from the PA to banks articulate issues and concerns regarding offshore operations. - The AML team within the Financial Conglomerate Supervision Department conducts AML/CFT supervision of subsidiaries in foreign jurisdictions and monitors remedial actions; AML/CFT team works with frontline prudential supervision teams for offsite monitoring. - Further needs - South African authorities should deepen cooperation globally, specifically with other African and U.K. authorities, particularly in early intervention, recovery and resolution planning. - Recovery and resolution plans need strong collaboration with U.K. authorities where ties exist. - The PA should account for impacts of potential stresses on host jurisdictions where South African banking groups are systemically important when planning recovery/resolution and early intervention measures. ### Recommendations (as presented in the source) - Establish a formal framework for disclosure of meeting discussions and a record of actions taken for the coordinating bodies such as the FSOC and the FSCR; - Streamline the domestic coordination and collaboration bodies membership and mandate to ensure efficient operation of the authorities involved; - Develop criteria for the independent evaluation of cooperation and collaboration among regulators with relevant stakeholders; - Develop group wide recovery plans to include nonbanking activities beyond the controlling company; - Articulate and embed group-wide and conglomerate-wide supervisory tools in the supervision framework; - Incorporate Level 3 data in the prudential reporting forms to assess the impact of conglomerates’ supervision. ### Supervisory approach, tools, and implementation status - Commitment to international standards - South Africa committed to implement BCBS internationally agreed standards, with adjustments as appropriate. - PA is implementing Basel III post crisis reforms and updating the large exposures regime. - Challenges noted with implementation of IFRS 9 in the banking sector. - PA plays an active role in international standard-setting bodies and uses a collaborative and consultative approach domestically and with neighboring countries. - New PA supervisory framework - PA is implementing a unified supervisory framework across sectors (banking, insurance and other sectors), published together with the PA Regulatory Strategy 2018–2021. - Framework key features: risk-based and proportional, forward-looking (pre-emptive), outcome-focused and integrated. - Framework based on four pillars: licensing, ongoing supervision, enforcement, and resolution. - Implementation commenced with the ongoing supervision phase incorporating SREP principles from the former Banking Supervision Department (supervisory planning, risk assessment, off-site and on-site supervision, banks’ ICAAP assessment, reporting to banks, follow up, and quality assurance). - Risk Framework and internal procedures - PA developing a new Risk Framework to guide supervisors on risk identification and assessment covering inherent risk, risk management, corporate governance and business model assessment, ratings and tolerance of risk, and supervisory judgment application. - Framework will inform intensity of supervision at solo, consolidated and conglomerate level and strengthen linkage to industry analysis. - Four interim supervisory guidelines approved in December 2019 covering supervisory planning, off-site analysis, appointment of independent reviewers and governance and culture reviews. - Transitional phase: mix of former supervisory methodologies and new guidelines in use; considerable work remains to complete implementation and fully transition to new processes and procedures. - PA has a dedicated unit for drafting supervisory internal procedures, but requires more resources for this work to progress. *Source: Excerpt from IMF assessment text provided in content unit 1zafea2022007 - 31.* ### 50. Different levels of supervisory engagement should be clearly prescribed in supervisory ### 1zafea2022007 - 50. Different levels of supervisory engagement should be clearly prescribed in supervisory ### Supervisory engagement levels and supervisory intensity model - The PA needs to clearly define its risk tolerance and apply a level of supervisory engagement commensurate with its risk assessments for individual banks. - The PA is developing its supervisory intensity model and should consider including the following in this model: - 22 i) not only the overall rating of the bank, but also the ratings of individual risks and components should drive the supervisory cycle; - ii) the systemic importance and complexity of the bank; - iii) its own reputational and political risk in the case of failures; and - iv) supervisory activities for the minimum level of (annual) supervisory engagement. - The approaches and techniques for different levels of supervisory engagement should be prescribed in the related methodology and framework. ### Historical supervisory approach and its risks - The PA’s approach historically relies on strong relationships with banks’ Boards, senior management, internal and external auditors, and regular prudential meetings (trilateral, bilateral, etc.). - Regular interactions cover strategies, business model and risks, corporate governance, culture, management issues and succession planning, and supervisory findings/expectations. - The PA relies on banks’ Boards, senior management, and the three lines of defense, as well as banks’ self-assessments, internal audit and external audit reviews. - Risk identified: excessive reliance on third-party assessments can create blind spots and may prevent early identification of emerging risks and unsafe or unsound practices. ### On-site supervision: current state and required strengthening - On-site inspection is included as a supervisory tool to: - challenge and test effectiveness of processes and procedures; - test validity of risk assessments from off-site information; - identify risks and assess whether they