SOUTH AFRICAN BANK REGULATOR MOVES CLOSER TO BASEL II

Friday, March 23, 2007
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SOUTH AFRICAN BANK REGULATOR MOVES CLOSER TO BASEL II
Michael Doherty

Implementation Process
In South Africa, the regulator of banks is committed to implementing the International Basel Committee on Banking Supervision’s Revised Framework of International Convergence of Capital Measurement (known as Basel II) in full. An Accord Implementation Forum ("AIF") was established to manage and co-ordinate the process. The AIF has a Steering Committee and its members include the Registrar of Banks (as Chairman), delegates from National Treasury, various departments of the South African Reserve Bank, the banks and the auditing profession.
The Steering Committee in turn has a Regulatory Framework Sub-Committee ("RFSC") which has been given the task of reviewing the current legal framework and identifying necessary amendments to give effect to Basel II. The FRSC has assisted the Office of the Registrar of Banks in the drafting of a Banks Amendment Bill ("Bill"). The Bill was published on 16 February 2007 and is likely to be passed into law in the near future. The Bill contains mainly amendments necessitated by Basel II.
Regulatory Environment
The stated aim of the Bill, in so far as Basel II is concerned, is to create a sufficiently robust regulatory environment to enable the Registrar to regulate banks, controlling companies and banking groups on a solo, cross-border or consolidated basis. Towards this end, the Bill introduces definitions of such terms as "consolidating supervisor", "host supervisor", "division", "eligible institution", "external credit assessment" and "hybrid debt instrument".
A consolidating supervisor may be the South African Registrar of Banks, who is responsible for the regulation and supervision of a bank, controlling company or banking group on a consolidated basis. Alternatively, a consolidating supervisor may be a foreign supervisor who is responsible for the regulation and supervision, on a consolidated basis, of a foreign institution which conducts a business similar to the business of a South African registered bank.
A host supervisor may be the South African Registrar of Banks, who is responsible for the regulation and supervision of a foreign institution which has been authorised and registered to conduct the business of a bank in South Africa. Alternatively, a host supervisor may be a foreign supervisor who is responsible for the regulation and supervision of any branch, subsidiary, joint venture or related entity of a bank or controlling company, incorporated or operating within its jurisdiction.
The Bill gives the Registrar the power and authority to enter into co-operation agreements from time to time with a host supervisor in a foreign jurisdiction, a consolidating supervisor in a foreign jurisdiction or any other person. Such a co-operation arrangement may include-
• acceptance by the Registrar of methods and approval processes used by a foreign institution or a bank at a group level;
• on-site examinations and inspections by the Registrar of a bank or controlling company that is conducting business by means of a branch, a subsidiary company, joint venture or related entity within the jurisdiction of the relevant host supervisor or consolidated supervisor;
• on-site examinations and inspections by a host supervisor or consolidating supervisor in a foreign jurisdiction of a branch, a subsidiary company, joint venture or related entity of a bank or a controlling company;
• sharing by the Registrar with the relevant host supervisor of information relating to the financial condition and performance of branches, subsidiaries, joint ventures or related entities of a bank or controlling company;
• provision to the Registrar by the relevant host supervisor of adverse assessments of qualitative aspects of the foreign operations of a bank or controlling company;
• provision by the Registrar to the relevant host supervisor of information regarding significant problems that are being experienced within a bank, controlling company or banking group; and
• Such other matters as the Registrar may consider relevant from time to time.
The Bill also gives the Registrar the power and authority to implement and maintain a supervisory review process. Such process may include any one or a combination of the following-
• on-site or off-site examination, inspection or review of a bank or controlling company and its branches, subsidiaries, joint ventures or related entities, within or outside South Africa;
• a discussion with an executive officer, chief executive officer or employee in charge of a risk management function of a bank or controlling company, including a discussion with an executive officer responsible for compliance or internal audit of a bank or controlling company;
• a discussion with a member of the board of directors or a member of a board-appointed committee of a bank or a controlling company;
•a review of the work done by an external auditor of a bank or controlling company; and
•a review of the periodic reporting in terms of the provisions of the Banks Act by a bank, controlling company or banking group.
In order to ensure the appropriate use by a bank, a controlling company or a branch, of an external credit assessment issued by an eligible institution, the Registrar is required by the Bill to-
• assign such external credit ratings to such risk weights as may be prescribed; and
• publicly disclose which external credit assessment or rating issued by an eligible external credit assessment institution relates to which prescribed risk weight.
