## _cr08349

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### Overall assessment
- South Africa’s sophisticated financial system is fundamentally sound.
- The system is diversified and spans a broad range of activities supported by an elaborate legal and financial infrastructure and a generally effective regulatory framework.
- Financial institutions benefited from a prolonged economic expansion, supported by prudent macroeconomic management and high commodity prices.
- The system weathered the global financial market turmoil without major pressures.
- Banks and insurance companies have enjoyed good profitability, capitalization levels, and reserves.
- The system faces increased macro-financial risks and financial institutions are bracing for a less benign environment.

### I. Macroeconomic setting and risks
- Economic activity and inflation
  - Pace of economic activity has started to ease after robust expansion; rising interest rates, domestic power supply constraints, and weaker global growth are damping GDP growth.
  - Inflationary pressures continue; consumer credit growth has yet to slow appreciably in response to higher interest rates.
- Household sector
  - Household debt reached some 78 percent of disposable income in early-2008.
  - Debt service costs have risen to 11 percent of disposable income, the highest level since 1998–99.
- External sector and reserves
  - Current account deficit widened to 9 percent of GDP in the first quarter of 2008.
  - Portfolio inflows turned negative.
  - SARB international reserves had been rebuilt to US$35 billion by end-July.
  - External debt is 26 percent of GDP; close to half of this is denominated in rand.
  - The rand fell by 11 percent in nominal effective terms over the first seven months of 2008, before recovering somewhat more recently.
- Downside risk scenarios and channels (selected)
  - Sustained drop in net capital inflows → sharp exchange rate depreciation, rising inflation, further monetary tightening, higher debt servicing costs, sharp slowdown in consumption and investment.
  - Sharp fall in commodity prices → hit to resources sector, portfolio equity outflows, wider current account deficit.
  - Intensification of global slowdown → reduced demand for exports and weaker commodity prices.
  - Household overextension → servicing historically high household debt may become too burdensome; a sharp drop in housing prices with rising job losses would aggravate risks.
- Mitigants
  - Good macroeconomic management, strengthened public finances, flexible exchange rate regime, and SARB efforts to expand reserve cushions.

### II. Financial institutions and risks
- Banks
  - Commercial banks’ assets represent some 120 percent of GDP.
  - Four banks (ABSA, FirstRand Bank, Nedbank, Standard Bank) account for almost 85 percent of total assets.
  - System withstood global turmoil; limited exposure to U.S. subprime-related products.
  - Significant liquidity risks from heavy reliance on domestic wholesale corporate deposits.
  - Emerging asset-quality pressures: NPLs low but rising; policy rate increases since 2006 have increased NPL ratios and arrears on credit card debt.
  - Funding maturity is short and shortening; large portion of funding is wholesale from domestic sources including life insurers and asset managers.
- Insurance sector
  - Life company assets around 80 percent of GDP at end-2007.
  - Insurance penetration is 16 percent of GDP.
  - Nearly 50 percent of long-term insurers’ balance sheets are underwriting of retirement funds.
  - Insurers enjoyed strong recent performance but face exposures to interest rates, equity prices, mortality/longevity, and policy lapses.
- Pension funds
  - Over 13,000 funds in 2005; total assets in 2008 exceeding ZAR 2 trillion.
  - Supervision complicated by large number of funds; consolidation, governance, and trustee capability weaknesses noted.
- Stress tests and resilience
  - Stress tests indicate capital and reserve cushions at banks and insurers are generally adequate to absorb large but plausible shocks, though severe scenarios can push some institutions below regulatory minima.
  - Recommendation: proactively use scope under Basel II and Pillar 2 add-ons to ensure adequate buffers, particularly for lending to highly leveraged borrowers.

### III. Financial markets, infrastructure, and safety nets
- Market structure and vulnerabilities
  - Money, FX, and capital markets are relatively well developed but susceptible to contagion due to close offshore linkages.
  - Significant role of nonresident inflows: nonresident-sourced turnover accounts for some one-fifth of JSE turnover and 71 percent of FX market turnover.
  - Foreign participation on BESA is about one-third of turnover; foreigners have been net purchasers of bonds.
  - OTC foreign exchange derivatives activity is large; offshore component is difficult to gauge and not fully captured in official statistics.
  - For maturities < one week, FX swap turnover exceeds US$9 billion daily versus less than US$3 billion in the spot market.
- Market development priorities (selected)
  - Foster liquidity and depth in local markets and attract foreign direct investment.
  - Further develop bond market (e.g., infrastructure financing) and increase stock market liquidity (expand “free float”) while continuing measured exchange control liberalization.
- Surveillance and infrastructure
  - Recommendation: enhance surveillance of OTC FX derivative markets by systematic processing and analysis of information on offshore activity and onshore hedging flows.
  - SAMOS enables real-time settlement with dynamic collateral and same-day square off; effective for early indications of counterparty payment problems.
- Exchange controls and liberalization
  - Authorities pursue gradual liberalization; February 2008 measures include raising institutional investors’ foreign exposure limits, simplifying banks’ foreign exposure regulation, and streamlining administration.
  - Limit on banks’ foreign exposure planned to be raised to 40 percent of liabilities (definition and reporting still being worked out).
  - NT to study impact of lifting remaining controls, especially on bank funding.
  - Recommendation: continue cautious approach; prepare banks to diversify funding; ensure proper reporting to the central bank.
- Crisis preparedness and liquidity frameworks
  - Financial Sector Contingency Forum (FSCF) established; SARB enhanced liquidity assistance mechanisms.
  - SARB can provide exceptional short-term liquidity assistance against collateral or government guarantee; for insolvent banks MOF (NT) can appoint curator.
  - South Africa lacks deposit insurance; SADIS launch process revived but unresolved issues remain (Board composition, role in resolution, scale of initial government funding).
  - Recommendations:
    - Undertake a financial crisis simulation centered on failure of a systemic institution.
    - Consider formalizing resolution process (e.g., authorize registrar of banks to directly appoint curator).
    - Specify eligible collateral for LOLR operations.
    - Ensure deposit insurance adheres to sound principles and protects small depositors without creating ambiguities in intervention powers.

### IV. Financial supervision and standards assessments
- Institutional framework
  - SARB: commercial bank regulation and supervision; BSD has around 100 staff.
  - FSB: insurance, pension funds, intermediaries, oversight of capital markets; about 370 staff.
  - NCR: enforces National Credit Act; full time staff of 65.
  - Multiple SROs (JSE, BESA, Strate) with delegated responsibilities.
- Progress and gaps
  - SARB implemented Basel II as of January 1, 2008; minimum capital requirement set at 9.75 percent under Basel II.
  - Banks’ capital currently about three percentage points above that requirement.
  - FSB licensing, supervision, and enforcement capacity enhanced; IFRS and ISAS adopted early.
  - Need for stronger cross-sectoral cooperation, clearer delineation of responsibilities, and improved information exchange.
  - Recommendation: enhance day-to-day collaboration among regulators, strengthen market conduct supervision, harmonize FSB risk-based models, and improve data reporting for pension supervision.
- IOSCO assessment highlights (selected)
  - FSB has broad inspection, investigation, and enforcement powers; limited surveillance capacity over OTC markets.
  - Recommendations include granting FSB authority to publish regulations without MOF approval, reviewing ACI’s delegated authority, assessing OTC market oversight, and converting certain FSB guidance into enforceable regulation.
  - Suggested priorities: proactive monitoring of company disclosure, conversion to T+3 equity settlement cycle, establishing a central counterparty, and improving trading infrastructure capacity.

### V. Financial access and inclusion
- Progress
  - “Banked” population grew from about 25 percent in 1994 to 63 percent (aggregate); for lower income brackets, bank account access increased from 33 percent in 2005 to 45 percent in 2007.
  - The Financial Sector Charter (FSC) and National Credit Act (NCA) instrumental in broadening access and reining in reckless lending.
- Remaining challenges
  - Bringing nonsalaried individuals into the system.
  - Broadening access to nonbank services (savings, insurance).
  - Financing SMEs and affordable housing.
- Housing finance
  - Mortgage markets expanded; housing finance concentrated in four large banks and South African Home Loans.
  - FSC mortgages represent 4.4 percent of banks’ mortgage portfolios.
  - Government considering consolidation of three housing DFIs; NHFC has not fulfilled its development mandate.
  - Recommendations: conduct in-depth analysis of affordable housing finance needs, redefine role of housing DFI(s), adjust FSC objectives in housing finance, and review credit-linked subsidies and tax-credit proposals for developers.

### Box: Main recommendations (selected)
- Financial stability
  - Closely monitor emerging risks and conduct early warning analysis; focus on household credit and bank liquidity and funding risks.
  - Proactively use scope under Basel II to ensure adequate buffers for lending to highly leveraged borrowers, including residential mortgages.
  - Undertake a crisis simulation exercise and strengthen bank-intervention procedures; work towards implementation of well-designed deposit insurance.
- Money, FX, and capital markets
  - Enhance surveillance of OTC FX derivative markets by processing and analyzing offshore activity information.
  - Facilitate further development of stock and bond markets, including measured liberalization of exchange controls calibrated to macroeconomic conditions.
- Supervision and regulation
  - Strengthen coordination and information exchange among regulators; minimize gaps and overlaps and delineate responsibilities.
  - FSB to develop standards for corporate governance, risk management, and internal controls; harmonize risk-based models across sectors.
  - Enhance supervision of insurance groups and review solvency buffers for life insurers ahead of new international standards.
  - Consider imposing fit-and-proper requirements for pension fund trustees and ensure pension reform preserves savings until retirement.
- Inclusion and consumer protection
  - Preserve the FSC and enhance inclusion targets while safeguarding financial soundness.
  - Review mandates, products, and governance of DFIs to maximize catalytic role; consider mechanisms for promoting affordable housing finance.
  - Review NCR resources, staffing, and institutional arrangements to ensure adequacy.