are well managed; and - identify areas for improvement. - Prior to establishment of the PA, an on-site review team conducted inspections on standardized approach for credit, Basel II operational risk reviews, impairment processes on retail mortgages and unsecured lending, and governance. - After PA establishment, the separate on-site review team was dissolved; work was partly shifted to Risk Support Department specialists and frontline analysts who undertake on-site visits for particular risks and ICAAP discussions. - Consequence: limited resources and reliance on external experts have resulted in on-site supervisory intensity that is on the lower end compared to international peers, risking gaps in identification of emerging risks and assessment of governance, risk management and control functions. - The PA is encouraged to perform more in-depth reviews of key internal processes, including governance and risks, to align with international best practices. - The PA has recently drafted its on-site supervision guidelines and is prepared to strengthen this tool. ### Use of independent reviews - Banks Act (Section 7) empowers the PA to engage independent reviewers, at the cost of the bank, to commission detailed assessments (e.g., banks’ calculation of capital requirements, value of assets or liabilities, governance framework). - FSAP team reviewed several independent review reports and found them comprehensive and substantive. - The recently approved guidelines on the process to select an independent reviewer include criteria to assess skills and capability. - Recommendation: PA should have procedures for assessing whether third parties’ output can be relied upon to the degree intended. ### Revisiting mix and intensity of on-site vs off-site supervision (deteriorating macroeconomic situation) - The PA should consider increasing frequency and intensity of on-site supervision and making greater use of risk specialists for on-site supervision, in particular for D-SIBs and higher risk banks. - Duration of on-site visits should be extended to allow full scrutiny of banks’ understanding and risk management practices. - Use on-site function for deeper assessment of corporate governance effectiveness. - A detailed on-site supervision methodology, including different inspection techniques, should be developed. - More resources will be required to achieve these objectives. ### Risk-rating methodology and supervisory focus - Frontline analyst teams use a dual rating system: one component reflecting systemic relevance, and the other tracking the risks the bank faces. - Under the current risk-rating methodology: - quantitative ratios attract a weighting of 70 percent; - assessment of corporate governance, management and staff, compliance, AML/CFT, internal audit issues attract a weighting of 30 percent. - Semi-annual risk review reports are more detailed and descriptive but do not provide a comprehensive assessment of a bank’s risks and governance. - Supervisory ratings determine length of supervisory cycle, but PA’s processes do not (yet) provide a structured and formal approach for varying supervisory intensity in accordance with risk ratings (in practice approach differs by judgement for large vs smaller banks). - Recommended shift: supervisory intensity should be differentiated by rating of individual risk components (credit risk, market risk, operational risk, liquidity risk) rather than being driven mainly by overall rating. - Example: a worse rating for operational risk should result in increased supervisory intensity in that area, but not necessarily in other areas. - The PA communicates findings via prudential meetings and feedback letters; documentation indicates relatively widespread use of regulatory exemptions that can undermine supervisory efforts. ### Moving to a more intrusive, structured supervisory model and technology enablement - Implementation of the Supervisory framework, including the new Risk Framework, should yield a more structured, intrusive approach with priority on assessing effectiveness of banks’ governance and risk management arrangements. - Achieving this requires: - additional resources; - more detailed supervisory methodologies; - development of additional guidance to industry on supervisory expectations and best practices. - The PA should consider providing more feedback to industry on thematic reviews, “flavor of the year” discussions, and prudential meetings to guide industry behavior and foster greater risk awareness. - Direct access to credit registers and other databases, and continuous improvement of IT systems including suptech, should facilitate ongoing supervision. ### Need for internal supervisory methodologies and clearer priorities - Many banks’ ratings have not changed for several years. - Limited written internal guidance exists for supervisors to rate risk profiles, despite necessary knowledge being present within the PA. - Regulators are essential but not granular enough; internal supervisory methodologies should: - describe best practices for all relevant risk areas (including corporate governance and risk management); - allow supervisors to assign consistent and timely ratings across the entire risk spectrum. - Formalizing guidance and sharing materials internally will ensure a more granular and consistent rating process. - The PA should set annual priorities for banking supervision focusing on key challenges in macroeconomic, regulatory, and supervisory environment. - The PA currently decides annually on two or three “flavor of the year” topics; for 2020 the topics were not directly relevant to banking sector financial risks (IFRS 17 Insurance; The impact of new technologies, including FinTech and disruptive technologies on the regulated institutions). - The PA should consider setting annual priorities for each sector under its supervision to focus industry attention, elucidate supervisory expectations, and ensure industry-specific vulnerabilities are addressed. ### Recommendations (as