## EXECUTIVE SUMMARY

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---

### Overview
- South Africa has made significant progress in strengthening its macroprudential policy framework and foundations since the 2014 FSAP.
- The 2017 Financial Sector Regulations Act introduced the current ‘Twin Peaks’ structure, provided SARB with a strong financial stability mandate, and sought to foster interagency coordination and collaboration (including via the establishment of the Financial System Council of Regulators).
- South Africa has a hybrid macroprudential policy framework that combines a ‘strong’ decision maker in the SARB Governor, supported by an advisory committee structure, fostering effective cooperation and coordination.
- Systemic risk monitoring has been enhanced and some macroprudential policy tools have been phased-in.

### Institutional framework
- Key institutional features:
  - The Financial Sector Regulation (FSR) Act 9 of 2017 defined key features of the institutional framework and a policy framework agreed between the Minister of Finance and the Governor.
  - SARB has a strong mandate to protect and enhance financial stability and to restore financial stability in case a systemic event has occurred.
  - The Governor serves as the key decision-maker, backed by external and internal advisory committees.
  - Other financial regulators also have a financial stability mandate, resulting in more than one macroprudential authority, but SARB plays a leading role.
- Committees and roles:
  - Financial Stability Oversight Committee (FSOC): Statutory Committee under the FSR Act; advises the Governor; includes SARB, NT and all financial regulators; chaired by the Governor; normally meets biannually.
  - Financial Sector Contingency Forum (FSCF): Statutory forum established by the Governor to assist FSOC with identifying risks that could lead to a systemic event and coordinating contingency plans; chaired by a Deputy Governor designated by the Governor.
  - Financial Stability Committee (FSC): Internal SARB committee established in 2000 and restructured in 2010; Governor as Chairperson (cannot be outvoted); meets four times a year or as required; content and discussions shared with FSOC and communicated in the biannual Financial Stability Review publication. Records of FSC meetings are not published.
- Communication and accountability requirements:
  - Financial Stability Review must, at least biannually, set out: (a) SARB’s assessment of financial stability in the period under review; (b) identification and assessment of the risks and vulnerabilities to financial stability in at least the next 12 months; (c) overview of steps taken by SARB and the financial sector regulators to identify and manage risks during the period under review and that are envisaged to be taken during at least the next 12 months; and (d) an overview of recommendations made by it and the FSOC during the period under review and progress made in implementing those recommendations.
  - The Minister of Finance and the FSOC shall have two weeks to comment on the Review before its publication.
  - The FSC does not provide a summary of its meetings, except what is included in the Financial Stability Review; because the FSC meets four times a year and the Review is only published biannually, no information about the FSC’s assessment of risks or need for policy action is published every other time it meets.

### Willingness to act
- Institutional features that foster willingness to act:
  - Clear assignment of the macroprudential mandate, well-defined objectives, a strong role for the central bank, dedicated financial stability units, and accountability and communication frameworks.
- Governance risk: potential appointment of an individual with a strong inaction bias (or overly aggressive action preferences); mitigated by external advisory committees with clear mandates.
- The combination of a designated decision maker (the Governor) and advisory committee structure is likely to foster willingness to act.

### Ability to act
- SARB powers and constraints:
  - SARB’s powers are mostly confined to designating SIFIs and setting macroprudential policy constraints on SIFIs outside of declared systemic events.
  - The Governor designates which financial institutions are SIFIs, after consultation with FSOC, considering size, complexity, interconnectedness, and substitutability.
  - Based on designation, SARB can direct the Prudential Authority (PA), after consultation, to impose macroprudential regulations on SIFIs, including capital and liquidity tools and a countercyclical capital buffer (CCyB), which would apply to all banks, not just SIFIs.
  - SARB may advise other financial regulators and organs of state to take steps to mitigate risks, but without a ‘comply-or-explain’ mechanism.
  - SARB’s advice may carry extra weight due to its credibility.
- ‘Systemic event’ declaration and expanded powers:
  - To attain a wider range of powers, the Governor needs to declare an event as a ‘systemic event’.
  - The FSR Act gives the Governor, after consulting the Minister of Finance and potentially FSOC, the power to declare that an event or circumstances is a ‘systemic event’, regardless of whether they have already taken place or are considered imminent.
  - Following such a declaration, the SARB “must take all reasonable steps” to mitigate the risk and safeguard financial stability.
  - After declaration, all financial sector regulators must provide SARB with relevant information and consult SARB before exercising their own regulatory powers; SARB effectively attains authority over regulators’ directives to address the event (explicitly for the PA, FSCA, and the FIC).
  - The requirement to declare an event as ‘systemic’ creates incentives for policy actions to be taken too late or not at all; reconsideration of the need to declare an event as systemic is advised.

