Cape Town – Half of South Africa’s systemic risk is concentrated in only three of South Africa’s banks, research done by the University of Cape Town (UCT) shows.
Systemic risk is when the failure of one financial institution leads to severe instability or even collapse of the entire financial system.
Two UCT students – Qobolwakhe Dube and Trésor Kaya – have designed a risk ranking which is the first of its kind in South Africa and outlines what could happen in a financial crisis. The ranking also identifies which financial institutions put South Africa’s financial system most at risk and explains the reasons for it.
According to the ranking, Standard Bank leads the risk ranking at 25.56%, followed by Barclays Africa Group (trading as Absa in South Africa) at 13%. FirstRand Group is in the third place at 12.94% and Nedbank in fourth place at 12.61%.
The analysis comes as banks face heavy criticism due to overconcentration and lack of transformation as well as recent revelations of collusion and currency-fixing.
The Competition Tribunal is currently investigating collusion practices of 17 banks.
The UCT students point out that the ranking does not give any indication of the likelihood of a financial institution defaulting, but rather shows how such a default would affect other financial institutions.
Responding to Fin24’s questions by email, Kaya said the study makes it clear that systemic risk only indicates the impact a particular institution’s failure will have on the financial system as a whole. “It says nothing about the likelihood of a firm’s failure.”
He explains: “A small boutique asset manager, for example, may be exposed to high risk of failure, but in the event that it does happen, its collapse may just as well be inconsequential to the functioning of the entire financial system.”
Asked why Standard Bank in particular poses the biggest systemic risk, according to the risk ranking, Kaya said the bank is significantly larger than the other financial institutions.
“This alone is enough to place it ahead of most of its peers in terms of systemic importance. Ultimately it’s the interaction of factors, such as the size of the company, its degree of leverage and equity returns under distressed market conditions.”
According to Kaya, there are also certain activities a financial institution engages in which could put it in a position of increased system risk.
“Any form of activity that relates to increasing the size, its complexity and interconnectedness is likely to increase its contribution to systemic risk.”
He says a high degree of complex interaction with peer institutions exposes the financial system to the risk of “financial contagion” that may result in “cascading failures as institutions collapse in a domino-like fashion.”
If a system collapses, it threatens the overall stability of the market.
Plugging the gaps
Standard Bank chief financial officer Arno Daehnke said in reaction to UCT’s risk ranking that additional requirements are already in place for banks identified as systemically important in the jurisdiction in which they operate.
“There are for example additional capital buffers (also called systemic risk tax), there is more intensive supervision by regulatory authorities and recovery and resolution plans are in place for these institutions.”
Daehnke explains that through recovery planning, banks proactively identify plausible management actions which can be adopted during periods of “severe stress” to restore its financial strength and viability.
“Even though the South African banking sector, of which Standard Bank is part, is concentrated, it went through the global financial crisis relatively unscathed due to its sound regulatory framework, limited foreign debt due to exchange controls and sound capital levels.”
In Standard Bank’s view, Daehnke said, even systemically important banks continue to be appropriately capitalised and regulated to mitigate concentration and other risks.
A sound banking system
Nedbank, which was ranked in the fourth place according to the study, responded by saying South African banks are currently significantly stronger than before the global financial crisis.
Esme Arendse, executive head of Nedbank group communications, told Fin24 by email that the UCT report should have taken factors into account such as the fact that South Africa has the second most sound banking system, cited by the World Economic Forum.
“Nedbank and the other top three banks in SA all maintain high capital and liquidity levels,” she said.
Nedbank’s liquidity coverage ratio, for example, is at 109.3%, which exceeds the 2016 required minimum of 70%.
“So in summary, Nedbank feels the report is somewhat simplistic in categorising the big four banks as the biggest risk to the financial system – nothing that smaller, less diversified banks are generally more prone to failure as was evident by the recent African Bank failure.”
Cas Coovadia, director of the Banking Association of South Africa , declined to comment, saying his organisation will peruse the research first before responding.
At the time of publication, FirstRand and Barclays Africa had not yet responded to requests for comment.