presented in the source) - Direct more resources to implement the supervisory framework, including the new Risk Framework, effectively. - Ensure that the implementation of the supervisory framework results in a more structured, intrusive, comprehensive ongoing banking supervision with greater focus on assessing the effectiveness of banks’ corporate governance and risk management arrangements. - Assess the specific mix between on-site and off-site supervision and its effectiveness, with the aim to enhance banks’ governance and risks assessments. - Strengthen the on-site supervision function by increasing the frequency and intensity of on-site supervision and making greater use of risk specialists for on-site supervision function (D-SIBs and other higher risk banks). - Develop more detailed supervisory methodologies listing the range of observed good practices that will assist supervisors with rating their institutions and carrying out on-site inspections. - Set out annual priorities for banking supervision to focus resources on the key challenges facing banks in the macroeconomic, regulatory, and supervisory environment. ### Corrective and sanctioning powers — early messaging and escalation - PA raises supervisory concerns early via feedback letters after onsite meetings and offsite reviews; letters are comprehensive and substantive. - Issue: wording of feedback letters does not clearly distinguish deficiencies from matters requiring strengthening but not deficiencies, hindering judgment of nature and severity. - Recommendation: formal classification of nature and severity of issues and clearer articulation of urgency for remedial action. - Practice observed: banks vary on internal escalation—some table every feedback letter to Boards; others allow management discretion. Good practice: supervisors should decide which matters need to be raised with the Board. - Observed enforcement appetite is on lower end of spectrum; persistent unresolved concerns suggest protracted cooperative engagements can draw supervisory resources into prolonged efforts with non-cooperative institutions. - Recommendation: be more proactive, escalate issues quicker to Boards, and be more forceful in setting expectations for timely resolution. - Good international practice: develop structured and rigorous supervisory response frameworks linked to combined risk and impact assessments to determine supervisory actions for given assessment levels. - Such frameworks are typically linked to early intervention arrangements and include quantitative triggers (capital ratio, liquidity ratio, impaired assets, indicators of operational and market risk). - Early Warning Indicators (EWIs) should include leading indicators relating to earnings, interest rate margins, profitability, capital, asset quality, liquidity, funding, market risk and operational risk—with thresholds set well above regulatory requirements. - Frameworks are applied at licensed bank and banking group level where applicable, and are not to be used mechanistically but as basis for supervisory discussion and decision. *SOUTH AFRICA INTERNATIONAL MONETARY FUND* ### 63. The PA has not implemented a structured intervention framework, with triggers ### The PA has not implemented a structured intervention framework, with triggers ### Early intervention framework and early warning indicators (EWIs) - The PA has not implemented a structured intervention framework, with triggers (qualitative and quantitative) and indicative response actions in relation to triggers. - The PA uses various prudential and financial indicators in its supervisory analysis, including some EWIs, but the indicators tend to be mainly in relation to an institution’s current financial condition rather than early indicators of possible future deteriorations in financial condition. - Recommendation: develop a formalized intervention framework, with triggers and responses anchored both to the risk/impact ratings and to specific calibrations of current condition indicators and early warning indicators. - Recommendation: develop more comprehensive EWIs covering a range of risk metrics, with particular focus on indicators that can assist in foreshadowing or adumbrating future deterioration in financial condition. ### Watchlist and internal processes - The Risk Support Department prepares a watchlist of banks that raise specific concerns which is circulated to the Prudential Committee. - The monthly watch list is tabled at the PA MANCO for discussion. - This is an independent process driven by RSD and only PA MANCO can remove a bank from the list. - This process was introduced during 2019. ### New powers under the FSR Act and the Regulatory Action Blueprint - The enactment of the FSR Act has granted a suite of new powers to the PA and it now has a range of supervisory powers to decide on timely corrective actions at its disposal. - New powers include enforceable undertakings and debarment orders and issuing a directive to a key person of a financial institution. - The Regulatory Action Blueprint lists the actions the PA can take and the delegation of powers to Heads of Division and Heads of Department by the CEO. - The Prudential Regulatory Action Committee (PARAC) recommends to the CEO of the PA the regulatory action to be taken. - The PARAC includes SARB representatives. ### Contingency planning and testing - The PA has not yet developed contingency plans for dealing with weak banks. - Contingency plans typically include checklists of actions and strategies, including coordination arrangements, for common scenarios of emerging bank stress and deteriorating financial conditions in a bank. - The PA does not undertake regular testing of its capacity for responding to bank stress situations. - FSAP recommendation: develop contingency plans and undertake regular testing of capacity in this area. - Reference: BCBS (e.g., the 2015 paper) recognizes the helpfulness of contingency plans in establishing preparedness for dealing with weak banks. ### Appointment