### Coordination and cooperation
- The wide-ranging committee structure supports cooperation and coordination and sets South Africa apart from many other EMEs.
- Effective institutional arrangements to ensure close cooperation between regulators serve as important mitigants against the inaction bias and somewhat narrow powers of the SARB.
- Features supporting cooperation:
  - strong legal requirements for cooperation;
  - committee structures that entail overlap in membership (importantly also across to monetary policy);
  - explicit financial stability mandates of institutions;
  - presence of information sharing mechanisms.
- Recommendation on transparency:
  - The FSC could consider publishing a short record of its meeting, especially when the Financial Stability Review is not published, to enhance transparency and provide more frequent assessment of systemic risk. (SARB) — immediate (I)

### Systemic risk monitoring
- Status and features:
  - SARB’s systemic risk monitoring framework is well advanced and follows examples set by advanced and EME central banks and Fund guidance.
  - Uses macrofinancial indicators to build a heatmap of different types of risks; relies on financial conditions and financial cycle analysis, and the growth-at-risk framework.
  - Stress test capacity includes both solvency and liquidity stress tests, built-up in line with the 2014 FSAP recommendations.
  - Assessment summarized in the risk assessment matrix (RAM) and the Financial Stability Review.
- Data gaps and implications:
  - Important micro-level data gaps remain, particularly on borrowers, constraining assessment of tail risks and calibration of macroprudential tools.
  - Micro-level data enables: distributional analysis across borrower types; calibration of borrower-based tools; assessment of crisis effects on borrowers.
- Recommendation:
  - Continue the important work on developing a credit registry to facilitate risk analysis and calibration of macroprudential tools. (SARB, NCR, NT) — medium-term (MT)
  - Data priorities: timely and reliable micro-level data; loan-level data plus borrower characteristics (importantly income); coverage to include unsecured loans as well as mortgages, from both banks and other lenders.

### The macroprudential toolkit
- Current status:
  - Some macroprudential policy tools, in particular Basel III tools, have been phased-in.
  - South Africa stands out from peers as having a narrow toolkit.
- Toolkit composition and gaps:
  - Mainly Basel III-based and bank-centric.
  - Gaps include: no borrower-based tools, no sectoral capital buffers or RWs, limited scope of macroprudential measures on NBFIs.
  - Risk: narrow toolkit poses risk of domestic and cross-border leakages as the financial system evolves toward more market-based activity and credit moves outside SIFI banks.
- Ongoing efforts:
  - SARB and the FSC are working on broadening the toolkit, including considering borrower-based tools; a special working group was set up reporting to the FSC but has been inactive due to the pandemic and is under review.
  - SARB participates in Financial Stability Board work on market-based financing; international coordination is crucial.

### Measures to address the sovereign–financial nexus
- Nature of the nexus in South Africa:
  - Exposure of banks and the financial sector toward the sovereign is increasing, while still not excessive in international comparison.
  - Mitigants: relatively benign currency and maturity profile of government debt.
  - Amplifiers: fiscal and growth outlook risks, potential continued decline in nonresidents’ holdings given credit rating developments and potential tightening of global financial conditions.
  - FSAP solvency stress test: reveals sizable losses resulting from sovereign exposures in the adverse scenario over the 3-year horizon.
  - SARB has flagged this as a key systemic risk.
- Policy implications:
  - Fiscal consolidation is likely to be key to reducing sovereign risk in the financial sector; prudential policies can play an important complementary role.
  - Any prudential measure should be mindful of other prudential requirements and the broader need for financial institutions to hold government bonds; safeguard the smooth function of the government bond market and banks’ liquidity and profitability.
  - Prudential measures should aim at: (i) ensuring resilience through increased loss absorbing capacity; (ii) providing disincentives against excessive concentration of sovereign risk; and (iii) avoiding unintended side-effects.
- Possible measures and design considerations:
  - Higher risk weights:
    - Rationale: preferential risk-weight treatment of sovereign exposures is a key source of distortions due to national discretion in the Basel framework.
    - Note: IRB banks have endogenously increased RWA on sovereign holdings; authorities could introduce positive RWA for banks using the standardized approach to combine a two-fold solution.
    - Caveat: potential for procyclical dynamics would need consideration (Véron, 2017).
  - Capital surcharges:
    - Option: apply Pillar 1 or 2 capital surcharges calibrated to assessed risk.
    - Design: apply positive surcharges only above certain thresholds and rising gradually as exposures increase as a share of assets; potentially relax surcharges if sovereign risk materializes but any relaxation must be implemented carefully.
  - Concentration limits:
    - Quantitative alternative to price-based measures to reduce concentration.
    - Risk: unintended “cliff effects” leading to fire sales and market disruption.
- Implementation guidance:
  - Use stress tests and quantitative impact assessments to guide calibration and communication.
  - Quantitative impact assessments should examine effects on: (i) bank funding costs; (ii) bond yields; (iii) bank profitability; and (iv) bank liquidity position.
  - Start implementation before a significant further build-up of risk; provide a reasonable transition period; announce envisaged measures near-term with the applicable transition period to condition behaviour and smooth adjustment.