### Stress-testing results and key statistics (selected)
- Banking system and capital
  - Unweighted average CAR across the four large banks before shocks: 11.4 percent.
  - Under Basel II minimum capital requirement: 9.75 percent.
  - Under Basel I minimum had been 10 percent.
- Market-risk single-factor shocks (average impact in percentage point of capital)
  - Parallel upward shift of rand yield curve by 600 bps: +0.85.
  - Parallel downward shift of rand yield curve by 400 bps: -0.54.
  - Domestic shares (-35 percent): -0.32.
  - Residential real estate (-30 percent): -0.34.
  - Rand depreciation by 50 percent: +0.05.
  - None of the market risk scenarios caused banks to fall below 9.75 percent CAR.
- Credit-risk stress tests (high-severity outcomes)
  - Default of all counterparties with PD>10 percent: Average loss 2.6 percentage point of capital → resulting average CAR 8.8 percent; this shock would leave all four large banks below 9.75 percent.
  - Macroeconomic three-year recessionary scenario: Cumulative impact 1.8 percentage point of capital (BU across five banks) → resulting average CAR 9.9 percent; cumulative impact would leave two of the five banks below 9.75 percent.
  - Concentration: Default of three largest exposures → average loss 2.2 percentage point of capital → average CAR 9.3 percent; three of four large banks would fall below 9.75 percent in that scenario.
- Insurance stress tests (selected)
  - Unweighted average solvency ratio across four insurers before shocks: 7.7 percent.
  - Life insurers’ shocks (impact in percentage point of solvency ratio, averages)
    - Mortality +30 percent: -1.01 → after shock solvency = 6.72.
    - Morbidity +30 percent: -0.22 → after shock solvency = 7.51.
    - Longevity (annuities) -30 percent mortality: -0.61 → after shock solvency = 7.13.
    - Parallel downward shift by 400 bps: -2.10 → after shock solvency = 5.63.
    - Domestic and foreign shares (-35 percent): -0.78 → after shock solvency = 6.95.
    - Implied volatilities +100 percent: -1.61 → after shock solvency = 6.12.
  - Commentary: life insurers are more exposed to downward interest-rate shocks and equity declines; two insurers are particularly affected by a 400 bps downward interest-rate shock.
- Liquidity stress scenarios for banks (selected)
  - Scenario 1 (three months): Secured/unsecured spread +600 bps; pool of collateral shrinks 30 percent; 30 percent of eligible assets fall below SARB thresholds.
  - Scenario 2 (one month name crisis): 15 percent deposit withdrawal; 50 percent tapping of committed credit lines; liquid assets take 20 percent haircut.
  - Findings: banks generally would remain liquid under single-name stresses but could face serious funding problems in market-wide events without SARB liquidity support.

### Selected macroeconomic and financial indicators (selected items)
- Nominal GDP (2007): US$ 282.6 billion
- Population (2007): 47.9 million
- GDP per capita (2007): US$ 5,907
- Real GDP (annual percent change): 2003:3.1 2004:4.9 2005:5.0 2006:5.4 2007:5.1 2008 Proj.:3.8 2009 Proj.:3.7
- CPI (annual average): 2003:5.8 2004:1.4 2005:3.4 2006:4.7 2007:7.1 2008 Proj.:11.3 2009 Proj.:9.2
- Unemployment rate (percent): 2003:28.0 2004:26.2 2005:26.7 2006:25.5 2007:23.0 2008 Proj.:22.9 2009 Proj.:22.9
- Gross reserves (SARB, billions of U.S. dollars): 2003:8.0 2004:14.7 2005:20.6 2006:25.6 2007:33.0 2008 Proj.:36.6 2009 Proj.:39.6
- Current account balance (percent of GDP): 2003:-1.1 2004:-3.2 2005:-4.0 2006:-6.5 2007:-7.3 2008 Proj.:-9.0 2009 Proj.:-9.6
- National government debt (percent of GDP): 2003:37.3 2004:36.4 2005:35.3 2006:33.1 2007:28.6 2008 Proj.:25.6 2009 Proj.:22.8

*Executive Summary from _cr08349 (IMF staff report content, extract provided).*

### Executive Summary ......................................................................................................

### _cr08349 - Executive Summary

### Overall assessment
- South Africa’s sophisticated financial system is fundamentally sound.
- The system is diversified and spans a broad range of activities supported by an elaborate legal and financial infrastructure and a generally effective regulatory framework.
- Financial institutions have benefited from a prolonged economic expansion, supported by prudent macroeconomic management and high commodity prices.
- The system has weathered the global financial market turmoil without major pressures.
- Banks and insurance companies have enjoyed good profitability, capitalization levels, and reserves.
- However, the system faces increased macro-financial risks and financial institutions are bracing for a less benign environment.

### I. Macroeconomic setting and risks
- Pace of economic activity has started to ease following a period of robust expansion; rising interest rates, domestic power supply constraints, and weaker global growth are beginning to dampen GDP growth.
- Inflationary pressures continue and consumer credit growth has yet to slow appreciably in response to higher interest rates.
- Household debt reached some 78 percent of disposable income in early-2008 and debt service costs have risen to 11 percent of disposable income, the highest level since 1998–99.
- The current account deficit widened to 9 percent of GDP in the first quarter of 2008 while portfolio inflows turned negative.
- SARB international reserves had been rebuilt to US$35 billion by end-July.
- External debt is moderate at 26 percent of GDP and, with close to half of this denominated in rand, exposure to currency movements in the public and private sectors is limited.
- The rand fell by 11 percent in nominal effective terms over the first seven months of 2008, before recovering somewhat more recently.
- Downside risk scenarios and channels highlighted:
  - Sustained drop in net capital inflows due to concerns about domestic growth prospects and political/policy uncertainties, potentially triggering sharp exchange rate depreciation, rising inflation, further monetary tightening, increasing debt servicing costs, and a sharp slowdown in consumption and investment.
  - Sharp fall in commodity prices threatening the resources sector and possibly leading to portfolio equity outflows; a lower value of commodity exports would push the current account further into deficit.
  - Intensification in the global slowdown reducing demand for South African exports and weakening commodity prices via spillovers from key emerging market economies.
  - Household sector overextension risks: servicing historically high household debt may become too burdensome; a sharp drop in housing prices—especially with a deeper-than-expected slowdown and rising job losses—would aggravate these risks.
- Mitigating factors: good macroeconomic management, strengthened public finances, a flexible exchange rate regime, and continuing SARB efforts to expand reserve cushions.

### II. Financial institutions and risks
- Banks face increased credit risk, especially in household loan portfolios, given record household indebtedness and mounting debt service burden.
- Banks are seeing some impairment of asset quality and returns while continuing to rely heavily on domestic wholesale deposits.
- Stress tests indicate capital and reserve cushions at banks and insurance companies are adequate to absorb large but plausible shocks.
- Insurance companies have enjoyed good profitability, capitalization levels, and reserves.
- Pension fund supervision is complicated by the large number of pension funds; consolidation, governance, and risk management strengthening are encouraged.

### III. Financial markets, infrastructure, and safety nets
- Money, foreign exchange, and capital markets are relatively well-developed but may be subject to contagion risks given close linkages with offshore markets.
- Significant role of nonresident inflows in stock and bond exchanges underscores susceptibility to changes in investor sentiments and the importance of policies that induce investor confidence.
- OTC market activity in foreign exchange derivative products has been expanding; its offshore component is difficult to gauge due to a lack of information and regulatory oversight.
- Recommendations noted:
  - Foster liquidity and depth in local markets and attract foreign direct investment inflows.
  - Continue a cautious approach to foreign exchange regime liberalization with due regard to macroeconomic circumstances.
- Crisis preparedness and liquidity frameworks:
  - The Financial Sector Contingency Forum has been established to facilitate preparedness and inter-agency coordination.
  - SARB has enhanced its liquidity assistance mechanisms.
  - Framework for bank intervention and resolution could be further enhanced by implementing a well-designed deposit insurance system and authorizing the registrar of banks to appoint a curator for failing institutions.

### IV. Financial supervision and standards assessments
- The regulatory framework is modern and generally effective.
- SARB’s early implementation of Basel II has proceeded well.
- The Financial Services Board (FSB) licensing, supervision, and enforcement capacity and overall resources have been enhanced.
- Model validation and stress testing capacities have been upgraded, though there is scope to improve the information base for financial stability analysis.
- The SARB should proactively use the scope allowed under Basel II to ensure adequate buffers at banks to manage risks associated with lending to very highly-leveraged borrowers.
- Insurance regulatory regime is well-developed, though gaps remain (e.g., supervision of groups).
- Supervision of the pension system is complicated by the large number of pension funds; authorities should encourage consolidation and strengthen governance and risk management.
- Extensive interlinkages and financial conglomerates underscore the need for strong sectoral supervision and cross-sectoral supervision.
- Efforts toward greater cooperation, consistency, and effectiveness of regulation are welcome, but there is need to further strengthen information exchange, identify gaps and overlaps, and establish clear delineations of responsibility among regulators.
- FSB actions and market conduct:
  - FSB has acted to curb abuses in the contractual savings segment and has brought successful misconduct cases relating to trading on the JSE.
  - Continued efforts are recommended to increase disclosure and transparency and to strengthen market conduct regulation and supervision beyond the limited scope of the NCA and FAIS.

### V. Financial access and inclusion
- Access to financial services improved markedly: the “banked” population grew from about 25 percent in 1994 to 63 percent today.
- The Financial Sector Charter (FSC) has been instrumental in broadening access and could provide further impetus through appropriately revised objectives.
- The National Credit Act (NCA) has reined in reckless lending and improved consumer protection.
- Remaining challenges:
  - Bringing nonsalaried individuals into the system.
  - Broadening access to nonbank services.
  - Financing small-and medium-sized enterprises (SMEs) and affordable housing.

### Box 1 — Main recommendations (selected)
- Financial stability:
  - Closely monitor emerging risks and conduct early warning analysis; enhanced focus on banking system risks, including household credit and bank liquidity and funding risks.
  - Proactively use the scope available under Basel II to ensure adequate buffers in banks to cope with risks associated with lending to highly leveraged borrowers, including for residential mortgages.
  - Undertake a crisis simulation exercise and further strengthen procedures for addressing banking problems; work towards implementation of a well-designed deposit insurance system.
- Money, foreign exchange, and capital markets:
  - Enhance surveillance of the OTC forex exchange derivative markets by systematic processing and analysis of information on offshore activity.
  - Facilitate further development of the stock and bond markets, including by continued measured liberalization of exchange controls calibrated to take account of the macroeconomic situation.
- Financial sector supervision and regulation:
  - Strengthen coordination and information exchange among regulators and policymakers; minimize gaps and overlaps and clearly delineate responsibilities.
  - FSB should develop standards for corporate governance, risk management, and internal controls and harmonize its risk-based models for different sectors.
  - Enhance supervision of insurance groups and review adequacy of solvency buffers for life insurers ahead of impending new international standards.
  - Consider imposing fit and proper requirements for pension fund trustees and ensure pension reform proposals preserve pension savings until retirement and align drawdown of living annuities with life expectancy.
- Financial sector inclusion and consumer protection:
  - Preserve the Financial Sector Charter and enhance its inclusion targets with due regard to financial soundness and stability.
  - Review mandates, products, and governance of development finance institutions (DFIs) to maximize catalytic role, and consider sound mechanisms for promoting affordable housing finance.
  - Review resources, staffing, and institutional arrangements of the NCR to ensure they are adequate.