of a curator and pre-resolution powers - Currently, the appointment of a curator requires the approval of the MOF, which undermines the independence of the PA. - In a case where the PA believes that a bank will be unable to repay deposits or will probably be unable to meet any other obligations, the MOF may currently appoint a curator of the bank, in whom the management of the bank is vested. - The curator, who operates under the supervision of the PA, can: - suspend or reduce the right of creditors of the bank to claim or receive interest; - make payments to creditors; - cancel any agreement between the bank and other parties to advance funds or extend facilities; - convene a meeting of creditors; - negotiate with creditors; and, - cancel guarantees issued by the bank. - The curator is required to provide the PA with monthly reports indicating whether there is a reasonable probability that the bank will become a successful concern. - The FSLAB will eliminate the power to appoint a curator, thus removing an essential tool from the PA’s supervisory toolkit. - The power to place institutions under official control is explicitly required under the Basel Core Principles and can reduce contagion risk and be crucial to maintaining financial stability. - Recommendation: retain the power for the PA to temporarily place institutions under official control in pre-resolution situations, subject to appropriate triggers (such as the PA being satisfied, on reasonable grounds, that a bank’s viability is potentially at risk and that timely remediation is not likely to materialize if the bank’s current management remains in control). ### Suspension/cancellation notice period and emergency action - There is a requirement to give 30 days prior notice in suspending registration or restricting activities of a bank or a controlling company. - The 30-day notice requirement can hamper timely supervisory responses and potentially undermine confidence because cancellation or suspension does not become effective during that time. - The PA could apply to the court for an order of cancellation or suspension of the registration, in which case the 30-day notice period would not apply, but it is not clear if such a request can be processed expeditiously and in strict confidence. - The Legal Services Department of the PA is of the view that the suspension or cancellation of a license is an administrative action that is subject to the Promotion of Administrative Justice Act (PAJA); since PAJA allows for immediate action, the Legal Services Department is of the view the PA can take steps to immediately cancel or suspend a license. - This opinion and potential court application remain untested in practice. - It is essential that supervisors are prepared for urgent crisis situations when informal measures may not work. - Recommendation: remove the 30-day notice for suspending registration or restricting activities of a bank or controlling company. ### Consolidated recommendations (supervisory response and escalation) - Develop a formal classification of the nature and severity of the issues raised and a clearer articulation of the urgency in the feedback letters. - Clearly define the matters that need escalation to the Boards of Directors of supervised institutions in the feedback letters. - Maintain the power for the PA, as a pre-resolution instrument, to place institutions under official control (via a temporary administrator or statutory manager) without ministerial involvement. - Remove the 30-day notice for suspending registration or restricting activities of a bank or controlling company. - Develop a rigorous and structured framework for a consistent early intervention supervisory response. - Strengthen EWIs and make them more forward looking. - Develop and regularly test contingency plans for dealing with banks and bank stress scenarios. *International Monetary Fund — Selected excerpts on PA intervention framework, contingency planning, and supervisory powers.* ### 81. Although credit risk is the main driver of the South African banks’ risk profile, there is ### 1zafea2022007 - 81. Although credit risk is the main driver of the South African banks’ risk profile, there is ### Credit risk, external auditors, and PA reliance - Credit risk is the main driver of the South African banks’ risk profile; the PA considerably relies on external auditors for review of credit risk management and provisioning. - External auditors prepare annual reporting for significant weaknesses in the system of internal controls relating to: granting of loans, making of investments, ongoing management of loan and investment portfolios, and relevant credit impairments or loan loss provisions and reserves. - Auditors are required to determine that the banks give due consideration to off balance sheet exposures. - There may be an expectations gap in the PA’s reliance on external auditors for consistency in application of principles-based accounting standards across banks. - All South African banks are required to comply with IFRS 9, a principles-based standard that allows a high degree of management discretion. - The PA engaged early with industry and auditors via a technical accounting and auditing unit; issued guidance note 3 on IFRS 9 in 2016 and Directive 5 in 2017; engagement mainly through working groups facilitated by SAICA where most large banks, IRBA and audit firms were represented; most small banks were not regular attendees. - Position papers from those working groups are not publicly available. - IRBA issued a staff practice alert on the audit implication of the Expected Credit Loss (E) model for external auditors. - External auditors and banks reported divergence in the application of IFRS 9 definitions across banks (examples: segmentation, modifications, SMEs, write offs). - External auditors ensure compliance with IFRS on an individual bank basis but cannot ensure consistency in application across the industry. - Ultimately it is the bank’s board that is responsible for