### Borrower-based tools: rationale, design, and readiness
- Rationale:
  - Borrower-based tools are among the most widely used macroprudential tools globally and have not been implemented in South Africa to date.
  - Capital-based tools provide resilience but are less effective than borrower-based tools in reducing credit growth and feedbacks between asset prices and credit.
  - Borrower-based tools are targeted and can complement capital tools to improve cost-benefit trade-offs when broad credit developments are weak but pockets of sectoral vulnerabilities exist.
- Tools under consideration:
  - Caps on loan-to-value (LTV);
  - Caps on debt service to income (DSTI);
  - Caps on debt/loan to income (DTI/LTI).
- Design, legal and data considerations:
  - Closing data gaps via a credit registry is important; ensure legal framework allows use of borrower-based tools.
  - The FSR Act provides for sectoral tools, but it is unclear if this applies only to sectoral capital/liquidity tools or also borrower-based tools; a 2nd tier legislation may be needed.
  - Potential costs to avoid: discouraging healthy borrowing, excessively undermining consumption growth and economic growth, undermining financial inclusion.
- Design features to improve cost-benefit trade-offs:
  - More generous LTV caps for first time buyers;
  - Allow for “speed limits” where banks can deviate from requirements for a certain share of new loans;
  - Allow banks to perform their own income assessments of borrowers to take all income into account;
  - Issue guidelines on LTV and DSTI ahead of binding rules to observe impact and guide calibration;
  - Start caps at relatively neutral rates and tighten gradually.
  - Rely on a portfolio of borrower-based tools rather than any single tool.
  - If sectoral credit growth is strong, income-related measures (DSTI or LTI) are likely needed.

### Key recommendations (selected, with timeframes)
- Institutional arrangements:
  - Ensure that SARB has adequate powers — if needed extending beyond the systematically important financial institutions — and for the need to declare an event as systemic to attain more wide-ranging powers to be reconsidered. (SARB, Parliament) — short-term (ST)
  - The FSC could consider publishing a short record of its meeting, in particular when the Financial Stability Review is not being published, to further enhance transparency. (SARB) — immediate (I)
- Systemic risk monitoring:
  - Continue the important work on developing a credit registry to facilitate risk analysis and calibration of macroprudential tools. (SARB, NCR, NT) — medium-term (MT)
- Toolkit:
  - Consider carefully calibrated prudential measures to address the sovereign-financial nexus. (SARB) — short-term (ST)
  - Continue preparations to use borrower-based tools and consider design features that could allow for a more beneficial cost-benefit tradeoffs. (SARB, NCR) — medium-term (MT)
- Timeframe legend used in recommendations:
  - I−immediate: within one year
  - ST−short-term: one to three years
  - MT−medium-term: three-five years

### Annex I — Macroprudential Policy Measures in Place (selected measures and values)
- Countercyclical capital buffer: 0 percent. Framework in place since January 1, 2016, but announced since April 2013. Kept at zero throughout.
- Capital conservation buffer: 2.5 percent. Fully implemented since January 1, 2019, but phased-in starting January 1, 2016, as announced in April 2013. Banks were encouraged to make use of the buffer from April 6, 2020 as part of the pandemic policy response.
- Leverage ratio: 4 percent. Fully implemented from January 1, 2018 as announced in May 2016. Has not been adjusted since January 1, 2018.
- Forward-looking loan provisioning (IFRS 9): From financial years ending after January 1, 2018. Clarified in March and May 2020 as part of the pandemic response.
- Pillar 2A capital requirements: 1 percent (systemic add-on). Relaxed April 6, 2020 as part of the pandemic response, but to be reinstated from January 1, 2022.
- Liquidity coverage ratio: 100 percent. Phased in from January 1, 2015 to become fully implemented by January 1, 2019 as announced in December 2012. Reduced to 80 percent from April 1, 2020 as part of the policy response to the pandemic.
- Liquid asset ratio: 5% of their adjustable assets. In place since the late 1990s.
- Net stable funding ratio: 100 percent. From January 1, 2018 as announced in December 2012. Has not been adjusted.
- Capital surcharge on domestically systematically important institutions: 0.5-2.5 percent. Phased-in January 1, 2016 to January 1, 2019. Has not been adjusted.