The Bill importantly gives the Registrar the power and authority, to implement, after consultation with the banks, such international regulatory or supervisory standards and practices as the Registrar deems appropriate.
In the interests of transparency, the Registrar is given the power and authority to publicly disclose-
• the criteria relating to the review if the internal capital assessment of banks; and
• the factors relating to the setting by the Registrar of capital adequacy ratios that are in excess of the prescribed minimum capital adequacy ratios.
The Registrar is required by the Bill to publicly disclose-
• the process and criteria for recognising eligible institutions; and
• the international regulatory or supervisory practices and standards that he decides to implement after consultation with banks.
Primary unimpaired reserve funds.
The Bill extends the application of the defined term "primary unimpaired reserve funds" to controlling companies. It also adds to the listed components of primary unimpaired reserve funds-
• such percentage of a reserve arising from compliance with financial reporting standards as may be prescribed; and
• such percentage of minority interests arising from the consolidation of accounts as may be prescribed.
Secondary unimpaired reserve funds.
The Bill also extends the application of the defined term "secondary unimpaired reserve funds" to controlling companies and consolidated financial statements. The term is also extended to include-
•such percentage of a reserve arising from compliance with financial reporting standards as may be prescribed;
• such percentage of minority interests arising from the consolidation of accounts as may be prescribed;
• funds constituting primary unimpaired reserve funds where such funds or any portion thereof, are excluded from qualifying primary reserve funds as a result of a prescribed limit; and
• only if so prescribed, any fund required to be maintained in terms of any other law.
Minimum capital and reserve funds in respect of a controlling company.
At present, the Banks Act requires a controlling company to maintain capital and reserve funds equal to the sum of the required capital amounts of the individually regulated entities, as determined by their respective regulators, plus a capital proxy amount in respect of unregulated entities. This means that at present a banking group is not required at any stage to calculate consolidated or aggregate risk positions or exposures before calculating a capital requirement, even in the case of a local bank and its foreign branches. In order to comply with the requirements of Basel II, individual entities within a banking group have to be adequately capitalised on a stand-alone basis and in addition the banking group has to be adequately capitalised having regard to the overall activities and aggregated risk exposures in the group.
The Bill accordingly sets out for controlling companies, both-
• its minimum primary and secondary capital, primary and secondary unimpaired reserve funds and tertiary capital; and
• the minimum capital and reserve funds of any regulated entity included in the banking group and structured under the controlling company, determined in respect of the relevant regulated entity in accordance with the rules and regulations of the regulator responsible for the supervision of the relevant entity.
Concentrated Risk
The Banks Act already deals comprehensively with "large exposures". The Bill renames this "Concentration Risk", in view of the requirement of Basel II that supervisors should assess the extent of a bank’s risk concentrations, how they are managed and the extent to which the bank considers them in its internal assessment of capital adequacy under Pillar 2. The Bill now provides that when an exposure to an industry, sector or geographical area exceeds a prescribed amount, the relevant bank, controlling company or branch must-
• comply with such conditions or requirements as may be prescribed; and
• report such an investment in or such a loan or advance or other credit exposure to a specific industry, sector or geographical area in such manner and on such form as may be prescribed.
The Bill also gives the Registrar the power and authority, with the consent of the Minister, to exempt such exposures as the Registrar may determine. This power has been given due to the size of certain corporate conglomerates in relation to banks, the uniqueness of certain corporate structures and the extent of corporate concentration in South Africa.
Conclusion
South Africa is committed to the implementation of Basel II and is in the process of introducing appropriate amendments to strengthen the existing legislation under which banks are regulated. The amendments go to the regulation of banks and banking groups on a consolidated basis. The respective roles and responsibilities of consolidating and host supervisors will be stated. Provision will be made for co-operation and sharing of information between supervisors. The responsibilities of banks, banking groups, boards of directors of banks and banking groups are being clarified. Provision is being made for comprehensive disclosure by banks and banking groups and reporting requirements are being increased. The Bill aims to facilitate the various options available to banks and banking groups in calculating minimum capital requirements in respect of credit risk exposure, market risk exposure and operational risk exposure. The amendments introduced by the Bill will also elaborate the supervisory review process in order to assess the capital adequacy and control environment of banks and banking groups.