*Executive Summary from _cr08349 - Executive Summary*

### 5.      The generally favorable macroeconomic performance has underpinned the

### 5.      The generally favorable macroeconomic performance has underpinned the

### Overview
- The financial sector is advanced and diversified, comprising a sophisticated banking sector, well-established capital markets, and nonbank institutions including insurance companies, pension funds, and collective investment schemes.
- The system is dominated by a few large conglomerates with interlocking ownership and activities across banking, insurance, brokerage, and asset management.
- Capital markets exhibit significant activity in derivatives, securitization, and hedge fund markets.
- Securitization operations—60 percent of which is linked to residential property—started in 2002, took off in 2006, but still represent a limited share of banks’ balance sheets.

### A. Commercial Banks — Structure and market position
- Commercial banks’ assets represent some 120 percent of GDP.
- Four banks—the Amalgamated Bank of South Africa (ABSA), FirstRand Bank, Nedbank, and Standard Bank—account for almost 85 percent of total assets and have substantial international presence.
- South African banks have expanded rapidly into African markets (Botswana, Mozambique, Namibia, and Zimbabwe) and represent substantial market shares there, though foreign activities on the continent represent a small share of their balance sheets.
- Foreign presence in South Africa has increased, e.g., takeover by Barclays as main shareholder of ABSA in 2005 and Industrial and Commercial Bank of China’s acquisition of 20 percent stake in Standard Bank at the end of 2007.
- Public debate exists on high concentration and potential lack of competition; June 2008 Competition Commission enquiry panel recommended actions on (i) penalty fees; (ii) ATM carriage fees; (iii) access to the national payment system; (iv) payment cards and interchange fees; and (v) products and pricing.

### A. Commercial Banks — Resilience and risks
- The banking system withstood recent global market turmoil and was not significantly exposed to subprime-related products in the United States.
- Market-related losses have been limited; banks secured funding without much difficulty due to largely domestically-generated, rand-denominated liabilities.
- Significant liquidity risks arise from heavy reliance on domestic wholesale corporate deposits, partly reflecting long-standing limitations on capital outflows by corporates and institutional investors.
- Emerging pressures on balance sheets due to sustained increases in interest rates and softening property prices:
  - Nonperforming loan (NPL) ratios appear relatively low with substantial provisioning.
  - Increases in policy rates since 2006 have led to increased NPL ratios and arrears on credit card debt.
  - Property markets softened since the beginning of 2008 after several years of significant property price inflation.
  - Corporate credit appears less concerning as South African corporations tend to rely relatively less on debt financing.

### Stress tests — credit, market, and liquidity vulnerabilities
- Stress testing shows the banking system is most exposed to credit risk and to a lesser extent to market risk, although capital levels remain close to regulatory requirements after sizable shocks.
- Since the implementation of Basel II in January 2008:
  - the minimum capital requirement has been set at 9.75 percent, the level of capital in the system being currently three percentage points above that requirement.
  - Under Basel I, capital adequacy ratios were required to be at a minimum of 10 percent.
- The larger banks have implemented the advanced internal ratings based (IRB) approach under Basel II, developing sophisticated risk monitoring and modeling capabilities.
- Single factor stress tests indicate greatest exposure to retail-sector credit risk.
- A severe macroeconomic stress scenario generates considerable strain with substantial additional credit losses; combined market-related losses could occur should a sudden stop in capital inflows trigger a severe correction in equity and bond prices.
- Stress tests caveats:
  - Key parameter estimates are based on limited data that may not reflect structural changes and current and future conditions.
  - Profits and balance sheet adjustments are not taken into account in the analysis.
  - The risk management processes of banks appear robust and could allow prompt management actions.

### Liquidity and funding
- Vulnerability to market risks is generally moderate and the banking system as a whole has ample liquidity.
- Most banks take only small active positions and hold substantial liquid assets.
- Banks devote considerable resources to liquidity stress testing and have sophisticated liquidity management systems.
- Funding maturity is short and shortening further; a large portion of funding is wholesale from domestic sources, including life insurance companies and asset managers.
- Currently, banks have not experienced significant funding pressures beyond slightly firmer pricing and some shortening of maturity.

### Regulatory and supervisory recommendations
- The SARB has strengthened stress testing and model validation capacity under the impetus of Basel II.
- Recommendation: off-site stress testing should become an integral part of SARB analysis and include individual bank data for the major banks to avoid masking institution-level variations.
- SARB might consider working with the FSB to integrate insurance sector stress tests in financial stability analysis.

### B. The Insurance Sector — size and structure
- Life company assets were around 80 percent of GDP at end-2007.
- Insurance penetration—premiums in relation to GDP—is 16 percent of GDP.
- Nearly 50 percent of long-term insurers’ balance sheets are accounted for by underwriting of retirement funds.
- A large and increasing share of investment risks in insurers’ asset portfolios is borne directly by policy holders via investment and bonus reserves.
- General insurers have benefited from a prolonged upswing in the underwriting cycle with a low incidence of major losses.
- The sector has implemented long-run risk-management initiatives addressing HIV/AIDS and high levels of crime.

### B. The Insurance Sector — outlook, risks, and stress tests
- Recent performance strong due to buoyant economy and equity-market growth; insurers maintain large and growing surpluses in excess of regulatory minima; no significant insurer failures in recent years.
- Emerging concerns:
  - For life insurers: high interest rates, rising inflation, and prospects for economic downturn have begun to result in higher policy lapses and surrenders.
  - Reductions in new business in some life products and in general insurance.
  - Continued strong competition for savings business from mutual funds.
  - Increases in cost and operational pressures from scarcity of technical skills.
  - Increased regulatory scrutiny and pressure to improve standards of market conduct following problems in contractual savings (including high early termination penalties).
  - Government planned retirement and social security reforms could drain retirement savings and protection business in favor of mandatory contributions to state insurance funds, depending on final design.
- Stress tests indicate life insurers are generally resilient but exposed to interest rate and equity price movements and unexpected increases in mortality or longevity.
  - Investment and bonus reserves cushion shocks but in several cases would diminish regulatory solvency buffer; buffers would stay above minimum capital requirement in all but one case.
- Risk management improvements: life companies are valuing market risks related to guarantees and taking more strategic approaches; however, annuities pose hard-to-manage longevity and matching risks.
- Potential contagion risks: interrelationships between insurance and banking since four of the five largest insurance groups have ownership links to major banks.

### C. Pension Funds
- Large and highly developed pension and provident fund sector; most formal sector employees covered by occupational retirement fund arrangements described as “quasi-mandatory.”
- Voluntary retirement savings, supported by tax incentives, are largely limited to middle and upper income workers and cover about 60 percent of workers in the formal sector.
- There were over 13,000 funds in 2005 with total assets in 2008 exceeding ZAR 2 trillion.
- Weaknesses and reforms:
  - Adverse publicity regarding equity and fair treatment of consumers underscores substantial weaknesses in disclosure to trustees and customers and in meeting consumer-protection objectives.
  - Strengthening of enforcement powers of the registrar of pensions is expected to improve compliance culture.
  - Limited understanding by many trustees of fiduciary responsibilities remains a major problem; need for independent trustee training through industry association or accredited institutions.
  - Current payout rules do not ensure lifetime income; ability to draw down retirement savings in as little as six years has been constrained by law changes and industry codes, but more is needed to align draw-downs with life expectancy.
  - Planned pension reform package should ensure provident funds provide a form of lifetime income and move away from only lump-sum payments; reform proposals supporting “preservation” until retirement will be a major step forward.

### III. FINANCIAL MARKETS, INFRASTRUCTURE, AND SAFETY NETS — A. Financial Markets: Equity and bond markets
- JSE performance robust but volatile, with recent net selling of industrial and financial shares by foreigners.
- The rise in the All-share Index was supported primarily by gains in commodity sectors (gold and platinum).
- Market capitalization of the JSE is the largest among emerging markets.
- Nonresident-sourced turnover accounts for some one-fifth of the total on the JSE.
- Stock market liquidity is more limited relative to other emerging markets due to a few large listings and buy-to-hold domestic institutional investors.
- The JSE trades index and single stock futures and lists currency derivatives settled in rand.
- The Bond Exchange of South Africa (BESA) has seen increased capitalization and private issuance; historically dominated by sovereign listings but provides price transparency to an active OTC bond market.
- At one-third of turnover, foreign participation on BESA is currently higher than on the JSE; foreigners have been net purchasers of bonds in recent months, partially offsetting net selling of shares.
- BESA supports derivatives and provides transparency to OTC trade in repos, interest rate swaps (IRS) and forward rate agreements (FRA).

### Policy-relevant market development priorities
- Continued focus on policies to support investor confidence and foster greater depth and liquidity.
- Two priority areas:
  - Further development of the bond market, e.g., for infrastructure financing.
  - Efforts to increase stock market liquidity, such as by expanding the amount of shares available for trading on the stock market (“free float”) within the policy of gradual relaxation of foreign investment limits for domestic institutional investors.

### III.A — Money and foreign exchange markets
- Swap transactions dominate turnover in the foreign exchange market.
  - For maturities of less than a week, foreign exchange swap turnover exceeds US$9 billion daily versus less than US$3 billion turnover in the spot market.
- The foreign exchange derivatives market, measured as turnover to GDP, is the largest among major emerging markets, reflecting high turnover in short-maturity foreign exchange swap transactions.
- Short-term liquidity management by banks underpins the market; SARB occasionally uses swaps to drain liquidity.
- Banks rely on negotiable certificates of deposits for longer maturities, particularly liquid at three-month maturity; JIBAR is based on these instruments.
- Nonresident activity accounts for 71 percent of turnover in the foreign exchange market, reflecting significant participation of foreign banks and trading between London and Johannesburg desks.
- High interest rates make offshore rand-denominated bonds attractive for carry trade; issuers often swap proceeds back into dollars using liquid FX and derivative markets.
- Hedging activity and large mergers and acquisitions can lead to spikes in FX volatility.

*Source: _cr08349*

### 26.      Surveillance of the OTC foreign exchange derivative markets needs therefore to

### _cr08349 - 26.      Surveillance of the OTC foreign exchange derivative markets needs therefore to

### Surveillance of OTC foreign exchange derivative markets
- Trading between offshore dealers are not captured in official statistics and potential ensuing imbalances during settlement on the onshore spot market may go undetected.
- With most offshore dealers ultimately hedging their rand positions with South African counterparts, enhanced monitoring of hedging transactions based on the data already being collected on onshore transactions could provide useful information on the offshore market.
- Footnote example: an investor buying rands to invest into an offshore bond will ultimately purchase them from South Africa and these rands may find their way back via a swap.

