FINANCE, COMPETITIVENESS & INNOVATION INSIGHT | FINANCIAL STABILITY & INTEGRITY Financial Safety Nets and Bank Resolution Frameworks in Southern Africa: Key Issues and Challenges © 2019 The World Bank Group 1818 H Street NW Washington, DC 20433 Telephone: 202-473-1000 Internet: www.worldbank.org All rights reserved. This volume is a product of the staff and external authors of the World Bank Group. The World Bank Group refers to the member institutions of the World Bank Group: The World Bank (International Bank for Reconstruction and Development); International Finance Corporation (IFC); and Multilateral Investment Guarantee Agency (MIGA), which are separate and distinct legal entities each organized under its respective Articles of Agreement. We encourage use for educational and non-commercial purposes. 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Photo Credits: Shutterstock.com FINANCE, FINANCE, COMPETITIVENESS COMPETITIVENESS & INNOVATION & INNOVATION INSIGHT INSIGHT | FINANCIAL INCLUSION, STABILITY | FINANCIAL & INTEGRITY INFRASTRUCTURE & ACCESS TABLE OF CONTENTS ABBREVIATIONS AND ACRONYMS III ACKNOWLEDGMENTS V EXECUTIVE SUMMARY VII 1. INTRODUCTION 1 2. TERMINOLOGY 3 2.1. Financial Safety Nets 3 2.2. Bank Resolution Framework 4 2.3. “Key Attributes of Effective Resolution Regimes for Financial Institutions” 8 2.4. Deposit Insurance 10 3. FINANCIAL SAFETY NETS AND BANK RESOLUTION IN SOUTHERN AFRICA 11 3.1. Overview of Banking Sectors in Southern Africa 11 3.2. Summary of Recent Reform Efforts 13 3.3. International Cooperation on Cross-Border Issues 16 4. KEY ISSUES AND CHALLENGES 19 4.1. Preventive and Corrective Action Frameworks 19 4.2. Recovery Planning 22 4.3. Bank Resolution 23 4.4. Domestic and International Cooperation and Coordination 27 4.5. Deposit Insurance Arrangements 28 4.6. Emergency Liquidity Assistance 30 5. POLICY RECOMMENDATIONS 33 ANNEX I: POTENTIAL AREAS FOR TECHNICAL ASSISTANCE, BY COUNTRY 35 ANNEX II: IADI “CORE PRINCIPLES FOR EFFECTIVE DEPOSIT INSURANCE SYSTEMS” 43 ANNEX III: EARLY WARNING INDICATORS 45 ANNEX IV: STRESS TESTING 47 ANNEX V: SUMMARY OF BANK RESOLUTION (BR) AND DEPOSIT INSURANCE (DI) IN SOUTHERN AFRICA 51 REFERENCES AND OTHER READINGS 53 FINANCIAL SAFETY NETS AND BANK RESOLUTION FRAMEWORKS IN SOUTHERN AFRICA: KEY ISSUES AND CHALLENGES I LIST OF BOXES Box 1: Principal Resolution Options 6 Box 2: Summary of Key Attributes 8 Box 3: Supervisory Capacity in Namibia and South Africa 14 Box 4: Preconditions for Effective Deposit Insurance 29 LIST OF FIGURES Figure 1: Financial Safety Nets and Regulatory and Resolution Frameworks 3 Figure 2: Bank Assets to GDP and Market Share of Top 5 Banks 11 Figure 3: Nominal GDP and Population, Selected Countries 12 Figure 4: Systemic Banking Crises in Sub-Saharan Africa, 1975–2011 13 LIST OF TABLES Table 1: Summary of Recommendations XI Table 2: Indicative Triggers and Responses for a Supervisory Preventive and Corrective Action Framework 20 Table 3: Examples of Early Warning Indicators (EWIs) for Capital, Asset Quality, and Liquidity 45 TABLE OF CONTENTS II FINANCE, COMPETITIVENESS & INNOVATION INSIGHT | FINANCIAL STABILITY & INTEGRITY ABBREVIATIONS AND ACRONYMS AMC asset management company BCBS Basel Committee on Banking Supervision BOM Bank of Mozambique BOB Bank of Botswana BON Bank of Namibia BOZ Bank of Zambia CBL Central Bank of Lesotho CBS Central Bank of Swaziland CMA Common Monetary Area for South African Rand CMG crisis management group DGS deposit guarantee scheme DIF deposit insurance fund D-SIB domestic systemically important bank ELA emergency liquidity assistance EWI early warning indicators FSAP Financial Sector Assessment Program FSB Financial Stability Board FSC financial stability committee FSSA Financial System Stability Assessment G-SIB global systemically important bank IADI International Association of Deposit Insurers IMF International Monetary Fund KA Key Attributes of Effective Resolution Regimes for Financial Institutions MOU Memorandum of Understanding MPE multiple points of entry NPL nonperforming loans P&A purchase and assumption PCA prompt corrective action RBZ Reserve Bank of Zimbabwe SANT South African National Treasury SARB South African Reserve Bank FINANCIAL SAFETY NETS AND BANK RESOLUTION FRAMEWORKS IN SOUTHERN AFRICA: KEY ISSUES AND CHALLENGES III SCV single customer view SG supervisory group SPE single point of entry SRR special resolution regime TA technical assistance WB World Bank ABBREVIATIONS AND ACRONYMS IV FINANCE, FINANCE, COMPETITIVENESS COMPETITIVENESS & INNOVATION & INNOVATION INSIGHT INSIGHT | FINANCIAL INCLUSION, STABILITY | FINANCIAL & INTEGRITY INFRASTRUCTURE & ACCESS ACKNOWLEDGMENTS T his report provides an assessment of the current state of development of financial safety nets and bank resolution frameworks in eight countries in southern Africa (Botswana, Eswatini [formerly Swaziland], Lesotho, Mozambique, Namibia, South Africa, Zambia, and Zimbabwe). It has been prepared to inform ongoing and planned technical assistance projects in the southern Africa region and to provide a basis for engagement with the authorities in each of the countries covered by the study. This summary draws from more detailed material contained in a comprehensive study.1 The report was prepared by Geof Mortlock An earlier version benefited from insights and (consultant) and Julian Casal and Gunhild Berg (both recommendations made by Jan Nolte (formerly World Bank staff) with guidance from Douglas Pearce World Bank). It has benefited from comments (practice manager), Paul Noumba Um (country from Barend Jansen, Pamela Lintner, Uzma Khalil director, AFCS1), Mark R. Lundell (country director, (all World Bank), and Constant Verkoren AFCS2), Sebastien Dessus (program leader), and (International Monetary Fund). Lastly, we also thank Carolin Geginat (program leader). Aichin Lim Jones for design and production services. 1 Cross-country study for financial safety nets and bank resolution frameworks for Southern Africa, May 2018. FINANCIAL SAFETY NETS AND BANK RESOLUTION FRAMEWORKS IN SOUTHERN AFRICA: KEY ISSUES AND CHALLENGES V ACRONYMS AND ABBREVIATIONS VI FINANCE, COMPETITIVENESS & INNOVATION INSIGHT | FINANCIAL STABILITY & INTEGRITY EXECUTIVE SUMMARY M acrofinancial developments in some southern African countries2 have exacerbated economic and financial sector risks and can undermine economic growth and development. Macroeconomic risks include currency volatility, commodity prices fluctuation, relatively high fiscal deficits, elevated interest rates (associated in some cases with high inflation rates), and the potential for capital flow reversals, among others. Sovereign debt is emerging as a key vulnerability in the subregion, particularly as the composition of that debt has shifted from concessional financing to market-based financing, often denominated in foreign currency. Higher debt burdens and the increasing exposure to interest rate and foreign currency risks raise concerns about debt sustainability. As a result, more countries in the region have been classified as being at high risk of debt distress. Sudden reversals in capital flows could add pressure to the currencies of many countries in the subregion and widen current account deficits. Recent developments have increased investor risk aversion and the potential for greater volatility in cross-border capital flows. Financial stability risks have increased in many support currencies (unless a currency depreciation countries in southern Africa. These risks include is desired as part of the macroeconomic adjustment a rise in nonperforming loans (NPLs), a larger share process). This dynamic increases the cost of of bank lending in foreign currency (which is not financing, can put pressure on already over- always hedged against currency risk), and increased indebted individuals and firms, and can potentially sovereign exposures (direct and indirect, including exacerbate banks’ credit risks. to state-owned enterprises, some of which are in Financial crises can have severe and lasting effects arrears). Increases in NPLs reduce liquidity, tie bank on economic activity and on the welfare of firms capital, and undermine credit growth as lenders and individuals. Bank failures can result in large tighten conditions. Higher levels of NPLs also reduce fiscal costs, have contagion effects on other banks, and bank profitability, even once credit losses have been can undermine the stability and health of the financial recognized, because of the potentially long overhang system in general. Financial crises are