*Source: IMF staff text from the provided content unit.*

### EXECUTIVE SUMMARY __________________________________________________________________________________ 4

### EXECUTIVE SUMMARY

### Overview
- South Africa has made significant progress in strengthening its macroprudential policy framework and foundations since the 2014 FSAP.
- The 2017 Financial Sector Regulations Act introduced the current ‘Twin Peaks’ structure, provided SARB with a strong financial stability mandate, and sought to foster interagency coordination and collaboration (including via the establishment of the Financial System Council of Regulators).
- As a result, South Africa has a hybrid macroprudential policy framework that combines a ‘strong’ decision maker in the SARB Governor, supported by an advisory committee structure, fostering effective cooperation and coordination.
- Systemic risk monitoring has been enhanced and some macroprudential policy tools phased-in.

### Institutional framework
- Key institutional changes and features:
  - The Financial Sector Regulation (FSR) Act 9 of 2017 defined key features of the institutional framework and a policy framework agreed between the Minister of Finance and the Governor.
  - The SARB has a strong mandate to protect and enhance financial stability and to restore financial stability in case a systemic event has occurred.
  - The Governor serves as the key decision-maker, backed by external and internal advisory committees.
  - Other financial regulators also have a financial stability mandate, resulting in more than one macroprudential authority, but SARB plays a leading role.

- Committees and roles (as described):
  - Financial Stability Oversight Committee (FSOC): Statutory Committee under the FSR Act; advises the Governor; includes SARB, NT and all financial regulators; chaired by the Governor; normally meets biannually.
  - Financial Sector Contingency Forum (FSCF): Statutory forum established by the Governor to assist FSOC with identifying risks that could lead to a systemic event and coordinating contingency plans; chaired by a Deputy Governor designated by the Governor.
  - Financial Stability Committee (FSC): Internal SARB committee established in 2000 and restructured in 2010; Governor as Chairperson (cannot be outvoted); meets four times a year or as required; content and discussions shared with FSOC and communicated in the biannual Financial Stability Review publication. Records of FSC meetings are not published.

- Communication and accountability:
  - The Financial Stability Review must, at least biannually, set out: (a) SARB’s assessment of financial stability in the period under review; (b) identification and assessment of the risks and vulnerabilities to financial stability in at least the next 12 months; (c) overview of steps taken by SARB and the financial sector regulators to identify and manage risks during the period under review and that are envisaged to be taken during at least the next 12 months; and (d) an overview of recommendations made by it and the FSOC during the period under review and progress made in implementing those recommendations.
  - The Minister of Finance and the FSOC shall have two weeks to comment on the Review before its publication.
  - The FSC does not provide a summary of its meetings, except what is included in the Financial Stability Review; because the FSC meets four times a year and the Review is only published biannually, no information about the FSC’s assessment of risks or need for policy action is published every other time it meets.

### Willingness to act
- Institutional features that foster willingness to act are present:
  - Clear assignment of the macroprudential mandate, well-defined objectives, a strong role for the central bank, dedicated financial stability units, and accountability and communication frameworks.
- The combination of a designated decision maker (the Governor) and advisory committee structure is likely to foster willingness to act.
- A noted governance risk: potential appointment of an individual with a strong inaction bias (or overly aggressive action preferences); mitigated by external advisory committees with clear mandates.

### Ability to act
- SARB powers and constraints:
  - SARB’s powers are mostly confined to designating SIFIs and setting macroprudential policy constraints on SIFIs outside of declared systemic events.
  - The Governor designates which financial institutions are SIFIs, after consultation with FSOC, considering size, complexity, interconnectedness, and substitutability.
  - Based on designation, SARB can direct the Prudential Authority (PA), after consultation, to impose macroprudential regulations on SIFIs, including capital and liquidity tools and a countercyclical capital buffer (CCyB), which would apply to all banks, not just SIFIs.
  - SARB may advise other financial regulators and organs of state to take steps to mitigate risks, but without a ‘comply-or-explain’ mechanism.
  - SARB’s advice may carry extra weight due to its credibility.

- ‘Systemic event’ declaration and expanded powers:
  - To attain a wider range of powers, the Governor needs to declare an event as a ‘systemic event’.
  - The FSR Act gives the Governor, after consulting the Minister of Finance and potentially FSOC, the power to declare that an event or circumstances is a ‘systemic event’, regardless of whether they have already taken place or are considered imminent.
  - Following such a declaration, the SARB “must take all reasonable steps” to mitigate the risk and safeguard financial stability.
  - After declaration, all financial sector regulators must provide SARB with relevant information and consult SARB before exercising their own regulatory powers; SARB effectively attains authority over regulators’ directives to address the event (explicitly for the PA, FSCA, and the FIC).
  - The requirement to declare an event as ‘systemic’ creates incentives for policy actions to be taken too late or not at all; reconsideration of the need to declare an event as systemic is advised.