### Systemic Liquidity Management
- The global market turmoil did not pose any serious challenges for the management of domestic liquidity; money markets were barely affected and banks have built up adequate liquidity buffers.
- There has been no unusual recourse to SARB’s standing facilities or repo operations and the money market showed no abnormal signs of strain (Appendix I Figure 7).
- The close linkage of the domestic money market with the offshore rand and foreign exchange markets is a potential channel for contagion in times of stress.
- Maturities of money market instruments have tended to shorten in the wake of rising domestic interest rates, resulting in shorter maturities of wholesale deposits in the banking system.
- Significant concentration of bank funding on the wholesale depositor base and greater vulnerability of smaller banks could potentially engender broader liquidity pressures; smaller banks tend to rely heavily on refinancing facilities with larger banks.
- Recommendation: authorities should work with banks to develop medium-term strategies to reduce their dependence on wholesale market funding.
- SARB instrument flexibility:
  - In May 2007, the SARB broadened its list of collateral for its refinancing operations to include government securities, SARB debentures, Land Bank bills (category 1), and nongovernment bonds—mainly issued by parastatals excluding banks (category 2).
  - For overnight liquidity needs, banks have daily access to standing facilities.
  - Standing facilities are available in the form of bilateral repo or reverse repo maturing the following day at a penalty rate of 50 bps above the repo rate.
  - In exceptional temporary liquidity shortage in an individual bank, the SARB can temporarily waive cash reserve and liquid asset requirements.
- Payments system support:
  - The South African Multiple Option Settlement (SAMOS) enables real-time settlement and is designed with a dynamic collateral facility and same day square off in compliance with the BIS Core Principles for Systemically Important Payment Systems.
  - SAMOS has been effective in providing early indications of impending counterparty payments problems and underscores the importance of proper coordination within the monetary operations framework.

### Exchange controls
- Strategy: authorities pursue gradual liberalization of exchange controls; since 1995 most capital controls on nonresidents were eliminated and residents’ foreign exchange transaction limits have been increased in stages.
- In February 2008, significant further liberalization measures were announced involving:
  - (i) raising limits on foreign exposure by institutional investors;
  - (ii) simplifying the regulation of banks’ foreign exposure; and
  - (iii) streamlining the administration of foreign exchange controls.
- The changes are designed to shift from controls to a framework based on prudential measures.
- The limit on banks’ foreign exposure is to be raised to 40 percent of liabilities, although the definition and reporting of foreign exposures are still being worked out.
- Further liberalization is challenging given volatility in financial markets, heavy reliance on portfolio inflows, and corporate deposits in the banking system: corporate rand deposits in banks equaled some 22 percent of GDP in March 2008.
- The National Treasury (NT) plans to undertake a study to assess the impact of lifting remaining controls, especially on the funding of banks.
- Recommendation: continue cautious approach to liberalization and prepare banks for necessary diversification of their funding base; success depends on (i) appropriate timing to minimize reversal risk; and (ii) proper reporting by commercial banks, securities dealers, and other market participants to enable the central bank to take corrective actions in a timely manner.

### Crisis Management and Safety Nets
- Contingency planning:
  - Channels of communication between the NT and the SARB for crisis prevention have widened, including regular bilateral meetings between the minister of finance (MOF) and the governor, and various subcommittees.
  - In 2003, the Financial Sector Contingency Forum (FSCF) was created to coordinate preparedness for managing financial crises; the forum has led crisis exercises, created a smaller incident-management team, and prepared a manual emphasizing liquidity issues.
  - More formal coordination arrangements involving memoranda of understanding (MOUs) and even legislation are being contemplated.
  - Cross-border contingency planning is supported by regular exchanges between the Banking Supervision Department (BSD) and other supervisors.
- Lender-of-last-resort (LOLR) arrangements:
  - Authorities use a case-by-case approach to providing emergency liquidity support, considering potential systemic threat and solvency (based on a solvency audit).
  - The SARB can provide exceptional short-term liquidity assistance against pledged collateral or a government guarantee; for solvent banks, assistance can be provided in conjunction with other remedial measures.
  - For insolvent banks, only the MOF (NT) has the power to appoint a curator; the course of action is decided in collaboration with the SARB.
  - The NT is likely to be involved in liquidity problems at a solvent but systemically important institution and can play a larger role and provide public funds on a case-by-case basis in the event of insolvency of such an institution.
  - For systemically insignificant insolvent banks, the BSD can approach the MOF to appoint a curator or apply to the courts for liquidation.
  - A detailed operational framework is not formalized to retain flexibility.
- Recommendations to strengthen arrangements:
  - Undertake a financial crisis simulation centered on the failure of a systemic institution to identify weaknesses.
  - Consider formalizing the resolution process, possibly in a MOU, to authorize the registrar of banks to directly appoint a curator to prevent delays and limit systemic contagion; the current appointment of a curator by the MOF requires the written consent of the chief executive officer or chairperson of the Board of the bank, which could delay the process.
  - Specify eligible collateral for LOLR operations in times of general market distress.
  - The SARB is reviewing all its crisis management strategies as part of FSCF work in light of past global crisis episodes.
- Deposit insurance:
  - South Africa currently lacks deposit insurance; the process for launching a deposit insurance has been revived but faces challenges concerning:
    - (i) composition of the Board of the South African Deposit Insurance Scheme (SADIS) and its degree of independence;
    - (ii) the nature of the role of the agency in resolution matters; and
    - (iii) the scale of initial government funding for the scheme.
  - Related legislation is being redrafted, to be discussed with the SARB and presented to the Cabinet prior to public consultation.
  - Recommendation: ensure deposit insurance arrangements adhere to sound principles, protect small depositors in the banking sector, and avoid creating ambiguities in bank intervention powers.

### Financial Supervision and Standards Assessments — The Supervisory and Regulatory Framework
- Institutional arrangements (Figure 5 summary):
  - The SARB—responsible for commercial bank regulation and supervision. The Banks Act and the Mutual Banks Act assign powers to the registrar of banks, an appointment made by the SARB subject to the approval of the MOF. The BSD is funded from central bank resources and has around 100 staff.
  - The FSB—responsible for insurance, pensions funds and intermediaries as well as oversight of capital markets. The FSB is governed by a Board of Directors accountable to government and parliament, funded by fees paid by regulated entities and has 370 staff.
- Other bodies:
  - The National Credit Regulator (NCR) operates under the National Credit Act, regulates granting of consumer credit by all credit providers, is funded by the Department of Trade and Industry (DTI) and has a full time staff of 65.
  - A number of self regulatory organizations (SROs) have responsibilities in capital and investment markets.
- Prudential regulation progress:
  - Since the 2000 FSAP, the authorities have strengthened the framework and are largely compliant with international standards.
  - The SARB implemented Basel II early; the FSB has increased resources to enhance licensing, supervision and enforcement capabilities.
  - South Africa adopted IFRS and ISAS early.
  - An AML/CFT assessment is being conducted by the Financial Action Task Force (FATF) and will be discussed at the FATF plenary meeting in February 2009 following which a ROSC will be circulated to the Executive Board for information.
- Need for supervisory cooperation:
  - Financial conglomerates operate across markets often in separate legal entities, requiring sectoral supervision combined with focus on cross-sector risks.
  - A mechanism for resolving policy disagreements among regulators and assessing trade-offs is lacking; the Policy Board for Financial Services and Regulation was created but plays a purely advisory role to the NT.
- Priority areas for future efforts:
  - Greater day-to-day collaboration among staff of different sectoral regulators on individual institutions and emerging risk issues, supplementing existing high-level meetings.
  - Enhance collaboration within the FSB to improve market conduct in retail markets; ensure NCR coordinates regarding household credit.
  - Increased focus on qualitative standards, including corporate governance, risk management, and internal controls; set clear prudential expectations, consistent with a move towards a more principles-based approach.
  - Develop supervisors’ skills to meet growing regulatory complexity and move away from a compliance-based approach; while resources appear adequate, enhance front-line skills across sectors.
  - Improve allocation of resources for off-site risk assessment models through a more consistent approach across sectors and increased central capacity at main regulators.

### Banking Supervision
- Basel II implementation:
  - Banks complied with the January 1, 2008 implementation deadline.
  - The SARB has offered both the standardized and IRB approaches.
  - Banks representing 80 percent of total assets are implementing the IRB approaches to credit risk, while one bank is also applying the advanced measurement approach for operational risk.
  - Subsequent implementation has proceeded well and Basel II has been largely capital-neutral for the four largest banks.
- SARB supervisory commitments:
  - BSD has addressed recommendations of the 2000 FSAP and its self assessment of compliance with the October 2006 Basel Core Principles (BCP) identified few areas of noncompliance.
  - BSD has reacted to emerging resource constraints through training programs, secondments and the use of outside experts, primarily auditors.
- Domestic and international coordination:
  - A comprehensive MOU between the BSD and the FSB governs domestic cooperation, including supervision of financial conglomerates.
  - BSD has entered into a number of MOUs with other supervisors and several others are pending; as both home and host regulator, BSD actively engages other supervisors but remains exposed in a crisis to the effectiveness of home supervisors.
- Supervisory focus and vulnerabilities:
  - BSD monitors banks’ risk estimates and retail risk weights on a portfolio basis and stands ready to respond under Basel II regulatory provisions if supervisory intervention is warranted.
  - Lending to new borrowers with relatively short credit history requires close vigilance and a forward-looking approach, including proactive use of additional Pillar 2 add-ons.
  - Lending is concentrated to a limited range of corporate clients; large exposures policies are in place.
  - BSD seeks to improve governance at banks by ensuring Boards have appropriate skills and available time for prudential matters.
- Recommendation: supervisors need to enhance focus on funding and liquidity issues; banks do not appear to have comprehensive contingency plans if access to domestic wholesale funding becomes restricted (for example, if remaining exchange controls were lifted).
  - Further analysis is warranted as part of a collaborative exercise between the SARB, the NT, and the FSB, possibly in the context of a Basel II Pillar 2 exercise and the planned study of effects of lifting remaining capital controls.

*Source: _cr08349 - 26.      Surveillance of the OTC foreign exchange derivative markets needs therefore to*

### 48.      The insurance regulatory regime is generally well-developed. The FSB has a

### _cr08349 - 48.      The insurance regulatory regime is generally well-developed. The FSB has a

### Insurance regulation — current framework and supervisory practice
- The insurance regulatory regime is generally well-developed.
- The FSB has a modern solvency regime for life insurance and is in the process of introducing new risk-based requirements for general insurers with extensive quantitative and qualitative reporting.
- The FSB has an excellent process for reviewing returns and following up on issues; results are integrated into a modern, though still evolving, risk-assessment framework focused mainly on prudential issues but also including regular onsite work.
- Supervisors work closely with relevant overseas regulators.

### Insurance regulation — recommended institutional adjustments
- There is a need to review the responsibilities of the NT and the FSB in insurance regulation.
  - The NT is highly involved in regulatory policy in the consumer protection area and is responsible for steering draft regulations through the legislative process.
  - Giving the FSB greater powers to set its own requirements would help ensure its operational independence from government.
  - In the consumer protection area, the NT could look to the FSB to take a greater leadership role in policy formulation to increase the FSB’s focus on market conduct issues, complementing its strong capabilities in the prudential arena.