ensuring that financial statements are prepared in accordance with accounting policies and practices. ### Prudential reporting, data needs, and supervision intensity - Prudential reporting forms are being updated to align with IFRS 9; additional data on restructuring like cure rates and roll rates need to be collected. - The PA is updating prudential reporting forms and aligning them to IFRS 9; this is an opportunity to collect additional data on distressed restructurings at individual bank level to be aggregated for the banking system. - Trends such as cure rates and migration rates for restructured and defaulted exposures should inform the intensity of supervision. ### Engagement with auditors and assessment of audit quality - There is regular and active engagement between the PA and bank external auditors through bilateral (pre-final audit) and trilateral (post-audit) meetings. - The PA requires two audit firms to act as joint auditors for large banks, with each auditor taking equal responsibility; feedback indicates this practice has contributed to audit quality. - No comprehensive and deep assessment of audit quality is performed by the PA. Note: a deep and comprehensive assessment would include a review of audit working papers. ### IRBA oversight limitations and recent pressures on audit quality - The PA relies on the IRBA to oversee audit quality of external auditors, but IRBA’s scope is limited to statutory audit; IRBA’s reach does not extend to the regulatory audit the PA requires external auditors of banks to perform. - Audit quality has come under pressure in South Africa, particularly following the failure of two smaller banks and other corporate scandals. - IRBA established under the Accounting Profession Act in 2006; has around 40 projects ongoing to support confidence in the audit profession and developed a suite of audit quality indicators. - IRBA inspections resulted in 50 and 60 percent of inspected audits with one or more findings, above the international rate of 33 percent. - IRBA does not have any staff with bank expertise and cannot be relied upon to oversee audit quality in the banking sector on an ongoing basis. - IRBA spent 10 percent of its budget to investigate the external auditors of African bank using external consultants and guidance of foreign peers. - Ongoing investigations by IRBA of one audit firm following allegations of complicity of an audit engagement partner in a bank failure underscore the importance of establishing adequate oversight of bank audit quality. Details of the allegation include: the audit firm concealed the bank’s financial position; an unqualified audit opinion was issued despite materially misstated financial statements; the regulatory audit opinion was also materially misstated; the external audit firm partner who signed the opinions received very substantial loans from the bank which were not declared, compromising independence. - Following the VBS corruption scandal, several banks migrated to different audit firms or sought enhancements of audit teams (e.g., addition of non-local staff and external review partners). - The PA refrained from withdrawing the firm’s approval to perform bank audits, citing confidence in measures taken by the firm to strengthen internal procedures; the PA should (i) disseminate factors underpinning this decision to guide future PA–auditor interaction, and (ii) consider additional safeguards across the audit profession informed by cost-benefit analyses (examples: independent reviews, strengthening external audit teams, broader rollout of joint audit requirements already applicable for the largest banks). - The PA (jointly with IRBA, as appropriate) should push for substantial enhancement of the oversight framework of bank audits; work must be adequately funded so several experts with background in bank audit can be allocated to the task. - The Accounting and Auditing ROSC performed in 2013 should be updated. ### Audit firm and partner rotation; IFRS 9 skills in smaller banks - Mandatory partner rotation: Companies Act states the same individual may not serve as auditor/designated auditor of a company for more than five consecutive years. - IRBA rule on mandatory audit firm rotation of ten years will apply to all banks for financial years commencing on or after April 1, 2023. - Rotation requirements put strain in an oligopolistic market with joint audits and strict independence requirements. - IFRS 9 skills in small banks are thin and effective implementation of the three lines of defense has been a challenge. - Discussions with smaller banks and external auditors showed heavy involvement of the second line of defense in IFRS 9 model implementation and a lack of IFRS 9 skills in the third line of defense. - The PA is aware of these weaknesses; no proactive supervisory stance has been debated. Potential supervisory actions could include: a regulatory provisioning overlay with fixed percentages, additional capital requirements, or a direction to the bank to source more resources with relevant skills, internationally or domestically. ### Collateral treatment, collateral regulation gaps, and distressed restructuring - For standardized banks, credit exposures are classified into substandard, doubtful and loss categories; contrary to international best practices, these classifications consider value of any underlying security, potentially distorting identification of nonperforming loans. - Basel requirements indicate an exposure could be considered nonperforming, substandard or doubtful even when the security or collateral value exceeds past due exposures. - Regulation dealing with collateral is in line with Basel II requirements but falls short on many qualitative good practice requirements: - No requirement for external valuation of collateral for significant credits. - No prohibition on reliance on collateral as a substitute for borrower’s ability to meet contractual obligations. - No requirements for policies to ensure collateral remains enforceable