typically of loans that do not provide a yield, placing further associated with a severe erosion of real economic pressure on banks’ capital. Ultimately, high NPLs activity and—as the government intervenes to stave lead to bank stress that can undermine the stability of off a collapse of the financial system—a significant a country’s financial system. increase in public indebtedness occurs, which Shocks have the potential to exacerbate financial undermines growth and the government’s ability to stability risk by increasing the number of firms adequately attend to social and equity objectives. and individuals that struggle to pay back For countries that have experienced bank failures their loans amid slower economic growth. on a systemic scale, the disruption to economic During times of crisis, banks tend to face tighter activity, the loss of savings, and the interruption to application of prudential rules on loan classification credit creation have had long-lasting adverse effects and provisioning, which can exacerbate a credit on economic growth, employment, and poverty. crunch and affect mainly riskier borrowers such as Those adverse effects have been evidenced in many small and medium enterprises. For countries with regions, including in East Asia and Pacific, Europe a floating exchange rate, capital outflows increase and Central Asia, Latin America and the Caribbean, pressure on policy makers to raise interest rates to South Asia, and Sub-Saharan Africa. 2 For the purposes of this report, this statement refers to Botswana, Eswatini (formerly Swaziland), Lesotho, Mozambique, Namibia, South Africa, Zambia, and Zimbabwe. FINANCIAL SAFETY NETS AND BANK RESOLUTION FRAMEWORKS IN SOUTHERN AFRICA: KEY ISSUES AND CHALLENGES VII Strong systems for the early detection of bank reform efforts have yet to show concrete results. risks, corrective action, and resolution, along Significant reforms are under way in Mozambique, with financial safety nets, can help countries Namibia, and South Africa and smaller changes identify and manage financial risks and resolve in existing frameworks are being considered or bank distress quickly and with minimal have recently been implemented in Lesotho and disruption to the economy and wider financial Zimbabwe. Recent experience with bank failures system. Countries with poorly developed systems in the region has also highlighted the need to for detecting and responding to bank stress in a update existing frameworks, and several countries timely manner and with inadequately designed and in the subregion are considering reforms. Reforms implemented resolution frameworks and financial are also being—or have been—implemented in safety nets, have generally experienced deeper and banking supervision, which provides a critical longer-lasting economic effects than countries with underpinning of financial stability and the robust frameworks in these areas. frameworks needed for the early detection of bank stress and early intervention arrangements. Given the increase in risks in the southern Africa subregion and the need for a comprehensive The lack of adequate financial safety nets and stocktaking there, the World Bank undertook crisis preparedness in the region is worrisome a detailed analysis of corrective action and given the increase in macrofinancial risks in resolution frameworks and financial safety nets. southern Africa. In most respects, the supervisory The analysis was based on relevant laws, regulations, authorities have broadly satisfactory legal powers for and policies on early intervention, banking undertaking corrective actions. However, there are resolution, deposit insurance, and emergency some gaps and deficiencies in powers, such as poorly liquidity assistance (ELA) in southern Africa. The defined triggers for corrective action, the inability to report places existing work and reform efforts in replace directors and senior management, and the the context of broader regional and international inability to extend corrective action requirements to efforts. This report includes an assessment of bank a regulated group. The most significant gap is the resolution and financial safety net arrangements general lack in most of the countries of (a) policies in the subregion by reference to international best for adequate supervisory corrective action and (b) practice and standards, particularly those issued by contingency plans for dealing with bank stress. the Financial Stability Board (FSB) on bank recovery The bank recovery planning arrangements across and resolution, and by the International Association the subregion are underdeveloped. The activation of Deposit Insurers (IADI) on deposit insurance of a bank’s recovery plan needs to be integrated into arrangements. Whereas it is important to recognize supervisory corrective action frameworks, which is that these international standards need to be applied not currently the case in most countries in the region proportionally, depending on the development because of the lack of implementation of recovery of a country’s financial system and institutional planning requirements. It is therefore suggested that arrangements, many of the principles they cover are the supervisory authorities develop contingency applicable to less developed countries. In addition to plans for dealing with a range of bank stress and this report, an important part of the study is a series noncompliance scenarios, and that the authorities of tables that identify the main weaknesses and undertake regular internal testing of those plans areas needing additional work for each country in to build preparedness capacity. The supervisory the subregion, thus covering a wide range of aspects authorities that have not yet established recovery of bank recovery, corrective action, resolution, and planning requirements for banks should do so within financial safety nets. the limits of their legal powers, focusing initially on Whereas the modernization of financial safety domestic systemically important banks (D-SIBs) nets and bank resolution frameworks is a and then progressively extending recovery planning priority for many countries in the region, recent requirements to smaller banks. EXECUTIVE SUMMARY VIII Where reform efforts are under way, the The lack of deposit insurance in most southern framework for resolution of weak banks is largely African countries presents a significant gap in the inadequate, apart from Namibia and South financial safety net. Two countries, Mozambique Africa. In most countries, the law does not specify a and Zimbabwe, have a de jure deposit insurance resolution authority with explicit responsibility and scheme, but a de facto scheme is nonexistent, given accountability for bank resolution, and there is an that Zimbabwe is currently experiencing a liquidity inadequate specification of resolution objectives. crisis and Mozambique’s deposit guarantee fund Laws relating to bank resolution in southern Africa lacks operational capacity and funding to provide lack clearly defined statutory triggers for entry substantive protection to depositors. Moreover, into resolution (for example, based on the concept these deposit insurance arrangements also currently of nonviability). The triggers for resolution must lack the technical capacity to be effective in a occur well before insolvency to avoid excessive banking crisis, given the inability to make prompt disruption to the financial system, to maximize the payouts or facilitate purchase and assumption potential returns for creditors, and to limit the costs (P&A) transactions. associated with resolution. In most cases, the laws The absence of deposit insurance increases the risk apply resolution powers to licensed banks and do not of retail deposit runs in periods of banking system explicitly enable resolution powers to be exercised stress. Without deposit insurance, the probability of in relation to holding companies or subsidiaries, fiscal authorities coming under political pressure to which limit effective group resolution. Resolution bail out failing banks or introduce ad hoc protection powers are also broadly inadequate and need to be of deposits in cases of bank stress increases. The brought more in line with the Key Attributes (KA).3 relatively high level of interconnectedness between The inadequacies are even more acute for cross- banking systems in southern African countries border resolution frameworks, which do not results in a significant risk of contagion should exist beyond some incipient initiatives in South the parent banks fail or