### Insurance supervision — areas for strengthening
- Scope for the FSB to strengthen its approach to address risks and vulnerabilities, including:
  - (i) enhanced supervision of groups;
  - (ii) further guidance on governance, risk management, and internal controls;
  - (iii) enhanced life insurance regulation, including review of the adequacy of solvency margins in preparation for the finalization of new international standards and better integration of stress testing into its reporting and supervisory regime; and
  - (iv) greater effectiveness of its market conduct supervision.

### Pensions — industry structure and consolidation
- The large number of pension funds complicates the task of supervision; consolidation of the industry is being pursued by the FSB.
- Factors encouraging consolidation include: increased focus on the need for good governance, more intense supervision, rising costs, and potential benefits from economies of scale.
- Further measures to encourage consolidation could include strengthening governance and risk management requirements and increased sensitization of trustees of their obligation to consider the impact of high cost structures on members’ balances.

### Pensions — governance and supervisory tools
- The governance framework for retirement funds needs to be strengthened.
  - FSB’s recently issued circular sets out fiduciary responsibilities of trustees and suggests a range of good governance requirements.
  - Consideration should be given to converting the circular into a regulation enforceable by the FSB.
  - The FSB is developing a risk-based supervisory model for retirement funds; implementation is hampered by the lack of timely and accurate data reporting to the FSB.

### Pensions — enforcement powers and fit-and-proper standards
- Enforcement powers of the FSB have been strengthened considerably in the past year.
  - Amendments to the law in September 2007 gave the FSB the power to impose penalties for noncompliance with the act, to remove trustees, and to perform on-site visits.
  - Amendments before parliament will give the FSB extended enforcement powers.
- The FSB should consider introducing more specific fit-and-proper requirements supported by relevant training for those responsible for management and oversight of retirement funds (including trustees).

### Securities markets — recent progress and strategic considerations (IOSCO Assessment summary)
- Oversight and regulation of securities markets has been substantially strengthened.
- Progress has been made in addressing the recommendations of the 2000 FSAP.
- FSB’s legal authority has been greatly expanded through a series of new laws.
- The FSB has expanded its staff and onsite examination program for registered entities and SROs and has used its enforcement authority to address insider trading and market misconduct.
- The FSB should begin strategically assessing whether continued expansion of South African capital markets, including likely growth in the OTC market for specialized products, can be effectively regulated within the current structure.

### National Credit Regulator (NCR) and consumer protection
- The NCA and the NCR are bringing necessary and timely improvements to consumer protection.
  - The NCR is responsible for the regulation of all forms of household credit, extended by banks and nonbanks.
  - Compliance with the NCA’s prohibition on reckless lending required lenders to revamp underwriting and risk management procedures.
  - Market conduct and disclosure requirements have increased transparency and laid the basis for greater competition among lenders.
- Potential challenges and limitations:
  - There may also be potential unintended negative consequences, and compliance with reckless lending provisions is yet to be tested in the courts.
  - The NCR is credited with having moved forcefully to investigate infractions but may lack resources to enforce the full range of NCA provisions.
  - A key challenge is building an effective, nationwide network of well-trained and registered debt counselors as provided for in the law.
  - The National Debt Mediators Association, an industry-led initiative, is developing a code for debt work-outs which could serve as a mechanism to resolve debt distress cases before they come to counselors, magistrates, or tribunals.
  - NCR’s budget appears to be modest and subject to budgetary uncertainties relating to the DTI.

### Financial access and inclusion — recent performance and policy instruments
- Financial inclusion is part of the transformation agenda in South Africa.
- The proportion of the population with access to a bank account increased from 33 percent in 2005 to 45 percent in 2007 for the lower income brackets.
- The FSC, established in 2004, is viewed as an important catalyst for transformation with objectives including providing effective access to adequate financial services for all, improving racial representation in ownership, and fostering corporate governance that is representative of the community.
- The recent passage of the Broad-Based Black Economic Empowerment Act has resulted in some uncertainty regarding the future of the FSC; given its role in promoting financial inclusion, it is highly desirable that the FSC be recognized under the act and that it maintains appropriate financial inclusion objectives.
- Key concerns in financial inclusion:
  - (i) progress in access to bank accounts is characterized by a major divide between salaried and nonsalaried individuals;
  - (ii) lending to SMEs remains limited; and
  - (iii) other services beyond basic accounts lag far behind, notably savings and insurance products.
- As the FSC is being reviewed this year, there is an opportunity to further strengthen its targets.

### Housing finance — market structure and policy considerations
- Mortgage markets have undergone impressive expansion.
- The FSC has been instrumental in promoting financing for affordable housing.
- The housing finance portfolio is concentrated in the four large banks and one nonbank home lender, South African Home Loans.
- As demand for housing has outstripped supply and prices have risen faster than incomes, access to financing for housing has increasingly become difficult for lower and middle income groups.
- FSC mortgages presently represent just 4.4 percent of banks’ mortgage portfolios—only a fraction of the demand for new housing within stated income limits.
- The government is considering consolidation of the three housing DFIs.
  - The Rural Housing Finance Fund and the National Urban Residential Finance Corporation appear to serve their respective market niches well.
  - The National Housing Finance Corporation (NHFC) has not fulfilled its development mandate.
- Recommended actions:
  - Conduct an in-depth analysis of needs regarding affordable housing finance to redefine the role of any newly configured housing DFI and to optimize its structure, products, corporate governance, funding, and incentives for partnership with the private sector.
  - Adjust the objectives of the FSC in housing finance and assess the extent of the need for any state support in this area.
  - Carefully review the effectiveness of existing credit-linked subsidies and a new system of tax credits for developers in affordable housing.

### Annex I — IOSCO assessment: methodology, scope, and institutional overview
- This is an Update of the IOSCO assessment performed in 2000 as part of the FSAP of South Africa.
  - The FSAP Update was performed by Mr. Jonathan Katz, a technical consultant to the IMF/World Bank FSAP mission; interviews were conducted over a two week period in May 2008.
- Information and methodology used for assessment:
  - Assessment prepared on the basis of a self-assessment by the FSB, public information on the FSB web site and other South African entities, and a review of relevant South African laws and regulations.
  - Consultant relied upon the IOSCO Assessment Methodology for guidance.
- Institutional and market structure—overview:
  - The FSB was established in 1990 with the enactment of the Financial Services Board Act.
  - The FSB is subject to the general authority of the MOF who appoints members of the Board and selects senior officers after consultation with the Board.
  - The FSB has broad regulatory authority over the JSE Exchange and the BESA, financial advisors and intermediaries (FAIS), collective investment scheme operators (CIS), pension funds, and insurance companies.
  - The FSB has clear authority to perform on-site examinations, to require reports, and to investigate misconduct and to impose penalties for violations of applicable laws.
  - Other governmental agencies with roles relevant to IOSCO principles include the DTI (company registration) and the Securities Regulation Panel (SRP) for enforcement of laws concerning mergers, acquisitions, and changes in corporate control; the SRP is independent of the DTI.
  - The SARB has regulatory duties relevant to underwriting of securities and foreign exchange control authority for approving cross-border dual listings and foreign securities offerings.
- Legislative and institutional developments since 2000:
  - The Securities Services Act of 2004 expanded FSB’s enforcement authority.
  - The Collective Investment Schemes Control Act (CISCA) of 2002 and the Financial Advisory and Intermediary Services Act of 2002 expanded the authority of the FSB to register, regulate, and inspect asset managers, financial advisors (excluding stockbrokers and associated users already regulated by the JSE), and collective investment schemes.
  - The Corporate Laws Amendment Act of 2007 addressed several recommendations of the 2002 Accounting and Auditing ROSC.
- Role of Self-Regulatory Organizations (SROs):
  - The JSE Ltd is the primary and secondary market for listed equity securities, financial derivatives, agricultural commodities and a recently developed bond market.
  - The BESA is the principal bond exchange.
  - Both the JSE and the BESA operate as SROs with primary regulatory responsibility for licensing members (authorized users) and employees and to enforce the exchange’s listings requirements.
  - Strate is an SRO functioning as the central securities depository for listed equity securities and debt (government and corporate).
  - Two clearing houses licensed by the FSB: Strate (for equities and bonds) and SAFCOM (for derivatives).
- Disclosure and listing oversight:
  - The JSE acts as the primary regulatory body for setting disclosure requirements for its public listed companies; the DTI traditionally focuses on initial registration and defers to the JSE on disclosure regulation.
  - The JSE requires listed companies to retain the services of a company sponsor (main board stocks) or a company advisor (Altx) responsible for due diligence and ongoing advice on regulatory responsibilities.
- Regulation of CIS marketing and disclosure:
  - Regulation has been delegated by the FSB to the Association of Collective Investments (ACI), a voluntary industry organization that has declined to apply and be licensed as an SRO.
  - As a condition of registration the FSB requires CIS registrants that are not members of the ACI to agree to be bound by ACI guidelines.

*Source: IMF staff report content (extract provided).*

### 71.      The South African capital markets have benefited from a strong legal infrastructure. It

### _cr08349 - 71.      The South African capital markets have benefited from a strong legal infrastructure. It

### Legal infrastructure and institutional overview
- South Africa has a well-established judiciary perceived to be competent and independent.  
- Commercial laws and debtor-creditor laws are believed to be sound.  
- South Africa was one of the first countries to adopt the International Financial Reporting Standards promulgated by the International Accounting Standards Board.