and realizable. - No requirements for evaluation of external appraisers for independence. - No requirements for back-testing of collateral valuations. - No specifications for use of indexed valuations. - Recommendation: integrate these requirements in a prudential standard or guidance note to articulate PA expectations and assist frontline supervisors to grade institutions. - Directive 7/2015 defines distressed restructuring and prohibits using restructuring to conceal problem loans; requires evidence that restructure is necessary because of obligor financial distress and that the exposure be assessed for impairment. - Directive 7/15: a loan once restructured must be reported at a minimum as special mention for standardized banks and as default for IRB banks; restructured exposures must be classified as nonperforming assets for a minimum of six months, or six consecutive payments, under revised terms before reclassification as performing. - Basel guidelines on restructuring require an observation period of at least one year; Directive 7/15’s minimum of six months is lax and inconsistent with IRB banks. Recommendation: update the Directive with latest Basel Guidelines. ### Recommendations (as presented) - Align the Regulations on restructuring with the Basel Guidelines “Prudential Treatment of Problem Assets”. - Extend the observation period for restructured exposures to one year in accordance with Basel Guidelines “Prudential Treatment of Problem Assets”. - Amend the asset quality definitions of Substandard, Doubtful and Loss for standardized banks by eliminating the impact of the value of the security on the asset classification in accordance with the Basel Guidelines “Prudential Treatment of Problem Assets”. - Develop a prudential standard or at a minimum articulate the supervisory expectations in the area of collateral valuation. - Perform an Accounting and Auditing ROSC to obtain an independent assessment of the quality of the audit profession. - Assess IFRS 9 skills in the second and third line of defense in the small banks and consider imposing additional requirements while banks are building up expert resources. - Develop formal supervisory expectations reflecting good industry practice for credit risk and IFRS 9. - Establish independent oversight of the quality of bank audits. - Align the classification of restructured exposures as nonperforming between the IRB and standardized banks. ### Concentration risk, large exposures, and related-party transactions — key findings - Regulations require Board and senior management to establish and maintain adequate policies and procedures related to large exposures and concentration risk. - A bank may not make investments or grant loans or other credit to any person in an aggregate amount exceeding 10 percent of its capital and reserves without board or committee permission. - A bank or controlling company may not make an investment or grant any form of credit to a private sector nonbank person that exceeds 25 percent of the bank’s capital and reserves without prior written approval of the PA. - PA staff discuss loan approval governance including Board approval of larger credit exposures. No specific thresholds for sectoral, geographic, or other concentrations are in place, though these are regularly monitored by the PA. Credit risk mitigation concentrations are not covered by the Regulations and not always actively monitored by banks. - Several banks have exceeded the 25 percent limit single name concentration. In line with Basel standards, a risk weighting of 1250 percent (i.e., similar to a deduction against capital) is applied to the portion of the exposure in excess of the 25 percent limit. - Concentrations often represent exposures to the South African sovereign (including public sector entities) and exposures to other banks. Some banks hold capital add-ons for product concentration risk (e.g., unsecured lending, SME) or sector concentration (mining, construction, real estate). - New BCBS large exposure framework came into force on January 1, 2019 and is expected to be implemented on April 1, 2022. The framework: - Ensures internationally active banks’ exposures to single counterparties are appropriately monitored and limited. - Limits scope to losses incurred due to default of a single counterparty. - Requires all banks to report to national supervisors not only large exposures but also exposures that would have been large exposures without credit risk mitigation or exemption clauses. - Exempts sovereign exposures from standard thresholds but requires monitoring. - New BCBS framework changes measurement, aggregation, and control of exposures to single counterparties and groups of connected parties; defines “control relationship” and “economic interdependence”; specifies criteria where counterparties are deemed connected. These concepts are not yet included in the PA’s Regulations. - A preliminary PA impact assessment indicated some smaller banks will struggle to meet the interbank large exposure cap. Policy options being explored: exclude small banks from scope, exempt them, or grant transitional arrangements. ### Transactions with related parties — findings and gaps - Related-party transaction Regulations require banks and controlling companies to lend money to a related person on an arm’s-length basis and to have robust board-approved policies, processes, and procedures to monitor transactions and provide supervisory returns. Banks report related-party transactions to the PA. - Reporting thresholds: related-party exposures that exceed 0.1 percent of total capital are required to be reported on an individual basis; related-party exposures less than 0.1 percent of total capital are reported on an aggregate level. Exposures in excess of 1 percent of Tier 1 capital are subject to prior approval by the bank’s board. - Banks must attest through three questions that all related-party transactions are done at arms-length, are board-monitored, and whether steps have been taken to