Who is responsible to pay?

Christine Rodrigues, Partner at Hogan Lovells

The National Treasury document titled “Strengthening South Africa's Resolution Framework for Financial Institutions” highlights that South Africa has an implicit deposit insurance system that has historically been funded by the government. 

It is further noted in the document that there are no arrangements in place to recover compensation to depositors or failed banks from the private sector, and taxpayers ultimately fund the costs of bank failures. 

With the above mentioned, FAnews spoke to Christine Rodrigues, Partner at Hogan Lovells about the effects of bank failures and what this all means for the financial services industry. 

A stable financial system

In the period between 1990 and 2002, Rodrigues says 11 banks in the South African banking industry were placed under curatorship, three were liquidated and the financial issues of the rest were resolved in various ways. However, the end result is that 26 banks exited the banking industry.

To reduce the social and economic cost of failing financial institutions, the South African Reserve Bank’s (SARB) “Designing a deposit insurance scheme for South Africa” discussion paper motivated the need for an explicit, privately funded Deposit Insurance Scheme (DIS) for South Africa.

The main policy objective of a DIS for South Africa, according to the paper, is to protect the less financially sophisticated depositors in the event of a bank failure, thereby contributing to customer protection and enhancement of the stability of the South African financial system.

A DIS, Rodrigues says, will assist in maintaining financial stability in the following ways: 

• Effective resolution regime which ensures orderly allocation of losses with the minimum financial stability impact;
• Is a tool to support financial stability when a systematic event occurs; and
• Provides protection for the most vulnerable customers of financial institutions. 

“The Financial Sector Regulation Act 2017 (FSRA) aims to achieve a stable financial system that works in the interests of financial customers and supports balanced and sustainable economic growth. The FSRA will achieve its objective through various sector laws as well through the twin peaks model,” she says.

The intention of the DIS

“It is proposed that the DIS should be established as a subsidiary of the SARB, making it a separate legal entity with its own legislative framework and governance requirements, but physically located within the SARB. At the time of a claim, such claim would be submitted against the DIS,” says Rodrigues.

Rodrigues mentions that it is intended that the DIS must be made compulsory for all banks registered in South Africa or for all new licences.

“South Africa currently has no insurance for depositors, other than an implicit guarantee that the government, and ultimately the taxpayer, would rescue bank customers. The DIS is intended to therefore align South Africa with international best practice and other G20 countries. Where there have been bank failures in the past, compensation by government has been influenced by the size of the failing bank and the fiscal strength of the government at the time of the failure. Even if government does make pay-outs it is funded by tax payers and pay-outs can be a lengthy process as the government needs to execute the payments,” she says.

Compensation under the DIS 

The DIS, Rodrigues says, will cover what is considered to be "qualifying depositors", in effect this includes everyone that deposits funds at the bank except for:

• Deposits by banks;
• Deposits by the non-bank private financial sector, including money market unit trusts, non-money market unit trusts, insurers, pension funds, fund managers and other private financial corporate sector institutions;
• Deposits by government; including local, provincial and national government, public financial sector entities, the public investment corporation, other public non-financial corporations and monetary authorities; and
• Bearer deposit instruments such as negotiable certificates of deposit and promissory notes. 

“Compensation under the DIS would be limited to R100 000 per depositor per bank, but the bank will be able to consolidate or aggregate a single customer's deposit balances held across the bank. If a bank fails, depositors will initially be paid out within 20 working days after the closure of the bank for accounts where ownership is easily identifiable,” she continues. 

The goal, Rodrigues says, is to ultimately pay depositors within seven working days, in line with international best principles. 

Some form of assurance 

“The DIS will be partially pre-funded with the SARB providing the required liquidity in a pay-out and additional emergency funding in the event of shortfalls. The SARB may also lower the cash reserve requirements of banks to alleviate the initial funding of the DIS. Thereafter, banks will be required to maintain a lower cash reserve requirement and a DIS requirement of 5% of covered deposits,” continues Rodrigues.

“This insurance scheme would provide all depositors, except those that have been specifically excluded, some form of assurance that they will be protected by up to R100 000 in the event that there is a bank collapse. This amount is considered to be sufficient protection for retail and SME depositors however, this may not be sufficient for corporate depositors and private individuals,” she says.

“The DIS will therefore not cover all the qualifying depositors' deposits in any one bank. Therefore, it is important, like any other investment, to consider all the risks involved when making a financial decision. However, for the most part, South Africa does have a robust banking industry,” concludes Rodrigues.

Editor’s Thoughts:
As Rodrigues mentions, DIS is intended to assist in maintaining financial stability and provide protection for the most vulnerable customers of financial institutions. Could DIS align South Africa with international best practice? Please comment below, interact with us on Twitter at @fanews_online or email me your thoughts myra@fanews.co.za.