HILARY JOFFE: Management of risk key to healthy banking sector

South Africans watching the bank crises that have unfolded in the US and Europe will be doing so through the lens of our own history of bank failures over the past couple of decades.

That history is one of the reasons SA banks simply aren’t vulnerable in the way US regional banks such as Silicon Valley Bank (SVB) were before they collapsed, triggering loss of confidence across the sector. Nor are their regulators likely to let them slide as far as Credit Suisse did before it faced a run on deposits that prompted the Swiss authorities to force a taxpayer-backed takeover by rival UBS. 

SA learned the lessons of its 2002/2003 small banks crisis the hard way, which is why it acted earlier than most countries to tighten up banking regulation and supervision and make financial stability a core part of the Reserve Bank’s responsibilities. It’s why its banking sector came through the 2008/2009 global financial crisis unscathed. It’s also why it has seen just three banks put into curatorship in the two decades since the small banks crisis, all for specific reasons that were swiftly resolved.  

The US and Swiss crises do highlight pertinent issues for us though. One of these is about bonds, and  the risk they carry. SVB’s travails and those of Credit Suisse seem unrelated. But the link is the very rapid rise in interest rates in the US and Europe after more than a decade of near zero interest rates, which has led to much tighter funding conditions that expose vulnerabilities in bank balance sheets and business models.  

We always say bond yields or interest rates are the inverse of bond prices but often forget what this means in practice: when interest rates go up, bond prices come down. SVB’s problem was that it took in floods of deposits from rich Valley tech companies but couldn’t lend enough, so parked its funds in US treasury bonds. Of course treasury bonds, and other sovereign bonds such as SA’s government bonds, are considered the safest of all assets and banks are required to hold some to meet their liquidity and capital requirements. But they are not safe from interest rate risk — and in their many years of zero interest rates, advanced markets tended to forget about managing interest rate risk.

In the US it didn’t help that banks such as SVB weren’t required to “mark to market” the value of their bonds, so if they had to sell to give depositors their cash they suddenly found their bonds were worth way less than the books said they were. It didn’t help either that these smaller regional banks were subject to less regulatory scrutiny than large banks thanks to Trump era regulatory changes. And as it turned out, the regional banks posed a lot more risk to the system than the regulators had imagined.  

SA’s regulatory framework is a lot tighter, and banks and corporates are used to managing interest rate risk. However, the extent to which banks and other financial institutions hold large quantities of government bonds is a source of risk in itself, because it means the health of the financial system is closely linked to the health of the public finances. This “financial sector sovereign nexus” is an issue the Reserve Bank and IMF have flagged since the early days of the Covid pandemic, when government borrowing soared at the same time as foreign bond holders sold out, leaving the banks as the main buyers. An IMF study last March estimated government bonds and treasury bills peaked at about 25% of SA banks’ assets, and while it found the risk was still moderate, it was reassured that SA’s banking regulator was keeping a careful eye.  

One small example of how the risks of this nexus can play out elsewhere featured in recent financial results from Absa, whose Ghanaian operation took a hit because of the “haircut” that was imposed on Ghana’s government bonds as part of the country’s IMF bailout package. 

Bonds feature in the Swiss bank crisis in another way, which is the controversy and uncertainty the Swiss authorities have caused by wiping out Credit Suisse’s bondholders while the bank’s equity holders come out with $3bn. The standard regulatory approach is that the equity holders lose everything first when a bank goes down, then the bondholders, subordinated then senior. In both the US and Europe there have been questions about why regulators made the decisions they did; lack of regulatory certainty and clarity is never good for confidence in banks and the legacy of these crises could linger. 

Another set of issues the failure of SVB and other US regional banks highlights is the tension between competition or inclusion and the stability of the sector. In the US there’s a big debate about the tension between fighting inflation and restoring banking sector stability. The Federal Reserve went ahead with another interest rate hike this week, countering speculation it might hold back because of the banking crisis, though the backstop measures it has now put in place to safeguard all the banks could themselves pump cash into the economy and hamper inflation fighting efforts.  

For SA, though, the pertinent tension is the one between stability and inclusion. More than 20 banks disappeared in the 2002/2003 crisis, half the total number of banks in the sector at a time when regulators had been encouraging the entry of new smaller players. The famously sound and stable banking sector we have had since then has been to some extent at the cost of competition and inclusion.  How to foster that without putting the system or depositors at risk is an issue for the Reserve Bank, as it is for the banking sector and economy at large. In the US too, the thriving regional banking sector could be the casualty if the contagion continues, leaving the big banks to dominate.

One crucial backstop that’s needed is deposit insurance. Two decades on, SA finally has the legislation in place to insure deposits up to R100,000, though deposit insurance has implicitly been there from government all along. The key here is to look after the interests of more vulnerable depositors without making the insurance so generous that it encourages undue risk-taking by the banks and their customers. The US is grappling with that question after temporarily lifting the $250,000 cap on its deposit insurance to make it almost universal to buffer against the crisis.

One can’t help wondering why so many of SVB’s corporate customers seemed to have all their deposits and all their banking in a single institution. Would SA’s corporate treasurers have taken that risk? One of the teachings from each and every banking crisis is about how important it is to understand risk, and manage it. That applies as much to customers as it does to their bankers and regulators. 

• Joffe is editor-at-large.