control or mitigate these exposures. - Regulation 39 requires the Board and senior management to ensure monitoring and reporting of individual and aggregate exposures to related persons are subject to an independent credit review process. The PA may impose limits on a bank’s exposure to connected or related persons as it deems prudent; however, no limits have been set by the PA on any bank’s aggregate or case-by-case exposures to related parties. - Regulations unchanged since 2012 exhibit gaps with Basel Core Principle (BCP) 20 on related party transactions and should be updated: - Definition of “related party” does not capture certain groups. Related interests of the bank’s major shareholders, Board members, senior management, and key staff as well as corresponding persons in affiliated companies are not included. Definitions are not fully aligned with the new FSR Act or Banks Act (examples: “key members of staff” vs “key person”; “close relative” vs “close family member”; “significant shareholder” vs “significant owner”), risking inconsistent identification of related parties across the banking sector. - Insufficient scope of transactions with related parties: definition covers on-balance sheet and off-balance sheet credit exposures and claims, but does not cover dealings such as service contracts, asset purchases and sales, construction contracts, lease agreements, borrowings, and write-offs. The term “transaction” is not interpreted broadly enough to include situations where an unrelated party with an existing exposure subsequently becomes a related party. Regulations require policies, processes, and procedures only for lending transactions with related parties, not for all transactions. - Specific governance requirements for transactions with related parties are not clearly prescribed: Regulation 39 sets broad requirements but lacks detailed prescription (examples: no clear requirement that Board must provide oversight of related-party transactions; no clear requirement that exceptions to policies, processes and limits must be reported to appropriate senior management or Board). - Insufficient depth of review of banks’ practice on related-party transactions: PA obtains quarterly supervisory returns on related-party exposures; matters of concern are discussed in prudential meetings. PA uses external auditors to review banks’ compliance and verify supervisory returns, but there is an expectations gap in reliance on external auditors. In recent years, no on-site inspections (visits) on related-party exposures have been carried out by the PA. *Source: IMF country report content unit 1zafea2022007 - 81.* ### 100. The authorities are encouraged to: ### 100. The authorities are encouraged to: ### Related-party transactions and credit risk mitigation - Implement the new BCBS large exposure framework including the new requirements for connected counterparts and the limits on interbank exposures. - Ensure active monitoring of credit risk mitigation concentrations in banks. - Expand the definitions of “related party” and “related-party transactions” to ensure they are consistent with BCP 20; ensure that there is consistency of definitions for identification of related parties in the FSR Act, BA and Regulations. - Clearly prescribe specific governance requirements for transactions with related parties. - Conduct an independent verification that adequate policies, procedures and controls on transactions with related parties exist at banks, and the information reported by banks on these transactions is reliable as well as issue guidelines on industry best practices for areas of concern. ### H. Liquidity Risk — institutional framework and metrics - Banks in South Africa are currently subject to the LCR and the NSFR, on a solo and consolidated basis. - Two other liquidity ratios, the cash reserve requirement and the liquid asset requirement, were maintained when the LCR and the NSFR were introduced. - Regulation 26 and Directive 8/2017 provide detailed requirements on the calculation of the LCR and the NSFR. - Banks report the LCR on a daily basis to the PA. - The implementation of the LCR was assessed by the Basel Regulatory Consistency Assessment Program (RCAP) assessment as “Compliant” in June 2015. - The average banking sector LCR was around 140 percent at the end of 2019. ### H. Liquidity Risk — NSFR implementation challenges and mitigants - The South African NSFR implementation is not fully compliant with the Basel III requirements. - Structural market factors complicating NSFR implementation: limited supply of government bonds, an illiquid and small corporate debt market, and disintermediation of retail funding through money market funds into the banking sector. - For the NSFR calculation, the authorities assigned an Available Stable Funding (ASF) factor of 35 percent to secured and unsecured funding received in Rand from financial corporate customers, excluding banks, with a residual maturity of less than 6 months. - The PA has opined that the 35 percent ASF calibration (instead of zero percent in the Basel III requirements) better reflects the stability of this funding source in South Africa. - Justifications cited for the 35 percent ASF calibration: various regulatory and economic barriers that prevent liquidity from flowing out of the domestic economy, including the foreign exchange control regime and the limited foreign exchange funding by South African banks. - The SARB made a Committed Liquidity Facility available to commercial banks to assist them in meeting their LCR, in view of the limited availability of high-quality liquidity assets (HQLA) at the time that the requirements were introduced; this facility is now being phased out due to increased supply of government bonds in the market. ### H. Liquidity Risk — supervisory practice and reviews - The PA conducts both onsite and offsite ALM reviews as part of the supervisory framework. - For the larger banks, a questionnaire on liquidity risk is completed every two years. The