### Coordination and cooperation
- The wide-ranging committee structure supports cooperation and coordination and sets South Africa apart from many other EMEs.
- The hybrid model combines a strong single decision maker with multiple advisory and coordination bodies, enhancing overall governance.

### Systemic risk monitoring
- Systemic risk monitoring has been enhanced, including through stress tests as advised in the 2014 FSAP.
- Important data gaps remain, particularly micro-level data on borrowers, which constrain risk analysis and calibration of new tools.
- Recommendation:
  - Continue important work on developing a credit registry to facilitate risk analysis and calibration of macroprudential tools (SARB, NCR, NT) — medium-term (MT).

### The macroprudential toolkit
- Current status:
  - Some macroprudential policy tools, in particular Basel III tools, have been phased-in.
  - South Africa stands out from peers as having a narrow toolkit.
- Areas to broaden the toolkit:
  - Measures to address the sovereign-financial (bank) nexus.
  - Borrower-based tools.
- Sovereign-financial nexus considerations:
  - Fiscal consolidation is likely to be key in reducing sovereign risk in the financial sector, but prudential policies can play an important complementary role.
  - Prudential measures should be mindful of other prudential requirements and the broader need for financial institutions to hold government bonds.
  - Measures must safeguard the smooth function of the government bond market and banks’ liquidity and profitability.
  - Prudential measures should aim at: (i) ensuring resilience through increased loss absorbing capacity; (ii) providing disincentives against excessive concentration of sovereign risk; and (iii) avoiding unintended side-effects.
  - Any measures would need to be phased-in, carefully calibrated, and clearly communicated.

- Borrower-based tools:
  - Continue preparations to use borrower-based tools and consider design features that could allow for a more beneficial cost-benefit tradeoffs (SARB, NCR) — medium-term (MT).

### Key recommendations (from Table 1)
- Institutional Arrangements for Macroprudential Policy:
  - Ensure that SARB has adequate powers — if needed extending beyond the systematically important financial institutions — and for the need to declare an event as systemic to attain more wide-ranging powers to be reconsidered. (SARB, Parliament) — short-term (ST)
  - The FSC could consider publishing a short record of its meeting, in particular when the Financial Stability Review is not being published, to further enhance transparency. (SARB) — immediate (I)

- Systemic Risk Monitoring:
  - Continue the important work on developing a credit registry to facilitate risk analysis and calibration of macroprudential tools. (SARB, NCR, NT) — medium-term (MT)

- Toolkit:
  - Consider carefully calibrated prudential measures to address the sovereign-financial nexus. (SARB) — short-term (ST)
  - Continue preparations to use borrower-based tools and consider design features that could allow for a more beneficial cost-benefit tradeoffs. (SARB, NCR) — medium-term (MT)

- Timeframe legend used in recommendations:
  - I−immediate: within one year
  - ST−short-term: one to three years
  - MT−medium-term: three-five years

*Source: EXECUTIVE SUMMARY, Technical Note on Systemic Risk Oversight and Macroprudential Policy (South Africa).*

### 13. However, this is problematic in practice, may foster the inaction bias, and it is telling

### 13. However, this is problematic in practice, may foster the inaction bias, and it is telling

### Coordination and Cooperation
- Effective institutional arrangements to ensure close cooperation between regulators serve as important mitigants against the inaction bias and somewhat narrow powers of the SARB.
- Features supporting cooperation:
  - strong legal requirements for cooperation;
  - committee structures that entail overlap in membership (importantly also across to monetary policy);
  - explicit financial stability mandates of institutions;
  - presence of information sharing mechanisms.

### Recommendations (institutional scope and transparency)
- Extend the SARB’s power to put in place macroprudential measures beyond SIFIs if needed, and reconsider the need to declare an event as systemic.
  - Current arrangement: SARB’s authority is mostly confined to SIFIs, except when the Governor declared an event as systemic.
  - Rationale: Risks can arise without failure of an individual financial institution where capital or liquidity stress leads to disruption of financial services (IMF-FSB-BIS, 2009).
  - Vulnerability: Institutional framework is vulnerable to leakage as financial intermediation may migrate outside SIFIs subject to macroprudential restrictions, particularly if regulatory constraints are tightened further.
  - Concern: Requiring a systemic-event declaration risks action being taken too late, especially when policy actions need to go beyond SIFIs to be effective.
  - Recommendation: Reconsider the systemic-event declaration requirement, particularly when other amendments to the FSR Act are planned.
- The FSC could consider publishing a short record of its meeting, especially when the Financial Stability Review is not published, to enhance transparency.
  - Purpose: Provide market participants and the general public with more frequent assessment of systemic risk and how the FSC sees it evolving between meetings.
  - Examples: Iceland and Romania.
  - Additional step: Provide at least the FSOC with an opportunity to comment on the meeting records in a similar manner as they do with the Financial Stability Review.