become acutely distressed. Africa. This is a significant issue—given that banks Depositor preference (that is, a law under which in South Africa have a systemic presence in various depositors meeting eligibility criteria rank ahead of countries in the region, as do some foreign banks other senior unsecured creditors in the liquidation of domiciled outside the region—that increases the risk a bank) is another related issue that warrants careful of contagion. There is no established platform for consideration. The absence of depositor preference, the exchange of information and monitoring of risks which is the case in most countries covered in this of cross-border groups, and many large banking study, creates a heightened risk of depositor runs in groups continue to be inadequately supervised. periods of instability and can make it more difficult Supervisory authorities have established memoranda to apply certain forms of resolution, such as bail- of understanding (MOUs) with their counterparts in in. Resolution funding arrangements (beyond other countries to facilitate information exchange deposit insurance), for use in a systemic crisis, are and cooperation; but such MOUs mainly relate to nonexistent in the countries studied. supervision issues and do not specifically provide for Existing laws across the region generally provide the coordination of cross-border bank recovery or adequate powers for central banks to provide resolution. This report suggests that the authorities ELA to banks. However, in most of the countries in the region, led by the South African Reserve Bank the laws lack clear objectives for ELA. They also (SARB), undertake further initiatives to promote lack clarity on the preconditions for providing ELA (a) dialogue on cross-border cooperation and (b) and on the obligation of central banks to develop coordination on resolution and crisis preparedness. clearly specified policies and procedures for ELA. 3 Financial Stability Board, “Key Attributes of Effective Resolution Regimes for Financial Institutions,” (Basel, Switzerland, 2014). FINANCIAL SAFETY NETS AND BANK RESOLUTION FRAMEWORKS IN SOUTHERN AFRICA: KEY ISSUES AND CHALLENGES IX This lack of clear objectives limits transparency example of the importance of sequencing is found in and accountability. ELA policies and preparedness deposit insurance. It is essential that before deposit would appear to be underdeveloped in most countries insurance is established a country first establishes in the subregion, including in respect of indicative the prerequisites for deposit insurance. Those terms and conditions and collateral arrangements. prerequisites include a robust banking regulatory and supervisory framework, sound insolvency law, Countries in southern Africa need to undertake and high-quality governance and risk management significant reforms to strengthen financial safety practices in banks, together with robust financial nets and crisis preparedness. Reforms should reporting and auditing standards. Another example of focus on establishing robust frameworks for the sequencing is found in ELA. Before ELA policies are early detection of bank stress, recovery planning, formalized and announced, it is important to establish corrective action, ELA, resolution planning, comprehensive liquidity prudential requirements resolution measures, deposit insurance, and for banks, including minimum liquidity buffers, resolution funding. Strengthening is also needed for stress testing, and risk management requirements. domestic and cross-border coordination frameworks Likewise, the introduction of resolution laws needs across these areas. Capacity building is another to precede the development of detailed resolution pressing area, particularly in the form of regular policies and practices, which in turn need to precede domestic crisis simulation exercises and occasional the development of bank-specific resolvability cross-border exercises. To various degrees, technical assessments and resolution plans. assistance is likely to be needed to support countries in these efforts. The main recommendations resulting from the study are set out in table 1. These are general The sequencing of reforms is important. The recommendations for the entire southern African nature of sequencing will vary depending on the region, and the recommendations vary in relevance country in question and the stage of development depending on the country in question. More specific with a country’s economic policies, risk management recommendations by individual country are included arrangements for banks, banking supervision, in annex I. insolvency laws, and many other considerations. An EXECUTIVE SUMMARY X Table 1: Summary of Recommendations No. Recommendations Responsible Authority Time Frame Priority 1. Strengthen the capacity of supervisory authorities to detect emerging stress in banks and banking Supervisory authorities ST High systems, including through greater use of Early Warning Indicators (EWIs) and stress testing. 2. Strengthen the frameworks in supervisory authorities for early intervention and corrective action Supervisory authorities MT High and develop contingency plans for dealing with likely scenarios of bank distress. 3. For systemic banks with systemically significant operations in host countries, home authorities Supervisory authorities MT Medium should develop contingency plans for dealing with the global operations of the bank and should share this with the host authorities, with the host authorities developing contingency plans for their own jurisdiction and with the home authority. 4. Develop recovery planning requirements for banks, starting with the systemic banks and extending Supervisory authorities ST High progressively to medium-size banks and smaller banks, and develop the framework for supervisory review and regular testing of recovery plans. 5. Integrate the activation of recovery plans into supervisory corrective action frameworks. Supervisory authorities MT Medium 6. Strengthen bank resolution laws in broad alignment with the FSB Key Attributes, but with Resolution authorities, MT High modifications to suit the institutional arrangements and banking system characteristics of each finance ministries county. The amendments to the law should include the following: • Clearly stated resolution objectives • Clearly specified entry into resolution (well before bank insolvency occurs) • A resolution authority with robust governance, accountability and transparency arrangements • A comprehensive set of resolution powers to implement a range of resolution options • Clearly specified triggers for resolution powers • Resolution powers that extend to banks, holding companies and subsidiaries • Powers to obtain data from banks for resolution planning purposes • •owers to require banks to make changes to their structure and for operations (including at group level) to facilitate specified forms of resolution in accordance with resolution plans • Powers to exchange information between authorities at domestic and cross-border levels • Strong legal protections for the relevant authorities, their senior management, staff, and agents 7. Develop robust safeguards in the resolution laws, including in relation to the “no creditor worse off” Resolution authorities, MT High principle (with associated compensation and funding arrangements). finance ministries FINANCIAL SAFETY NETS AND BANK RESOLUTION FRAMEWORKS IN SOUTHERN AFRICA: KEY ISSUES AND CHALLENGES XI XII 8. Through amendments to the law, remove the ability of the courts to suspend, modify or terminate Resolution authorities, MT High resolution decisions and transactions, and instead rely on a safeguard of compensation for creditors finance ministries, justice (and shareholders) found to be worse off under the resolution than in a conventional winding up ministries under standard insolvency law. 9. Develop methodologies and bank data templates for assessing bank solvency, determining bank Supervisory authorities, in ST High nonviability and entry into resolution. consultation with resolution EXECUTIVE SUMMARY authorities 10. Develop or strengthen (as the case may be) resolution strategies, crisis management protocols, Resolution authorities MT High and guidance on resolution implementation. 