questionnaire covers qualitative and quantitative questions, based on the Basel Principles for Sound Liquidity Risk Management. - The PA’s liquidity risk analyst reviews the responses to the questionnaire and asks additional questions; during onsite meetings the results are discussed with bank management. - For the smaller banks, the frequency and intensity of ALM reviews is decided on an ad hoc basis, but the objective is to achieve a 3-year supervisory cycle for liquidity risk in the medium term. ### H. Liquidity Risk — concentration and simulation practices - Small foreign banks display liquidity funding concentration; monthly trigger reports indicate the ten largest deposits as part of total funding. - Recommendation: better articulate the PA’s risk tolerance for liquidity funding concentration risk with specific triggers and timelines for the foreign banks peer group; decide by peer group and embed in internal reporting. - Externally facilitated liquidity simulations have been used to test and complement Liquidity Contingency Plans and Recovery plans of the large banks. - All banks, branches of foreign institutions and controlling companies are required by Directive D1/2015 section 6(6) of the Banks Act no 94 of 1990 on the minimum requirements for the recovery plans of banks to conduct stress tests. - Section 8.2 of the Directive is particular on Reverse stress testing. Reverse stress testing is defined as identifying a scenario or combination of scenarios that lead to an outcome in which the institution’s business plan becomes unviable and the institution insolvent, as well as assessing the probability of realisation of such scenarios. - The simulations are dynamic; senior management of relevant banks as well as the SARB Financial Markets Department, the SARB Financial Stability Department, the National Payment System Department, and the PA participate. - Simulations are resource intensive and require long preparation times and have been performed on an ad hoc basis; recommendation to formalize scope and objectives and set a minimum frequency for large banks and for smaller banks with an elevated liquidity risk profile. ### Recommendations (paragraph 106) - Formalize the requirement for regularly externally facilitated liquidity simulations to test liquidity contingency plans for the large banks. - Embed a requirement for an externally facilitated liquidity simulation for smaller banks with elevated liquidity risk profile in the supervisory response framework. - Clearly articulate risk tolerance for funding risk concentration by peer group. ### Appendix I — status of selected 2014 FSAP recommendations (extracts) - CP1: Objectives of the supervisor have been clearly defined in the FSR Act. Prudential and joint standards were introduced; plans exist to convert Minister’s approved Regulations into prudential or joint standards. No change since 2014 on the Standing Committee for the Revision of the Banks Act; authorities should consider reviewing the Banks Act to remove the Committee or prescribe its composition and role. - CP2: Progress made; FSR Act provides for PA CEO fixed term and basis for removal but requirement to publish reasons for removal should be prescribed in legislation. Ministerial involvement in licensing removed; prudential standards replacing Minister’s Regulations. Resource adequacy reviewed with some vacancies; PA should consider increasing resources for further supervisory reforms. - CP3: Weaknesses addressed through section 251 of the FSR Act regarding confidential information use. - CP8: Ongoing. A Resolution Authority is being established within the SARB Financial Stability Department. FSLAB was passed by Parliament in December 2021 and implementation is underway. FSR Act empowers PA to regulate and supervise financial conglomerates and PA has started designating groups as financial conglomerates. - CP9: Ongoing. On-site review team was dissolved on PA establishment. PA conducts short-term on-site visits or can appoint an independent reviewer; PA should consider strengthening on-site supervision function. FSR Act empowers PA to regulate and supervise financial conglomerates; large financial groups are supervised by integrated supervisory teams with risk expert support. - CP11: No change since 2014 on suspension/limitation powers; adoption of the FSR Act addressed power to fine individuals. - CP12: Ongoing progress on group-wide stress testing and recovery/resolution planning; further work remains. - CP13: PA has significantly strengthened cross-border cooperation since 2014. PA conducted 10 onsite inspections in African countries in 2018-2020 and 9 inspections in other parts of the world. Cross-border recovery and resolution planning progress has been made but is ongoing. - CP18: Directive on restructured credit exposures has been finalized; new 2017 BCBS Guidance still needs incorporation into Regulations. - CP20: In Regulations, exposure to related parties is treated as subject to concentration limits and the PA has power to impose limits on a bank’s exposure to connected or related persons as it deems prudent or appropriate. - CP23: Oversight of Interest Rate Risk in the Banking Book (IRRBB) has been strengthened since 2014. - CP28: Pillar 3 disclosures are now reviewed. - CP29: Amendments to the FICA (2017) enhanced key preventive measures and introduced a risk-based approach; PA established a specialized AML/CFT review team conducting off-site and on-site supervision and imposing administrative penalties publicly disclosed. The PA should consider incorporation of AML/CFT findings into the prudential supervision framework. The PA’s AML/CFT unit supervises subsidiaries of South African banks in foreign jurisdictions and has conducted joint onsite inspections with Banks Supervision Departments and Financial Intelligence Units since 2013. *Source: IMF staff report content provided in the supplied document.* --- _Source: https://www.imf.org/-/media/files/publications/cr/2022/english/1zafea2022007.pdf_