### Summary findings on implementation of the IOSCO Principles (selected highlights from Table 1)
- Principle 1. The responsibilities of the regulator should be clearly and objectively stated.
  - The South African system of financial services regulation is complex, involving multiple government agencies, several advisory or oversight committees, and several self-regulatory organizations. While all areas of responsibility appear to be covered, there may be gaps in the implementation of duties, which will be discussed under the relevant substantive principles.
- Principle 2. The regulator should be operationally independent and accountable in the exercise of its functions and powers.
  - The FSB has full control over its budget and daily operations. However the MOF has the legal authority to block the promulgation of FSB regulations and to fire Board members and FSB senior staff.
- Principle 3. The regulator should have adequate powers, proper resources and the capacity to perform its functions and exercise its powers.
  - Since the 2000 assessment the FSB has obtained greatly expanded legal authority and has succeeded in building its capacity to exercise these responsibilities. The FSB lacks regulatory authority over disclosure requirements for public listed companies.
- Principle 4. The regulator should adopt clear and consistent regulatory processes.
  - The FSB has sound internal operating processes. Its internal processes have received ISO 9000 certification.
- Principle 5. The staff of the regulator should observe the highest professional standards.
  - The FSB has a Code of Conduct for its employees that addresses confidentiality of information, receipt of gifts from licensed entities, and ownership of securities.
- Principle 6. The regulatory regime should make appropriate use of SROs that exercise some direct oversight responsibility for their respective areas of competence and to the extent appropriate to the size and complexity of the markets.
  - The JSE, BESA ,and Strate perform several core regulatory functions. The ACI has delegated regulatory responsibilities but has declined to become an SRO, subject to FSB’s oversight.
- Principle 7. SROs should be subject to the oversight of the regulator and should observe standards of fairness and confidentiality when exercising powers and delegated responsibilities.
  - The FSB has broad authority to license, subject to annual renewal, its exchanges and SRO’s. Because the ACI has not registered and been licensed as an SRO, the FSB lacks comparable oversight authority, even though the ACI performs functions comparable to those of an SRO.
- Principle 8. The regulator should have comprehensive inspection, investigation, and surveillance powers.
  - The FSB has strong inspection and investigation powers and the JSE and the BESA provide it with surveillance capacity over listed markets. There is little surveillance capacity over OTC activities.
- Principle 9. The regulator should have comprehensive enforcement powers.
  - The FSB has expanded its ability to bring enforcement actions administratively and is seeking to expand this authority further.
- Principle 10. The regulatory system should ensure an effective and credible use of inspection, investigation, surveillance, and enforcement powers and implementation of an effective compliance program.
  - A system, involving so many entities, creates the potential for inconsistent or ineffective regulation. Regulation of public company disclosure by the DTI is an area of significant concern.
- Principle 11. The regulator should have the authority to share both public and non-public information with domestic and foreign counterparts.
  - The FSB has full legal authority to share information with domestic and foreign regulators.
- Principle 12. Regulators should establish information sharing mechanisms that set out when and how they will share both public and non-public information with their domestic and foreign counterparts.
  - The FSB has written agreements to share information with the SARB and the revenue authority.
- Principle 13. The regulatory system should allow for assistance to be provided to foreign regulators who need to make inquiries in the discharge of their functions and exercise of their powers.
  - The FSB is a signatory to the IOSCO multi-lateral MOU on information sharing.
- Principle 14. There should be full, timely, and accurate disclosure of financial results and other information that is material to investors' decisions.
  - Current disclosure standards provide investors with necessary information on public companies. Regulatory systems for proactively reviewing periodic company disclosures could be improved. Public disclosure of holdings by company officers and large investors require improvement.
- Principle 15. Holders of securities in a company should be treated in a fair and equitable manner.
  - The King Commission reports have contributed to an improved system of corporate governance and accountability. There is no effective method to enable third parties to solicit voting proxies from other shareholders.
- Principle 16. Accounting and auditing standards should be of a high and internationally acceptable quality.
  - South Africa was an early adopter of IFRS. There is a national system for oversight of the accounting and auditing profession.
- Principle 17. The regulatory system should set standards for the eligibility and the regulation of those who wish to market or operate a collective investment scheme.
  - The CISCA and FAIS provide the FSB with broad regulatory authority and the FSB has successfully addressed its responsibilities. Consideration should be given to issues raised by white label funds and linked investment service providers (LISPs). Legal gaps complicate the development and regulation of hedge funds.
- Principle 18. The regulatory system should provide for rules governing the legal form and structure of collective investment schemes and the segregation and protection of client assets.
  - The CISCA established a strong regulatory framework for the CIS. The FSB has used its licensing authority to address issues concerning segregation of investor assets in LISPs.
- Principle 19. Regulation should require disclosure, as set forth under the principles for issuers, which is necessary to evaluate the suitability of a collective investment scheme for a particular investor and the value of the investor’s interest in the scheme.
  - The FSB has delegated substantial responsibility for setting and enforcing disclosure standards for the CIS to the ACI, a non-SRO industry trade group.
- Principle 20. Regulation should ensure that there is a proper and disclosed basis for assets valuation and the pricing and the redemption of units in a collective investment scheme.
  - Regulation of CIS valuation and pricing is sound. Development of comparable requirements for LISPs should be a priority.
- Principle 21. Regulation should provide for minimum entry standards for market intermediaries.
  - The FSB has developed a comprehensive licensing system implementing its authority under the FAIS and the CISCA.
- Principle 22. There should be initial and ongoing capital and other prudential requirements for market intermediaries that reflect the risks that the intermediaries undertake.
  - The JSE capital adequacy standards for its licensed members appear to be sound and the JSE BDA system provides daily information on member firm open positions and exposure. Comparable standards for licensees under the FAIS have not been adopted by the FSB but are under consideration. It should also assess whether a general requirement of fiscal solvency provides sufficient protection for investors and for counterparties.
- Principle 23. Market intermediaries should be required to comply with standards for internal organization and operational conduct that aim to protect the interests of clients, ensure proper management of risk, and under which management of the intermediary accepts primary responsibility for these matters.
  - The FSB requires licensees to have internal control processes and internal compliance officers. All client funds must be held in segregated accounts and licensees must apply “know your customer” principles in providing financial advice. LISP regulation should be reexamined.
- Principle 24. There should be a procedure for dealing with the failure of a market intermediary in order to minimize damage and loss to investors and to contain systemic risk.
  - The FSB and the JSE have authority to order licensees to suspend or terminate operations and the FSB may seek a court order to appoint a conservator.
- Principle 25. The establishment of trading systems including securities exchanges should be subject to regulatory authorization and oversight.
  - The JSE and the BESA must apply for annual renewal of exchange licenses. The FSB annually performs on-site examinations of both.
- Principle 26. There should be ongoing regulatory supervision of exchanges and trading systems, which should aim to ensure that the integrity of trading is maintained through fair and equitable rules that strike an appropriate balance between the demands of different market participants.
  - Ongoing market surveillance is performed by the JSE and the BESA with FSB staff oversight through weekly meetings and reports.
- Principle 27. Regulation should promote transparency of trading.
  - The systems in South Africa for trading in listed securities are robust and comparable to international best practices. The challenge going forward will be to examine trading in the OTC market.
- Principle 28. Regulation should be designed to detect and deter manipulation and other unfair trading practices.
  - The JSE and the BESA have primary responsibility for listed market surveillance. The FSB has implemented its authority to enforce laws prohibiting insider trading and market manipulation. Consideration should be given to the need for market surveillance in the OTC market.
- Principle 29. Regulation should aim to ensure the proper management of large exposures, default risk and market disruption.
  - The JSE BDA system provides it with robust data on member firm exposures. Both the JSE and the FSB have the power to take action in the event of a firm failure to avoid systemic failures.
- Principle 30. Systems for clearing and settlement of securities transactions should be subject to regulatory oversight, and designed to ensure that they are fair, effective and efficient and that they reduce systemic risk.
  - The JSE system for clearance and settlement has a “zero failure” record. Nonetheless a priority goal should be conversion to a T+3 equity settlement cycle and legal action to establish a central counterparty system. Improvements in the trading infrastructure should also include expansion of IT telecommunications capacity for all trading.

### Recommended action plan to improve IOSCO implementation (selected from Table 2)
- Principle 2: The FSB should have the authority to adopt and publish its regulations without the approval of the MOF. The unlimited discretion of the MOF to terminate senior FSB staff and members of the FSB Board should be defined and limited to circumstances where there is “good cause.”
- Principle 5: The FSB should consider strengthening its rules for employees to report securities trading, the receipt of gifts from the industry, and negotiations for employment with regulated entities.
- Principles 6, 19: The status and delegated authority of the ACI should be carefully reviewed in light of its substantial authority to set and enforce regulatory standards for collective investment schemes.
- Principle 7: The FSB should obtain legal authority to formally review and approve JSE listing standards.
- Principle 8: the FSB should carefully examine whether it should assume greater responsibility in the OTC market.
- Principle 10: The ACI and the IRBA should publicly disclose disciplinary actions information including the identity of the parties. Either the ACI or the FSB should have the authority to impose meaningful sanctions for violations of the CISCA.
- Principle 14: The FSB or the JSE should pro-actively monitor ongoing periodic company disclosure reports. Public disclosure of holdings by company officers and large investors require improvement.
- Principle 15: Regulations providing an opportunity for third parties to solicit voting proxies should be a priority.
- Principle 16: The IRBA should consider requiring public disclosure of notices of accounting irregularities.
- Principle 17: The FSB should have broad legal authority to facilitate development of an effective regulatory environment for hedge funds.
- Principles 20, 22: Regulation of LISP disclosure and pricing publication practices should be a priority.
- Principle 22: The FSB should consider the creation of a capital adequacy requirement for non-JSE member intermediaries licensed under the FAIS. It should also assess whether a general requirement of fiscal solvency provides sufficient protection for investors and for counterparties.
- Principle 29: The abolition of customer margin rules and the potential for OTC derivative trading to affect exchange trading should be examined.
- Principle 30: A priority goal should be conversion to a T+3 equity settlement cycle and legal action to establish a central counterparty system. Improvements in the trading infrastructure should also include expansion of IT telecommunications capacity for all trading.

### Authorities’ response to the assessment (selected points)
- The FSB provided detailed comments on each principle and disagreed with the following IOSCO assessment conclusions:
  - that the FSB should obtain the legal authority to proactively review listed company disclosure reports or the JSE should initiate such a program;
  - that the FSB should, in the future, consider the need for greater regulatory surveillance of the over the counter (OTC) market in South Africa,;
  - that the lack of minimum customer margin requirements and concentration limits, combined with the lack of surveillance of OTC derivatives activities creates a counterparty risk exposure for JSE member firms that has systemic risk implications.
- The FSB and the JSE believe that the current system, in which the JSE has authority to set disclosure standards for listed companies, and proactively reviews initial listing application disclosures and refers complaints concerning periodic disclosure reports to an industry review panel is satisfactory.
- On OTC market regulation the FSB states: “it is our understanding that OTC trades are not regulated in most of the jurisdictions of our counterparts. Due to the wide variety of instruments being traded OTC in South Africa, it is practically not possible to regulate all OTC instruments.”
- On counterparty risk the FSB states: “The fact that we dropped the margin requirement on carry accounts does not mean that we have no regulation on the extension of credit.  If the member has accounted for any credit granted in their capital adequacy computation and they have the capital to absorb a client default then we don’t need to specify strict credit or collateral requirements.  The limits on counterparty concentration are imposed by the member’s available capital.  The fact that there are no specific limits does not create any systemic risk concerns provided the member has sufficient capital.”
- The FSB is seeking additional legal authority to establish capital adequacy standards and related regulatory standards for Financial advisers and intermediaries (FAIS). “Besides the introduction of capital requirements for certain categories of FAIS licensees that is currently receiving attention, the obligatory introduction of fidelity and professional indemnity cover for all FAIS licensees should be introduced during 2008.  These measures will go far in further protection of client interests."