11. Develop the methodologies for undertaking resolvability assessments and preparing resolution Resolution authorities, MT Medium plans for systemic and medium-size banks. in consultation with supervisory authorities 12. Undertake resolvability assessments and develop resolution plans, starting with the systemic Resolution authorities, MT Medium banks and progressively extending to medium-size banks with the potential to be systemic. in consultation with supervisory authorities 13. Strengthen domestic coordination frameworks on financial stability assessment and crisis All financial regulatory MT High resolution, including (as appropriate) through a financial stability committee or council of financial agencies and finance regulators. ministries 14. Further develop cross-border coordination frameworks for bank recovery and resolution, particularly All financial regulatory MT Medium for South African banks in the region, including through crisis management MOUs between home and agencies and finance host authorities and crisis management groups in individual systemic cross-border banks. ministries, led by the home authorities 15. Develop or refine (as the case may be) deposit insurance schemes with broad alignment to the IADI Deposit insurance agencies MT High Core Principles once the essential prerequisites for deposit insurance have been established. 16. Consider the benefits and costs of establishing depositor preference as a framework to support Deposit insurance MT Medium deposit insurance. agencies, finance ministries and central banks 17. Strengthen the policies, procedures, and practices in central banks with respect to Emergency Central banks, in ST High Liquidity Assistance (Lender of Last Resort). consultation with supervisory authorities and finance ministries 18. Strengthen the home/host coordination frameworks between central banks on ELA for cross-border Central banks, in LT Medium banks consultation with supervisory authorities and finance ministries 19. For countries in the Common Monetary Area (CMA) for the South African rand, consideration Central banks in the CMA, MT Medium should be given to the funding mechanisms and currency swap arrangements needed to facilitate led by the SARB ELA in a manner that does not undermine the parity of exchange rates. 20. Develop resolution funding arrangements for systemic bank resolution situations where funding Finance ministries, MT Medium beyond that available via deposit insurance might be needed, with the primary focus being on resolution authorities post-funded arrangements. 21. Establish and maintain a program of capacity building at a domestic level through a combination All financial regulatory MT High of regular staff training, senior management workshops and simulation exercises to test solvency agencies and finance assessment, collateral valuation, recovery and resolution arrangements, ELA, interagency ministries coordination and communications. 22. Undertake occasional cross-border exercises to test bank solvency assessment, collateral All financial regulatory LT • Medium assessment, and recovery and resolution frameworks between home and host countries in the region. agencies and finance ministries, led by the home jurisdiction authorities FINANCIAL SAFETY NETS AND BANK RESOLUTION FRAMEWORKS IN SOUTHERN AFRICA: KEY ISSUES AND CHALLENGES XIII FINANCE, COMPETITIVENESS & INNOVATION INSIGHT | FINANCIAL STABILITY & INTEGRITY 1. INTRODUCTION T his report discusses the financial safety net and bank resolution frameworks for eight countries in southern Africa: Botswana, Eswatini (formerly Swaziland), Lesotho, Mozambique, Namibia, South Africa, Zambia, and Zimbabwe.4 It provides a cross-country comparison of the state of development of financial safety nets and bank resolution frameworks in the region and identifies areas where technical assistance may be better targeted to address gaps and deficiencies in the countries’ bank crisis management arrangements. As most financial sector assets are held by deposit-taking banks, the analysis focuses mainly on them. However, many of the points made in the report are also applicable to other banks and some nonbank financial institutions. The report is based on a study undertaken by the World Bank (WB), which provides a detailed cross-country assessment of financial safety net and bank resolution arrangements. Effective bank resolution frameworks and financial Europe and Central Asia, Latin America and the safety nets are important to preserve financial Caribbean, South Asia, and Sub-Saharan Africa. stability, which is a prerequisite for economic The extent of damage that bank failures impose growth and sustainable poverty reduction. Financial on the economy and the resultant implications for crises can have severe and lasting effects on poverty depend on a country’s ability to identify economic activity and on the welfare of firms and and resolve bank distress quickly and with minimal individuals, especially depositors. Bank failures disruption to the economy and wider financial can result in large fiscal costs, can have contagion system. Countries with poorly developed systems effects on other financial institutions (banks and for detecting and responding to bank stress in a nonbank financial institutions), and can undermine timely manner, and with inadequately designed and the stability of the financial system. Financial crises implemented resolution frameworks and financial tend to result in lower financial intermediation at safety nets, have generally experienced deeper and higher costs, often for some years following a longer lasting economic effects than countries with crisis. They also generally take longer to recover robust frameworks in these areas. from than do other types of economic shocks. Financial crises and the long process of recovery This report assesses the financial safety nets and following a crisis reduce the ability of the financial bank resolution framework arrangements in the sector to perform its primary role, which is to eight countries on a range of topics. These include: transform savings into productive investments and provide an efficient framework for payments and • Early detection of emerging stress in banks and settlements. For countries that have experienced corrective action frameworks bank failures on a systemic scale, the disruption • Contingency planning by supervision authorities to economic activity, the loss of savings, and the for dealing with weak banks interruption to credit creation have had long-lasting • Recovery planning requirements for banks adverse effects on economic growth, employment, and poverty. Those effects have been evidenced in • Resolvability assessments many regions, including in East Asia and Pacific, • Resolution planning 4 Resolution is the restructuring of a bank using tools that safeguard public interests, including the continuity of the bank’s critical functions, financial stability, and minimal costs to taxpayers. FINANCIAL SAFETY NETS AND BANK RESOLUTION FRAMEWORKS IN SOUTHERN AFRICA: KEY ISSUES AND CHALLENGES 1 • Legal framework for bank resolution, including the Financial Stability Board (FSB) Key Attributes, objectives, resolution authority, triggers for and deposit insurance. Section 3 focuses on the resolution, legal powers for resolution, and state of financial safety nets and bank resolution safeguards frameworks in southern Africa. It provides an • Resolution strategies and crisis management overview of the subregion’s banking sectors, a preparedness summary of recent reform efforts, and an update on international cooperation efforts for cross-border • Domestic coordination for financial crisis issues. Section 4 summarizes the key resolution management and funding issues and challenges identified in • Cross-border cooperation and coordination for the comprehensive country-by-country study. This financial crisis management section includes the frameworks for corrective • Deposit insurance schemes actions, recovery planning, and resolution. It also looks at the arrangements for domestic • Systemic bank resolution funding and international cooperation and coordination, • Emergency liquidity assistance deposit insurance, and liquidity support. Section 5 concludes with policy recommendations and The structure of the report is as follows. Section suggestions of areas for additional work, including 2 defines key concepts and terms, including technical assistance. financial safety nets, bank resolution framework, 1. INTRODUCTION 2 FINANCE, COMPETITIVENESS & INNOVATION INSIGHT | FINANCIAL STABILITY & INTEGRITY 2. TERMINOLOGY 2.1. Financial Safety Nets F inancial safety nets are the set of arrangements to reduce the effects of the failure of one or multiple financial institutions on depositors, the financial system, and the economy. Financial institutions, particularly