*Systemic Risk Monitoring*

### Role of monitoring and framework status
- Macroprudential policy needs to rely on adequate monitoring of systemic vulnerabilities; this may entail “guided discretion” where key indicators generate signals but ultimate decisions use judgement.
- SARB’s systemic risk monitoring framework:
  - well advanced and follows examples set by advanced and EME central banks and Fund guidance;
  - utilizes macrofinancial indicators to build a heatmap of different types of risks;
  - relies on financial conditions and financial cycle analysis, and the growth-at-risk framework;
  - stress test capacity includes both solvency and liquidity stress tests, built-up in line with the 2014 FSAP recommendations;
  - summarizes assessment in the risk assessment matrix (RAM) and the Financial Stability Review.
- Limitation: SARB’s access to micro-level data is limited, constraining assessment of tail risks and calibration of macroprudential tools.
  - Micro-level data importance:
    - allows looking at distribution across borrower types to identify growing tail risks;
    - facilitates calibration of borrower-based tools (Nier et al., 2019);
    - helps assess effects of a crisis on borrowers (Olafsson and Vignisdottir, 2012) and assists policy making (IFC Bulletin, 2021).
  - Status: SARB is aware and work is underway to close this data gap, but extent of efforts remains uncertain.
- Footnote: This reflects lack of information powers to collect this type of data and therefore the need to work with the NCR.

### Recommendations (data infrastructure)
- Continue developing a national central credit registry to facilitate risk analysis and calibration of macroprudential tools.
  - Nature: Resource-demanding; requires collaboration among different financial regulators and agreement on approach and set-up.
  - Data priorities for SARB:
    - timely and reliable micro-level data;
    - not only loan-level data but borrower characteristics, importantly income;
    - coverage to include unsecured loans as well as mortgages, from both banks and other lenders, to effectively monitor risk and leakages.
  - Consideration: Including corporate loans depends on resources and legal/practical challenges; some countries gather corporate loan data above a certain threshold.

*The Macroprudential Toolkit*

### Current toolkit assessment and context
- Effective macroprudential policy requires a diversified portfolio of tools; over-reliance on a narrow set risks leakages and a poorer cost-benefit trade-off.
- South Africa’s experience:
  - has taken less macroprudential policy actions compared to EME peers, reflecting weaker credit and economic growth developments.
  - Based on Fund’s iMaPP database, South Africa began relatively late taking policy actions compared to peers.
  - Policy actions largely reflect introduction of Basel III measures, gradually phased-in; weak broad credit developments and GDP growth declines reduced urgency for measures addressing credit and asset price bubbles.
- Toolkit composition:
  - Mainly Basel III-based and bank centric.
  - Main broad-based capital tools in place:
    - CCyB kept at zero as result of weak broad credit developments;
    - 2.5 percent capital conservation buffer (CCB);
    - 4 percent leverage ratio (compared to 3 percent norm in Basel III);
    - 1 percent systemic Pillar II capital add-on (set by the PA), introduced to build additional resilience; temporarily relaxed in the pandemic.
  - D-SIBs (currently all SIFIs designated by the SARB are classified as D-SIBs by the PA) face capital surcharge of 0.5-2.5 percent, with the top bucket currently being empty.
  - Liquidity tools: liquidity coverage ratio (LCR), a liquid asset ratio, and the net stable funding ratio (NSFR).
  - Gaps: no borrower-based tools, no sectoral capital buffers or RWs, limited scope of macroprudential measures on NBFIs.
  - Additional limits: limit on banks’ net open position, limits on external assets of banks, pension funds and asset management funds as a share of their total assets (external asset limits are capital flow management measures (CFMs) under the IMF Institutional View, as they are residency-based).

### Risks and ongoing efforts
- A narrow toolkit poses risk of domestic and cross-border leakages as the financial system evolves toward more market-based activity and credit moves outside SIFI banks.
- SARB and the FSC actions:
  - working on broadening the macroprudential toolkit, including considering borrower-based tools; a special working group was set up reporting to the FSC but has been inactive due to the pandemic and is under review.
  - SARB participates in Financial Stability Board work on market-based financing, accelerated after pandemic-related market turmoil; includes domestic and cross-border aspects.
  - Recommendation: SARB should carefully monitor FSB work and any guidance; international coordination is crucial given ease of NBFI activity to move across borders.