### Selected macroeconomic and financial indicators (Appendix Table 3, selected items)
- Nominal GDP (2007): US$ 282.6 billion
- Population (2007):  47.9 million
- GDP per capita (2007): US$ 5,907
- Real GDP (annual percent change): 2003:3.1 2004:4.9 2005:5.0 2006:5.4 2007:5.1 2008 Proj.:3.8 2009 Proj.:3.7
- CPI (annual average): 2003:5.8 2004:1.4 2005:3.4 2006:4.7 2007:7.1 2008 Proj.:11.3 2009 Proj.:9.2
- Unemployment rate (percent): 2003:28.0 2004:26.2 2005:26.7 2006:25.5 2007:23.0 2008 Proj.:22.9 2009 Proj.:22.9
- Gross reserves (SARB, billions of U.S. dollars): 2003:8.0 2004:14.7 2005:20.6 2006:25.6 2007:33.0 2008 Proj.:36.6 2009 Proj.:39.6
- Current account balance (percent of GDP): 2003:-1.1 2004:-3.2 2005:-4.0 2006:-6.5 2007:-7.3 2008 Proj.:-9.0 2009 Proj.:-9.6
- National government debt (percent of GDP): 2003:37.3 2004:36.4 2005:35.3 2006:33.1 2007:28.6 2008 Proj.:25.6 2009 Proj.:22.8

*Source: IMF staff summary of the assessment and Appendix Table 3 contained in the provided content.*

### Appendix Table 4. South Africa: Financial Soundness Indicators, 2002–07

### Appendix Table 4. South Africa: Financial Soundness Indicators, 2002–07

### Capital adequacy
- Regulatory capital to risk-weighted assets 1 (2002–2007): 12.6 12.4 14.0 12.7 12.3 12.8
- Regulatory tier 1 capital to risk-weighted assets 1 (2002–2007): 8.7 8.9 10.5 9.7 9.0 9.5

### Asset quality
- Nonperforming loans to total gross loans 2 (2002–2007): 2.9 2.4 1.8 1.5 1.1 1.4
- Nonperforming loans net of provisions to capital 2 (2002–2007): 13.2 8.5 6.2 6.4 5.6 8.2
- Share of mortgage advances in domestic private credit 3 (2002–2007): 40.7 39.6 43.3 46.2 47.7 48.9

### Earnings and profitability
- Return on assets (average) (2002–2007): 0.4 0.8 1.3 1.2 1.4 1.4
- Return on equity (average) (2002–2007): 5.4 11.6 16.2 15.2 18.3 18.1
- Interest margin to gross income (2002–2007): 52.3 38.3 41.6 38.2 43.8 58.5
- Noninterest expenses to gross income (2002–2007): 60.4 74.8 68.5 61.5 48.5 48.9

### Liquidity
- Liquid assets to total assets (2002–2007): 4.7 4.7 4.7 4.8 4.6 4.6
- Share of short-term deposits in total deposits (2002–2007): 47.9 45.7 43.7 43.5 42.8 42.5

### Exposure to FX risk
- Maximum effective net open FX position to capital (2002–2007): 3.6 1.3 0.8 1.9 1.4 0.7
- Share of foreign currency loans in total lending (2002–2007): 13.6 11.9 10.9 11.1 11.4 9.3
- Share of foreign currency deposits in total deposits 4 (2002–2007): 4.4 2.7 2.7 2.7 3.3 3.0
- Share of foreign liabilities in total liabilities 5 (2002–2007): 6.3 3.8 4.0 4.2 5.3 6.0

*Source: South African Reserve Bank.*

### Appendix Table 9. South Africa: Single-Factor Market Risk Shocks for Banks

### Appendix Table 9. South Africa: Single-Factor Market Risk Shocks for Banks

### Defined single-factor market-risk shocks
- Interest rates
  - Parallel upward shift of the rand yield curve by 600 bps.
  - Parallel downward shift of the rand yield curve by 400 bps.
  - Steepening of the rand yield curve by 500bps, linearly spread between the overnight and 10-year rate.
  - Flattening of the rand yield curve by 500bps, linearly spread between the overnight and 10-year rate.
- Asset prices
  - Decline in domestic equity prices by 35 percent.
  - Decline in foreign equity prices by 35 percent.
  - Decline in domestic and foreign equity prices by 35 percent.
  - Decline in residential real estate prices by 30 percent.
  - Decline in commercial real estate prices by 50 percent.
  - Decline in residential real estate prices by 30 percent and commercial real estate prices by 50 percent.
- Exchange rates
  - Depreciation of the rand by 50 percent versus all other currencies.
  - Appreciation of the rand by 50 percent versus all other currencies.
- Implied volatility
  - Doubling of implied volatility (interest rates, equities and exchange rates).
  - Halving of implied volatility (interest rates, equities and exchange rates).
- Credit spread
  - Increase of credit spreads by 50 percent on all parties other than governments.

### Key market-risk stress-test results for the banks (summary statistics)
- Unweighted average capital adequacy ratio (CAR) across the four large banks before the shocks: 11.4 percent.
- Interest rate shocks
  - Parallel upward shift by 600 bps: Average impact on capital = 0.85 (percentage point of capital).
  - Parallel downward shift by 400 bps: Average impact on capital = -0.54 (percentage point of capital).
  - Steepening by 500 bps: Average impact on capital = 0.02 (percentage point of capital).
  - Flattening by 500 bps: Average impact on capital = 0.07 (percentage point of capital).
  - Commentary: Interest rate risk dominates other market risks for banks but remains limited because almost all assets (loans) are at floating rates and repricing is rapid.
  - An instantaneous 400 bps decrease across the entire rand yield curve would lead to losses corresponding to a decrease in capital of 0.5 percentage points on average (textual statement); Table value: -0.54.
  - None of the market risk scenarios resulted in any of the banks falling below the regulatory minimum capital requirement of 9.75 percent.
- Asset-price shocks (impact in percentage point of capital, averages)
  - Domestic shares (-35 percent): -0.32.
  - Foreign shares (-35 percent): -0.02.
  - Domestic and foreign shares (-35 percent): -0.34.
  - Residential real estate (-30 percent): -0.34.
  - Commercial real estate (-50 percent): -0.22.
  - Residential (-30) and commercial (-50) combined: -0.30.
  - Commentary: A 35 percent decline in domestic share prices on average costs banks 0.3 percentage point of capital, resulting on average in a CAR of 11.1 percent (textual).
- Foreign exchange shocks
  - Rand depreciation by 50 percent: Average impact = 0.05.
  - Rand appreciation by 50 percent: Average impact = -0.03.
  - Commentary: Depreciation yields a small average gain, appreciation a loss; driven mainly by translation risk from foreign subsidiaries rather than active FX positions.
- Volatility and credit-spread shocks
  - Implied volatilities +100 percent (doubling): Average impact = 0.04.
  - Implied volatilities -50 percent (halving): Average impact = -0.01.
  - Credit spreads +50 percent: Average impact = 0.00.
  - Commentary: Volatility and credit-spread risks are minor for banks.

### Concentration and credit risk findings
- Single-factor credit shocks (banks)
  - Concentration: Default of the largest three exposures (excl. government and interbank).
  - PD-LGD shocks:
    - Default of all counterparties with PDs above 10 percent.
    - Doubling of all PDs with a simultaneous increase of LGDs by 20 percent (with the exception of government bonds).
- Concentration-result statistics
  - Defaulting the three largest exposures resulted on average in a loss equivalent to 2.2 percentage point of capital, resulting in an average CAR of 9.3 percent.
  - In that scenario, three of the large four banks would fall below the 9.75 percent regulatory minimum capital requirement.
  - Commentary: Concentration risk is substantial in the South African system because a limited number of large corporates operate in a medium-sized economy with exchange controls.
- Macroeconomic scenario (three-year recessionary scenario)
  - Design: Simulated on quarterly data starting in Q1 2008 over a three-year horizon; assumes world-wide recession driven by major developed economies and slower growth in important emerging markets.
  - Global and commodity impacts:
    - World GDP declines by up to 1.6 percent in the last quarter of Year 1, after which it gradually recovers.
    - Lower demand for commodities assumed to lead to a halving of commodity prices over two years.
  - Macro-variable deviations from baseline (Appendix Table 12 rows preserved exactly)
    - 2008: -36 -0.7 -3.4 -0.6 1.3 13.9
    - 2009: -50 -1.2 -0.7 -3.3 -2.6 11.0
    - 2010: -33 -0.1 2.5 0.4 -0.9 9.0
    - (Table columns correspond to: Commodity prices deviations from 2007Q4 (in percent); World GDP growth (annual average growth rate) (in percent); SA GDP growth (annual average growth rate) (in percent); SA interest rate (annual average changes) (in percentage point); CPI Inflation (annual average changes) (in percentage point); Nominal exchange rate year-end deviations from 2007Q4 (depreciation in percent).)
  - Methodology: PDs linked to macro variables via econometric (logistic) models by sector; main regressors include household consumption, long-term interest rates, inflation, and unemployment; out-of-sample PDs computed for Years 1–3.
  - Commentary: The decline in GDP under the scenario is more severe than any recession South Africa experienced since World War II.

### Life insurers: market and insurance risk shocks and impacts
- Unweighted average solvency ratio across the four insurers before the shocks: 7.7 percent.
- Insurance risk shocks (Appendix Table 10 definitions)
  - Mortality risk: Increase in mortality rates of insured lives of 30 percent.
  - Morbidity risk: Increase in morbidity rates of 30 percent.
  - Longevity risk: Reduction in annuitant mortality of 30 percent across current and deferred annuitants.
- Key insurance and market-risk impacts (impact in percentage point of solvency ratio; averages)
  - Insurance risks
    - Mortality rates +30 percent: Average impact = -1.01; After shock solvency ratio = 6.72.
    - Morbidity rates +30 percent: Average impact = -0.22; After shock solvency ratio = 7.51.
    - Annuant mortality -30 percent (longevity shock): Average impact = -0.61; After shock solvency ratio = 7.13.
    - Commentary: Mortality and longevity risks are important for life insurers; mortality +30 percent reduces solvency ratios by an average of 1.0 percentage point; an upward shock to longevity impacts solvency by an average of 0.6 percentage point; morbidity exposure is lower.
  - Market risks for long-term insurers (averages and after-shock solvency)
    - Parallel upward shift by 600 bps: Average impact = -0.04; After shock solvency ratio = 7.70.
    - Parallel downward shift by 400 bps: Average impact = -2.10; After shock solvency ratio = 5.63.
      - Commentary: An instantaneous 400 bps parallel downward shift has a large impact on two of four insurers; average impact -2.1 percentage point of solvency ratio from an average pre-shock solvency of 7.7 percent to 5.6 percent on average (textual).
    - Domestic and foreign shares (-35 percent): Average impact = -0.78; After shock solvency ratio = 6.95.
    - Residential and commercial real estate (-50 percent): Average impact = 0.00; After shock solvency ratio = 7.74.
    - Rand depreciation (-50 percent): Average impact = 0.01; After shock solvency ratio = 7.74.
    - Rand appreciation (+50 percent): Average impact = -0.29; After shock solvency ratio = 7.44.
    - Implied volatilities +100 percent: Average impact = -1.61; After shock solvency ratio = 6.12.
    - Credit spreads +50 percent: Average impact = -0.07; After shock solvency ratio = 7.66.
  - Commentary on insurers:
    - Life insurers are more exposed to market risks than banks, especially to downward interest-rate shocks and equity declines.
    - Volatility risk is sizable for insurers due to nonlinear reserve increases for guaranteed products and model limitations; estimated impacts vary widely across companies.
    - Two insurers are particularly affected by the 400 bps downward interest-rate shock: one because of retrospective valuation methods and the other because of a large portfolio of guaranteed products.
    - Offsetting factors (e.g., higher mortality implying profit on annuity portfolios) and conservative use of U.K. mortality tables mitigate some measured longevity risks in practice.