banks, have a unique function in the economy as they take deposits from the public and play a critical role in payments and transactions between economic agents.5 Because of this, banks are subject to prudential requirements and close supervision. Financial safety nets fall into two categories: (a) those that apply to adequately capitalized and viable but illiquid banks and (b) those that apply to inadequately capitalized and nonviable banks, which need to be resolved. They serve different purposes—the first for liquidity support and the second as a means of providing support to protected depositors in an insolvency situation—but both aim to minimize adverse effects arising from bank distress or failure. Figure 1 represents the main elements of a financial safety net, which need to work in concert with each other and can involve harmonization of various regulatory frameworks. Figure 1: Financial Safety Nets the process of being restored to capital adequacy) and Regulatory and Resolution and when the bank has suitable collateral available to cover the central bank’s credit risk and market Frameworks risk associated with ELA funding. The ELA funds are generally extended for a short period (often less than one month) with a capacity for rollover and Bank Emergency Deposit are subject to conditionality, including measures Resolution Liquiidity Insurance the bank in question must take to restore itself Framework Assistance to a sound financial position. ELA is typically Regulatory provided at interest rates above prevailing market and Insolvency rates in recognition of the higher risk involved and Supervisory Framework to discourage banks from accessing ELA facilities Framework other than as a last resort. For a financial institution assessed as nonviable (that is, substantially undercapitalized and unable For banks that are assessed by the authorities as to conduct its business in a prudent manner) and viable and with sufficient collateral but in liquidity unable to restore itself to viability, financial safety stress, financial safety nets refer to emergency nets are designed to minimize effects on depositors liquidity assistance (ELA) provided by central and the wider financial system on the closure of the banks (also known as “lender of last resort” bank or other form of resolution. The main financial facilities). ELA is generally provided when a bank safety net for a failed bank is deposit insurance. is assessed as being adequately capitalized (or in Deposit insurance schemes provide a mechanism to 5 Banks are the primary financial institution in southern Africa, thus this report refers mainly to them. FINANCIAL SAFETY NETS AND BANK RESOLUTION FRAMEWORKS IN SOUTHERN AFRICA: KEY ISSUES AND CHALLENGES 3 insulate small depositors from loss and to give them Another form of financial safety net in bank prompt access to their deposits, up to a defined failure is the availability of systemic resolution level, on the failure of a bank. Deposit insurance funding.7 Such funding may be needed for a schemes are generally funded through regular levies range of purposes when resolving a systemic on banks covered by the scheme and supplemented bank, potentially including the need (a) to with a funding line from the government (known finance the transfer of deposit liabilities (beyond broadly as a pre-funded deposit insurance scheme). insured deposits) to another bank, (b) to fund the However, in some cases, deposit insurance schemes transfer of impaired assets to asset management are funded initially through government funding, companies (AMCs), (c) to fund the capitalization with ex post levies being imposed on banks if the of a bridge bank, and (d) to finance guarantees and government cannot recover its funding outlays indemnities. Its purpose is to reduce the adverse from the assets of the failed bank (known as post- impact of bank resolution on creditors, the financial funded deposit insurance schemes). system, and economy. Systemic resolution funding can be sourced from regular levies on banks or, Deposit insurance schemes fall into different more commonly, through government funding categories depending on their range of functions. that is repaid by the assets of the resolved bank, The simplest deposit insurance schemes are with any residual being repaid by ex post levies on referred to as “paybox” schemes. These are used to banks. Under an appropriately structured systemic reimburse insured depositors upon the closure of a resolution scheme, any resolution funding needs bank by payout to insured depositors and the funds to be provided subject to robust safeguards, such cannot be used for wider resolution purposes.6 An as (a) clearly specified statutory objectives, (b) alternative scheme known as “paybox plus” enables specified purposes for which the funding may be a deposit insurer to make a financial contribution used, (c) preconditions that must be met to access to a wider range of bank resolutions, including resolution funding (including that shareholders and purchase and assumption (P&A). The financial other capital providers, at a minimum, must absorb contribution to a resolution made by a deposit losses to the full extent of their legal liability before insurance scheme is normally subject to a least- any resolution funding is provided), (d) powers to cost test that limits the amount of funds provided apply terms and conditions to such funding, and (e) to the minimum amount that would have been paid a process for recovering the full net present value through payout. A deposit insurance scheme with of funding outlays (for example, through levies on an explicit mandate to seek the lowest-cost form systemic banks) over time. of resolution to meet the objective of providing insured depositors with access to their funds is known as a “loss minimizer” scheme. A smaller 2.2. Bank Resolution Framework number of deposit insurance schemes are referred A bank resolution framework refers to the set of tools to as “risk minimizer” schemes. These are schemes and arrangements available to resolve a nonviable in which a deposit insurer has comprehensive risk bank. There are several tools by which a nonviable minimization functions, including risk assessment bank can be resolved. For nonsystemic small- and and management, a full suite of early intervention medium-size banks where a commercial (privately and resolution powers, and, in some cases, funded) sale to another bank is not feasible, the prudential oversight responsibilities. standard options are to either implement a P&A Barend Jansen, “Challenges for Resolution of Banks in Africa” (World Bank Group, Washington, DC, forthcoming). 6 A systemic bank is a bank or banking group whose size, complexity, and other features have the potential to cause significant 7 disruption to the financial system and economy in during failure or distress. Under Financial Stability Board and Basel Commit- tee on Banking Supervision guidelines, a bank assessed as being systemically important at a global level (that is, across multiple countries and international financial markets) is categorized as a global systemically important bank (G-SIB). A bank that is not systemically important globally but is systemic at a domestic level is categorized as a domestic systemically important bank (D-SIB). 