*Measures to Address the Sovereign-Financial Nexus*

### Nature and risks of the nexus
- The sovereign-financial nexus can create distortions where private credit is crowded-out and systemic risk materializes through macrofinancial linkages and feedbacks (IMF, 2018).
- Addressing the nexus is difficult due to trade-offs, potential clashes with other policies, risk of unintended side-effects, and lack of international consensus (BCBS, 2017).
- In South Africa:
  - exposure of banks and the financial sector toward the sovereign is increasing, while still not excessive in international comparison.
  - Mitigants: relatively benign currency and maturity profile of government debt.
  - Amplifiers: fiscal and growth outlook risks, potential continued decline in nonresidents’ holdings given credit rating developments and potential tightening of global financial conditions.
  - FSAP solvency stress test: reveals sizable losses resulting from sovereign exposures in the adverse scenario over the 3-year horizon.
  - SARB has flagged this as a key systemic risk.

### Policy implications and design considerations
- Fiscal consolidation is likely key to reducing sovereign risk in the financial sector; prudential policies can play a complementary role.
  - Objective: ensure debt sustainability, strengthen growth outlook, and support wider diversification toward private sector exposures on financial institutions’ balance sheets.
- Any prudential measure should:
  - be mindful of other prudential requirements and the need for financial institutions to hold government bonds (e.g., HQLAs to fulfill LCR requirements and voluntary buffers);
  - consider that many NBFIs also need to hold government bonds for liquidity purposes;
  - safeguard smooth functioning of the government bond market and banks’ liquidity and profitability, as these are first-line buffers when shocks materialize.
- Prudential measures should aim at:
  - (i) ensuring resilience through increased loss absorbing capacity;
  - (ii) providing disincentives against excessive concentration of sovereign risk;
  - (iii) avoiding unintended side-effects (e.g., excessive reduction of liquidity, bond market pressures, or other unwarranted macro-financial dynamics).

### Possible measures (design principles: phased-in, carefully calibrated, clearly communicated)
- Higher risk weights:
  - Rationale: preferential risk-weight treatment of sovereign exposures is a key source of distortions due to national discretion in the Basel framework.
  - Note: IRB banks have endogenously increased RWA on sovereign holdings; authorities could introduce positive RWA for banks using the standardized approach to combine a two-fold solution.
  - Caveat: potential for procyclical dynamics would need consideration (Véron, 2017).
- Capital surcharges:
  - Option: apply Pillar 1 or 2 capital surcharges calibrated to assessed risk.
  - Design features:
    - allow increased resilience and disincentives to excessive concentration;
    - mitigate unintended side-effects by applying positive surcharges only above certain thresholds (to account for holdings needed to meet liquidity requirements) and rising gradually as exposures increase as a share of assets (example referenced: 2018 Romania FSSA).
    - Potentially relax surcharges if sovereign risk materializes, but any relaxation must be implemented carefully with judgement on cost-benefit trade-offs, including usability of released buffers (see IMF, 2014).
- Concentration limits:
  - A quantitative alternative to price-based measures to reduce concentration.
  - Risk: unintended “cliff effects” where banks near limits might resort to fire sales of bonds, with detrimental effects.

*Italic source attribution line*
*Source: 1zafea2022009 - 13. However, this is problematic in practice, may foster the inaction bias, and it is telling (PDF).*

### 35. Quantitative assessments could guide the calibration and help with communication of

### 35. Quantitative assessments could guide the calibration and help with communication of

### Sovereign–financial nexus: role of quantitative assessments
- Stress tests can help assess the level of resilience any measure should aim to provide, for instance, through higher RWs or capital surcharges.
- Objective is not necessarily to provide “insurance” against the full set of losses in an adverse scenario, but to judge the desired level of resilience against these potential losses.
- Quantitative impact assessments could examine potential effects of any measure on at least four areas:
  - (i) bank funding costs;
  - (ii) bond yields;
  - (iii) bank profitability; and
  - (iv) bank liquidity position.
- Example referenced: the 2018 Romania FSSA.

### Timing and calibration considerations
- Challenge: timing introduction of prudential measures to address the sovereign–financial nexus.
- SARB already has a framework to guide introduction of macroprudential tools and weighing cost-benefit trade-offs, including assessing the cost of inaction.
- It is advisable to start implementation before there is a significant further build-up of this risk in financial institutions’ balance sheets.
- Consider the normalization of pandemic-related relaxation of capital requirements and the broader economic context when timing measures.
- A reasonable transition period is needed to allow financial institutions time to adjust balance sheets.
- A near-term announcement of envisaged measures, with the applicable transition period, can help condition behavior and smooth the adjustment process.