### Liquidity stress scenarios (banks)
- Scenario 1 (secured/unsecured market and collateral shock, lasting three months)
  - Spread between secured and unsecured rand money market rates increases by 600 bps.
  - Pool of collateral accepted in the secured market (excl. government bonds) shrinks by 30 percent.
  - 30 percent of currently eligible assets (excl. government bonds) fall below the reserve bank’s threshold for accepting them as collateral.
  - Banks asked to report effects after 30, 60, and 90 days.
- Scenario 2 (name crisis-like scenario over one month)
  - Withdrawal of 15 percent of deposits over a one month period.
  - Simultaneous tapping of 50 percent of committed credit lines.
  - Liquid assets take a 20 percent haircut.

### Additional summary findings
- Market risks are generally not a major source of risk for the large South African banks; interest-rate risk dominates but remains limited due to widespread floating-rate lending.
- Other market-risk factors for banks (equities, real estate, derivatives, credit spreads) are minor compared to interest-rate risk.
- Credit risk stress tests (single-factor and macroeconomic scenario) show substantial impacts on banks; credit risk stress tests were not run for insurers.
- Differences between bottom-up (BU) and top-down (TD) results are modest; TD analysis is less granular and generally produces larger (more conservative) impacts.

*Source: IMF staff calculations.*

### Appendix Table 15. South Africa: Credit Risk Stress Tests for the Banks

### Appendix Table 15. South Africa: Credit Risk Stress Tests for the Banks

### Credit-risk stress-test outcomes and key statistics
- Single-factor shock (defaulting all counterparties with PD>10 percent):
  - Average loss: 2.6 percentage point of capital (reported as "loss of 2.6 percentage point of capital").
  - Resulting average CAR: 8.8 percent.
  - Regulatory minimum CAR: 9.75 percent; this shock "would leave all four large banks with a capital ratio below the regulatory minimum of 9.75 percent."
  - Characterization: "very severe."
- Macroeconomic scenario (cumulative over three years):
  - Cumulative impact: 1.8 percentage point of capital, on average across the five banks in the BU analysis.
  - Resulting average CAR: 9.9 percent.
  - Cumulative three-year impact would leave the capital ratio at two of the five banks below the regulatory minimum of 9.75 percent.
  - Timing of impact: "The most severe impact occurs in the first year, when PDs rise the most."
  - Note: "The impact on the CAR in the macro scenario is cumulative over three years."
- Pre-shock capital ratios:
  - "The unweighted average CAR across the four banks before the shocks is 11.4 percent. Including Investec (in the BU macroeconomic scenario), this average is 11.7 percent."
- Table reporting conventions:
  - "1/ Unweighted average across the four (concentration and single-factor credit risk) and five (macro scenario) banks."
  - "3/ The macroeconomic scenario comprises five banks in the BU analysis and four banks in the TD analysis (Investec is excluded)."

### Interpretation and caveats
- Single-factor PD>10 percent shock:
  - Causes: "relatively significant proportion of the retail book currently featuring PDs above 10 percent, resulting in a large exposure to this shock."
  - Alternative single-factor shock (100 percent increase in PDs and 20 percent increase in LDGs) has an even larger impact, but "much of this impact is actually caused by an increase in risk-weighted assets" and is considered "outside the scope of plausibility" and therefore not shown.
- Macroeconomic scenario:
  - Conservative in some respects: "no profits or management actions are taken into account over the full three years of the scenario."
  - Conservative in other respects: does not include feedback effects from financial sector stress to the real economy or from stress in a particular bank to the wider financial system.
  - BU and TD results: "The TD results are close to the BU results and, hence, support this analysis." (TD results for the macro scenario are based on four major banks only, excluding Investec.)
- Table and sample composition:
  - BU analysis: five banks included.
  - TD analysis: four banks included (Investec excluded because it uses the standardized approach while the others use internal ratings-based models).

### Liquidity stress tests (summary)
- Scenario 1:
  - A 30 percent haircut on assets accepted for secured lending has limited impact because "banks generally do not make much use of secured funding."
  - No major parties withdrawing funding assumed; impact primarily on income as banks would "have to pay significantly more for their (primarily unsecured) funding."
- Scenario 2 (limited bank-run / name crisis):
  - Moderate impact: banks "generally would be able to fund themselves ... by not rolling over short-term assets (which, as they are held to maturity would not take much of a haircut, if any), and possibly selling some of their liquid assets (with a small haircut)."
  - If scenario were a market-wide event rather than single-name, banks "would face serious funding problems" unless liquidity support from the SARB were forthcoming.
- Top-down (TD) liquidity analysis:
  - "TD analysis on liquidity revealed a similar pattern. Banks would generally remain liquid in case of substantial funding pressure."
  - Limitations: "the TD analysis was unable to replicate the shocks employed in the BU stress tests, and hence, the results are not directly comparable. In addition, the TD analysis did not calculate the impact on the P&L."

### Supervisory follow-up and qualitative findings (from in-depth discussions)
- Stress-testing practices:
  - "Stress tests are an integrated part of banks’ and insurers’ risk management practices at all levels. Risk management practices seem strong."
  - Institutions "regularly present stress testing results to senior management" and may mitigate risks "through hedging or changing positions."
  - "The stress tests covered most risks, and the scenarios were realistic and presented severe stress."
  - Insurers: "most life insurers have also modeled flu pandemic scenarios."
- Model risk and data concerns:
  - "Some model risk might be present. The high growth over the last few years has led to currently low-credit risk indicators for corporates. In the retail portfolio, the credit risk has recently started to increase rapidly. As most models are based on data collected (at least in part) during this period, the estimates of credit risk factors derived from these data might be somewhat optimistic."
- Liquidity funding vulnerability:
  - Banks rely "to a large extent on short-term domestic wholesale funding, which presents a vulnerability."
  - Liquidity risk managers recognize this risk but "no banks indicated that they were pursuing an active mitigation strategy of this risk, by, e.g., more longer-term and offshore issuance."
  - Constraint noted: "The lack of a domestic long-term reference curve plays a role here."
- Insurance sector:
  - "Discussions clearly brought out the mismatch between long-dated liabilities and assets. The development of a long-term bond market would, hence, be very beneficial for the life insurance industry."

### Key policy recommendations (selected, quoted with agency and timeframe)
- Financial Stability
  - "Integrate top-down stress testing of individual banks in financial stability analysis." — SARB — ST
  - "Remain vigilant on credit risk in banking, stemming from retail and concentrated corporate exposures, and on the funding risks, resulting from reliance on short-term domestic wholesale funding." — SARB — ST
  - "Focus on market risks in the life insurance companies, and actively engage the long-term insurance companies in a dialogue about their exposures to these risks." — FSB — ST
  - "Strengthen the off-site stress testing capacity and employ this capacity to inform the regular supervisory discussions." — SARB, FSB — MT
- Systemic Liquidity, Crisis Management
  - "Enhance focus on liquidity and funding issues and discuss medium-term strategies to reduce banks’ dependency on wholesale market funding. Analyze in a collaborative exercise between the SARB, the NT, and the FSB, for instance in the context of a Basel II Pillar 2 exercise and in drawing on the results of the planned study of the effects of an eventual lifting of remaining capital controls." — SARB, FSB, NT — ST
  - "Continue the strategy to gradually increase foreign exchange reserves and consider establishing standing swap lines with other central banks of the most important settlement currencies—e.g., the Federal Reserve, the ECB, and the Bank of England." — SARB — MT
  - "Review all strategies regarding crisis management as part of the work of the FSCF in light of past crisis episodes experienced globally, and consider undertaking a crisis simulation exercise relating to a macro-financial shock, such as a capital outflow or distress in a large financial sector institution." — SARB, FSB, NT — ST
  - "Clarify bank resolution powers by authorizing the registrar of banks, who has extensive powers to safeguard the soundness of the banking system, to directly appoint a curator—limiting the need for the MOF’s intervention only in those cases requiring use of public funds." — SARB, NT — MT
- Financial Sector Supervision and Regulation (selected)
  - "Enhance day-to-day collaboration amongst the staff of the different sectoral regulators, in respect of individual institutions and emerging risk issues." — FSB, SARB, NCR — ST
  - "Increase focus on qualitative standards, including corporate governance, risk management, and internal controls." — FSB — MT
  - "Further develop risk assessment models, taking a more consistent approach across sectors, and the creation of increased central capacity at the main regulators to identify risk and allocate resources flexibly to issues as they arise." — FSB, SARB — MT
- Insurance and Pensions (selected)
  - "Enhance the supervision of groups. The FSB should extend the reporting currently required only of the largest groups to all groups." — FSB — ST
  - "Consider further enhancements to its life insurance regulation. The FSB should (i) review whether the margin of solvency remains adequate; and (ii) better integrate stress testing into its reporting and supervisory regime." — FSB — MT
  - "Consider imposing fit and proper requirements for pension fund trustees, and encourage the development of adequate independent trustee training." — FSB — ST
- Financial Sector Inclusion, Consumer Protection and Housing Finance (selected)
  - "Continue to support efforts to preserve the FSC and enhance its inclusion targets by setting targets that prioritize higher-quality transaction and deposit products, establishing new access targets for using the delivery of social grants and other products to bring unbanked individuals into the formal system, giving attention to bringing down costs and increasing availability, and focusing on improved insurance products with emphasis on simple, flexible long-term products." — NT, DTI — MT
  - "Develop a regulatory framework for CPI-indexed mortgage loans that index both debt and repayments and which could be funded by CPI-indexed bonds." — NT, Housing — MT
  - "Consolidate and track data on overall housing finance debt and related performance including by income level and beyond the sole mortgage loans held by commercial banks." — SARB, FSB, NCR — MT

*Source: Individual banks, SARB, and IMF staff calculations; content reproduced from Appendix Table 15 and accompanying text.*

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