2. TERMINOLOGY 4 transaction (involving the transfer of insured deposits • There is a government agency with statutory and viable assets to another bank) or to implement a responsibility for resolving a bank. This agency, payout of insured deposits. In either case, the failed known as a resolution authority (RA), has the bank’s license is revoked, and nonviable assets are legal powers to intervene in a nonviable bank. auctioned or otherwise liquidated. P&A and deposit • There are statutory safeguards to protect against payout options are only viable if an established abuse of resolution powers, including the so- deposit insurance scheme) or some other form of called “no creditor worse off” principle, under resolution funding is available. which creditors rendered worse off in a resolution In the case of systemically important banks, the than they would have been under a conventional authorities would likely determine that closing a winding up are compensated through a resolution failing bank would adversely affect the stability funding mechanism. of the financial system, impede the continuity of • The legal framework provides tools for resolving critical functions, and cause significant damage to failing banks such as (a) closure and payout, (b) the economy. In those cases, resolution is likely to P&A transactions, (c) mergers, (d) recapitalization involve restructuring the bank to maintain critical through bail-in of creditors, (e) bridge banks, functions and services (that is, banking functions and and (f) nationalization. See box 1 for a set of services that are essential to protect bank customers definitions of different forms of bank resolution. and maintain the stability of the financial system). The selection of resolution options will depend This restructuring would generally be done either on several factors.9 These include the systemic through recapitalizing the bank, for example, through importance of the bank (having regard to its size and a conversion of certain liabilities into equity or a complexity and its market share in financial systems write-down in the value of those liabilities (that is, and markets) and the risk of contagion (that is, the a bail-in), or through an injection of capital from an potential for the distress or failure of one bank to external source, or through a transfer of the critical spread to other financial institutions). Subject to functions and services of the failed bank to a new these considerations, the selection of resolution entity, such as a “bridge bank.” A bridge bank would will also depend on the costs of the resolution. be capitalized either through the bail-in of liabilities The resolution option selected will be the one or through external capital injection. A variant of the that achieves the desired resolution objectives (of bridge bank option is the so-called “good bank/bad maintaining financial stability, maintaining critical bank” form of resolution, in which critical functions functions, protecting insured depositors, avoiding and services plus viable assets are transferred to the damage to the economy, and minimizing taxpayer bridge bank (the good bank) and impaired assets and risk) at the least cost. In the case of a nonsystemic nonsenior liabilities are either retained in the failed bank, the most effective and least-cost resolution bank (bad bank) or liquidated via asset management options tend to be those that favor P&A, with the companies (AMCs). A further option for resolving a residual (impaired) assets and uninsured deposits bank is to merge it into an existing bank by issuing and other liabilities being retained in the failed bank new equity to the acquiring bank, generally with the and liquidated. For systemically important banks, shareholders’ existing equity being written off or the most effective and least-cost resolution options severely diluted. tend to be those that maintain continuity of critical Bank resolution frameworks typically consist of the functions and systems, either within the bank in following:8 restructured form or in another bank.10 8 Javier Bolzico, Yira Mascaró, and Paola Granata, “Practical Guidelines for Effective Bank Resolution” (policy research working paper, World Bank, Washington, DC, 2007). 9 David C. Parker, Closing a Failed Bank: Resolution Practices and Procedures (Washington, DC: International Monetary Fund, 2011). 10 Claire L. McGuire, Simple Tools to Assist in the Resolution of Troubled Banks (Washington, DC: World Bank, 2012). FINANCIAL SAFETY NETS AND BANK RESOLUTION FRAMEWORKS IN SOUTHERN AFRICA: KEY ISSUES AND CHALLENGES 5 Box 1: Principal Resolution Options AMCs can be used in a range of bank resolutions. They involve the resolution authority establishing a company or other legal entity and funding it to acquire impaired assets at market prices or estimated recoverable values. In some cases, existing AMCs that Asset management are commercially owned may be used to acquire impaired assets from a failing bank, company (AMC) where in this case the AMC purchases the impaired assets at assessed recoverable value through a competitive bidding process. In either case, an AMC can be a useful way of separating impaired assets from a recapitalized bank or a bridge bank, thereby enabling management to focus on the resumption of normal banking business. There are two forms of bail-in, each of which can be used to assist in recapitalizing a failing bank or capitalizing a bridge bank. The first type of bail-in is the contractual bail-in of liabilities, such as convertible bonds issued by a bank. Where bonds or other debt instruments have been issued with the legal capacity for conversion to equity or write-down upon defined triggers being breached (e.g., capital or nonviability triggers), these instruments would be bailed-in using the legal mechanism provided. The second type of bail-in is “statutory” bail-in, under which statutory powers are used by the resolution authority to convert debt to equity or to write down the value of debt Bail-in upon a defined statutory trigger. Typically, this second type of bail-in occurs when the resolution authority deems a bank to be nonviable. Depending on the legal powers available, statutory bail-in could be applied to any subordinated and senior unsecured liabilities, excluding insured deposits. Bail-in would be applied in the inverse order of the ranking of liabilities in a winding up—that is, the lowest ranked liabilities in a liquidation would be bailed-in first, followed by the next lowest ranking, and so forth. Statutory bail-in is generally only a viable option if a bank has a reasonably significant tranche of subordinated debt or nondeposit unsecured senior liabilities (e.g., bonds); it is unlikely to be an attractive option if a bank is funded only by deposits. A bridge bank is a new bank, publicly owned and established by the resolution authority or another relevant agency, that acquires the critical business functions and services of a failing bank. It is capitalized through the transfer of assets (in an amount Bridge bank (BB) exceeding any liabilities transferred), to the bridge bank and by the bail-in of liabilities. Capitalization can also be achieved by the injection of funds through a resolution fund or the government. The noncritical functions and impaired assets of the failed bank are then wound up through liquidation processes. C&P involves withdrawing the operating license of a nonviable bank and payout of insured depositors by the deposit insurance agency. The bank’s assets are typically Closure and payout auctioned in tenders or similar processes and, after the deposit insurer has been (C&P) reimbursed for all expenses, noninsured creditors are paid based on the realized value of the assets. This option is only used for small- or medium-size banks of no material systemic importance. 2. TERMINOLOGY 6 GB/BB is a form of resolution in which the commercially viable business, insured deposits, and critical functions and services of the failed bank are moved to a bridge bank (or retained in the failed bank if that bank is recapitalized) and the impaired assets, subordinated liabilities, and noncritical functions and services are either retained in the Good bank/bad bank failed bank to be liquidated or transferred to asset management vehicles for progressive (GB/BB) winding up. The good bank is either a bridge bank with viable assets and critical functions and services, appropriately capitalized, or the original bank recapitalized and stripped of impaired assets. The bad bank is either the original bank in liquidation, containing impaired assets and nonsenior liabilities or an asset management company holding impaired assets. Under a merger, most or all of the failed bank is sold to another bank by either diluting existing equity in the failed bank and issuing shares to the acquiring bank or by canceling existing equity and issuing new shares to the acquiring bank. This option Merger and acquisition is generally only used (a) where the failing bank has positive equity or where liabilities (M&A) can be written down to eliminate losses and (b) where it is not so large as to result in excessive market concentration upon merger or acquisition. If implemented, a merger would need to be structured to ensure that only viable assets are included in the merger transaction or at least that impaired assets are fully written down to recoverable values. As a last resort, a bank can be resolved by a transfer of its ownership to the state, followed by being recapitalized through government injection of equity. This option Nationalization should be avoided where possible but is sometimes used in the case of systemic banks if the other resolution options are not feasible or would have adverse effects on the financial system or economy. This is the most