### Communication and governance
- Communication is key to smooth implementation of new measures.
- SARB has provided a thorough analysis of nexus risks; next steps:
  - Set out objectives;
  - Weigh policy options against those objectives;
  - Perform quantitative analysis to guide calibration.
- Once suggested calibration is in place, use committee structures to build consensus, followed by wider communication and a phase-in period.

### Borrower-based tools: rationale and readiness
- Borrower-based tools are among the most widely used macroprudential tools globally (Alam et al., 2019) but have not been implemented in South Africa to date.
- These tools may be needed to complement mostly capital tools in place.
- Empirical point: capital-based tools provide resilience but are less effective than borrower-based tools in reducing credit growth and feedbacks between asset prices and credit.
- Borrower-based tools are targeted and can complement broader capital tools to improve cost-benefit trade-offs when broader credit developments are weak but pockets of sectoral vulnerabilities exist.
- Potential borrower-based tools under consideration by SARB include caps on:
  - loan-to-value (LTV);
  - debt service to income (DSTI);
  - debt/loan to income (DTI/LTI).
- Resilience enhancement of borrowers embedded in the NCA legislation is a relevant factor.

### Data, legal framework, and design considerations
- Closing data gaps is important, preferably through a credit registry, and ensuring the legal framework allows use of borrower-based tools.
- The FSR Act provides for sectoral tools, but it is unclear if this applies only to sectoral capital/liquidity tools or also borrower-based tools.
- Most likely, a 2nd tier legislation to the FSR Act could establish a framework for borrower-based macroprudential tools.
- Potential costs to avoid:
  - Discouraging healthy borrowing (potentially slowing post-COVID recovery);
  - Excessively undermining consumption growth and economic growth by requiring too much saving;
  - Undermining financial inclusion.
- If costs become excessive, macroprudential policy could risk losing autonomy.

### Design features to improve cost-benefit trade-offs for borrower-based tools
- Consider the following design features:
  - More generous LTV caps for first time buyers;
  - Allow for “speed limits” where banks can deviate from the requirements for a certain share of new loans;
  - Consider ways to allow banks to perform their own income assessments of borrowers to take all income into account (appears to be addressed in the NCA);
  - Consider issuing guidelines on LTV and DSTI ahead of binding rules to observe impact and guide calibration;
  - Aim to start the caps at relatively neutral rates and gradually tighten.
- To be effective, rely on a portfolio of borrower-based tools rather than any single tool.
- If sectoral credit growth is strong, income-related measures (such as a DSTI or LTI) are likely needed as they are less affected by interactions between asset prices and credit than LTV.

### Recommendations
- Consider carefully calibrated prudential measures to address the sovereign–financial nexus.
  - Measures should have clear objectives, be calibrated and implemented to achieve those objectives, and be clearly communicated to foster understanding and diminish concerns about unintended side-effects.
- Continue preparations to use borrower-based tools and consider design features that could allow for a more beneficial cost-benefit tradeoff, taking South African country-specific circumstances into account.

### Annex I — Macroprudential Policy Measures in Place (selected measures and values)
- Countercyclical capital buffer: 0 percent. Framework in place since January 1, 2016, but announced since April 2013. Kept at zero throughout.
- Capital conservation buffer: 2.5 percent. Fully implemented since January 1, 2019, but phased-in starting January 1, 2016, as announced in April 2013. Banks were encouraged to make use of the buffer from April 6, 2020 as part of the pandemic policy response.
- Leverage ratio: 4 percent. Fully implemented from January 1, 2018 as announced in May 2016. Has not been adjusted since January 1, 2018.
- Forward-looking loan provisioning (IFRS 9): From financial years ending after January 1, 2018. Clarified in March and May 2020 as part of the pandemic response.
- Pillar 2A capital requirements: 1 percent (systemic add-on). Relaxed April 6, 2020 as part of the pandemic response, but to be reinstated from January 1, 2022.
- Liquidity coverage ratio: 100 percent. Phased in from January 1, 2015 to become fully implemented by January 1, 2019 as announced in December 2012. Reduced to 80 percent from April 1, 2020 as part of the policy response to the pandemic.
- Liquid asset ratio: 5% of their adjustable assets. In place since the late 1990s.
- Net stable funding ratio: 100 percent. From January 1, 2018 as announced in December 2012. Has not been adjusted.
- Capital surcharge on domestically systematically important institutions: 0.5-2.5 percent. Phased-in January 1, 2016 to January 1, 2019. Has not been adjusted.

*Source: IMF staff text from the provided content unit.*

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_Source: https://www.imf.org/-/media/files/publications/cr/2022/english/1zafea2022009.pdf_