commonly used means of resolving a small- to medium-size bank. It involves transferring the insured deposits (and sometimes other liabilities) and viable assets to another bank willing and able to acquire them. Deposits and other liabilities are “assumed” by the acquiring bank in exchange for purchasing assets of the failed bank or by being provided with cash or securities by the deposit insurance agency or the resolution authority or via an alternative resolution funding arrangement. The Purchase and residual assets of the failed bank are then sold off to repay remaining liabilities, often assumption (P&A) through a tender process where banks can bid competitively for the assets. This option can be used for banks of any size but is less likely to be used for systemic banks because issues over excessive market dominance of the acquiring bank can result from this. Moreover, in the case of large banks it may be impractical to implement a P&A transaction because other banks might not necessarily have the ability to absorb the business of the failing bank on such a large scale. The supervisory or resolution authority takes over the management of the troubled bank and runs it for a determined period, generally leading to either a restructuring of the bank and its restoration to viability, its sale, or resolution. Temporary administration is often used in situations where a supervisory authority lacks confidence in the ability of a bank’s board and management to resolve a bank in distress and therefore appoints Temporary an administrator to assume temporary control to manage the bank into a recovery administration situation or to initiate resolution. Administration is not a permanent mechanism or a form of resolution in itself; it is a process by which recovery and resolution options can be assessed and implemented. It should be terminated as soon as the recovery has been completed or resolution has been initiated (if resolution then occurs under the direct control of the resolution authority) or completed (if resolution occurs via an administrator). FINANCIAL SAFETY NETS AND BANK RESOLUTION FRAMEWORKS IN SOUTHERN AFRICA: KEY ISSUES AND CHALLENGES 7 2.3. “Key Attributes of Effective Financial Institutions” (Key Attributes) established Resolution Regimes for Financial by the FSB.11 The Key Attributes (KA) are the principal international guidance on bank recovery Institutions” and resolution issues and an important reference In undertaking this study, the authors referred to point for assessing the resolution frameworks of the the elements of bank resolution set out in the “Key countries covered in this study. A summary of the Attributes of Effective Resolution Regimes for KA is set out in the box 2. Box 2: Summary of Key Attributes The “Key Attributes of Effective Resolution Regimes for Financial Institutions” set out 12 essential features that should be part of the resolution regimes of all jurisdictions. They are briefly summarized here. • Scope. The resolution framework should at least apply to all systemically important financial institutions (banks, FMIs, insurance companies), including holding companies, subsidiaries, and foreign branches. • Resolution authority. There should be a dedicated authority responsible for the resolution of financial institutions, with appropriate governance, operational independence, legal powers, accountability, and transparency. • Resolution powers. There should be a comprehensive range of legal powers to enable a financial institution and members of the relevant regulatory group to be resolved in a manner consistent with resolution objectives. The powers should include the ability to assume control of a nonviable financial institution and relevant members of its group, replace senior management, implement a business transfer, recapitalize the financial institution, establish a bridge bank and implement a bail-in of liabilities. • Resolution powers. There should be a comprehensive range of legal powers to enable a financial institution and members of the relevant regulatory group to be resolved in a manner consistent with resolution objectives. The powers should include the ability to assume control of a nonviable financial institution and relevant members of its group, replace senior management, implement a business transfer, recapitalize the financial institution, establish a bridge bank and implement a bail-in of liabilities. • Set-off, netting, collateralization, segregation of client assets. The legal framework governing set-off rights, contractual netting, collateralization agreements, and the segregation of client assets should be clear, transparent, and enforceable and should not hamper the effective implementation of resolution measures. • Safeguards. Resolution powers should be exercised in a way that respect the hierarchy of claims while providing flexibility to depart from the general principle of equal treatment of creditors of the same class. Creditors should be compensated to the extent they are rendered worse off than under a conventional liquidation of the resolved financial institution. • Funding of firms in resolution. Jurisdictions should have statutory funding mechanisms or other arrangements in place so that authorities do not rely on public ownership or bailout funds as a means of resolving firms. Jurisdictions should have in place privately financed deposit insurance or resolution funds or a government-based funding mechanism with ex post recovery from the industry of the costs of providing temporary financing to facilitate the resolution of the firm. Any funding arrangements should be subject to robust safeguards to minimize taxpayer liability and moral hazard. • Legal framework conditions for cross-border cooperation. The statutory mandate of a resolution authority should empower and strongly encourage the authority wherever possible to achieve a cooperative solution with foreign The FSB’s “Key Attributes of Effective Resolution Regimes for Financial Institution” was first released in October 2011 and 11 revised in October 2014. See http://www.fsb.org/wp-content/uploads/r_111104cc.pdf?utm_content=VKD. 2. TERMINOLOGY 8 resolution authorities. Among other matters, the resolution framework should facilitate mutual recognition and enforcement in a host jurisdiction of a home authority’s resolution actions while enabling the host authority to separately resolve a branch operation, if necessary. • Crisis management groups (CMGs). Home and key host authorities should maintain CMGs with the objective of enhancing preparedness for, and facilitating the management and resolution of, a cross-border financial crisis affecting the firm. • Institution-specific cross-border cooperation agreements. For financial institutions of systemic importance and with significant cross-border operations, there should be institution-specific cooperation agreements between the home and host authorities that set out the framework and processes for achieving a coordinated cross-border resolution. • Resolvability assessments. Resolution authorities should regularly undertake resolvability assessments that evaluate the feasibility of resolution strategies and their credibility considering the likely effect of the firm’s failure on the financial system and the overall economy. To improve a firm’s resolvability, supervisory authorities or resolution authorities should have powers to require, where necessary, the adoption of appropriate measures to reduce the complexity and costliness of resolution. • Recovery and resolution planning. Jurisdictions should put in place an ongoing process for recovery planning and resolution planning, covering at minimum domestically incorporated firms that could be systemically significant or critical if they fail. The recovery plan and resolution plan should be informed by resolvability assessments and take account of the specific circumstances of the firm and reflect its nature, complexity, interconnectedness, level of substitutability, and size. • Access to information and information sharing. Jurisdictions should ensure that no legal, regulatory, or policy impediments exist that hinder the appropriate exchange of information. The KA were drafted mainly to apply to global countries. They need to be applied in a manner that systemically important financial institutions considers the institutional arrangements, structure of (principally banks) and in the context of the lessons the financial system, bank funding arrangements, and learned from the global financial crisis of 2009. complexity of banking operations. Whereas some However, many of the KA are equally relevant countries in the region, such as South Africa, may for domestic systemically important financial decide that a full application of the KA is appropriate institutions and, to varying degrees, small- to in their specific cases, the other countries in the region medium-size financial institutions. Although the would benefit from a proportional application of the KA are not binding on countries, they have become standards that considers the structural and institutional increasingly influential and have been adopted as one characteristics of their respective financial systems. of the international standards for the financial sector A recent paper suggested that 7 of the 12 KAs are used by the WB and the International Monetary Fund applicable to all countries, irrespective of the size (IMF) in providing Financial Sector Assessment and systemic importance of their financial system Programs (FSAPs) and technical assistance (TA). and banking institutions.12 Those seven include (a) Proportionality is an important principle in scope for the resolution regime (KA 1), (b) resolution assessing a country against the KA and in making authority (KA 2), (c) set-off/netting (KA 4), (d) recommendations for changes to resolution safeguards (KA 5), (e) cross-border cooperation arrangements based on the KA. This principle (KA 7), (f) resolvability assessment (KA 10), and recognizes that not all attributes are applicable to all (g) access to information and information sharing World Bank Group, “Using the FSB Key Attributes of Effective Resolution Regimes to Design Resolution Frameworks for Non- 12 FSB Members” (policy note, World Bank Group, Washington, DC, forthcoming). FINANCIAL SAFETY NETS AND BANK RESOLUTION FRAMEWORKS IN SOUTHERN AFRICA: KEY ISSUES AND CHALLENGES 9 (KA 12). Several other KAs should be implemented Some countries have resolution laws that apply proportionally, such as KA 11 on recovery and differently to systemic banks than to smaller banks, resolution planning, by focusing a risk-based approach with a wider range of resolution powers being on the largest and most complex institutions, as well available for systemic banks than for other banks as the KA related to funding (KA 6). The KAs related or nonbank financial institutions. However, it is to crisis management groups (KA 8) and cross-border generally more common for countries to have a cooperation agreements (KA 9) are primarily relevant standard set of resolution laws applicable to all banks for global systemically important banks (G-SIBs) regardless of systemic importance. In that way, the and other systemic cross-border banks. However, resolution authority has the flexibility to select the even smaller financial institutions need some degree appropriate resolution option for any given bank, of cross-border coordination where those financial depending on the circumstances. This recognizes that institutions have cross-border operations that are in some situations, such as in periods of acute financial systemically significant in home or host jurisdictions. system fragility, banks that would not ordinarily be This is the case with some South African banks, regarded as systemic may have systemic effects on given their dominance in several host countries in the failure. Therefore, jurisdictions should design their southern African region. resolution laws so that the resolution authority can flexibly determine which resolution tools to apply in The KA related to resolution powers (KA 3) is the prevailing circumstances. important and complex, and the application of the different criteria depends on the complexity and systemic nature of the institution under resolution. 2.4. Deposit Insurance The powers that are likely to be relevant in Deposit insurance is a core element in the bank all jurisdictions are the powers to (a) remove resolution framework. It provides a source of management, (b) appoint an administrator, (c) funding and associated processes to enable insured operate and resolve a firm, (d) override shareholder depositors to be fully protected from loss and to be rights, (e) transfer and assume assets and liabilities, given prompt access to their deposits up to a defined and (f) liquidate an institution. Jurisdictions may deposit limit (per depositor per bank) in a bank failure. want to include in their legal framework some of the Deposit insurance helps reduce the risk of depositor powers that are more appropriate for the resolution runs when the banking system is fragile. Deposit of systemic institutions. Examples include the power insurance also helps reduce the risk of government to (a) ensure continuity of essential services, (b) bailouts of banks, given that it provides a formal and carry out a bail-in, (c) impose a temporary stay on capped protection of the most vulnerable parties in a early termination rights, (d) impose a moratorium bank failure, that is, the small depositors. with suspension of payments, (e) establish a bridge bank, and (f) establish an asset management vehicle. In some deposit insurance schemes, the funds available in the scheme can be used for a wider Not all resolution tools may be needed for all range of bank resolutions than just depositor payout. financial systems. For instance, a banking sector For example, the funds can be used to fund the that is entirely or predominantly funded by deposits transfer of insured deposit liabilities to another bank (especially retail deposits) does not lend itself well to through a P&A transaction and can sometimes be bail-in. Bail-in also requires a comprehensive legal applied to other forms of resolution, such as options framework to ensure that legal challenges cannot with a bridge bank. The international standard for result in the resolution being suspended or terminated assessing countries’ resolution arrangements is the through the courts. As part of the legal framework, International Association of Deposit Insurers’ (IADI) bail-in requires a comprehensive framework and “Core Principles for Effective Deposit Insurance funding arrangements for compensating creditors Systems” (Core Principles), published in 2014 and who are rendered worse off because of a bail-in, summarized in annex II. as compared with the outcome that would have prevailed in a conventional winding up. 2. TERMINOLOGY 10 FINANCE, COMPETITIVENESS & INNOVATION INSIGHT | FINANCIAL STABILITY & INTEGRITY 3. FINANCIAL SAFETY NETS AND BANK RESOLUTION IN SOUTHERN AFRICA 3.1. Overview of Banking Sectors in Southern Africa T he banking sectors in southern Africa vary greatly in size and sophistication from some of the largest in the continent to some of the smallest. In South Africa, the banking sector is large and sophisticated, having the attributes of an advanced country banking sector. In Eswatini and Lesotho, the banking sectors are small, and at an early stage in their development, and provide only a relatively limited range of banking services. The banking sectors of Botswana, Mozambique, Namibia, Zambia, and Zimbabwe fall in between the two extremes, albeit at varying stages of development, but they are still significantly underdeveloped relatives to South Africa. Large parts of the population in all countries have limited access to financial services, and financial inclusion is particularly limited in rural areas. Figure 2: Bank Assets to GDP and Market Share of Top 5 Banks Assets to GDP Market Share of Top 5 Banks Botswana Botswana 100% 100% Zimbawe 80% Lesotho Zimbawe 80% Lesotho 60% 60% 40% 40% 20% 20% Zambia 0% Mozambique Zambia 0% Mozambique Eswatini Namibia Eswatini Namibia South Africa South Africa Source: World Bank FinStats 2018 (database). Note: GDP = gross domestic product. Most of the countries in southern Africa, except significant presence. Although foreign banks provide South Africa, have banking sectors dominated by undoubted benefits to the host countries, such as foreign banks. The major banks domiciled in South financial sector development and deeper capacity for Africa (especially Standard Bank and Nedbank) have the provision of credit and risk diversification, they a strong and systemically important presence in most also present a challenge to the host countries. The of the countries in the region, especially in Botswana, dominance of foreign banks creates a significant risk Lesotho, Namibia, and Eswatini. Foreign banks from of cross-country contagion through various channels, outside Africa, particularly the United Kingdom (in including credit exposures, funding, functionality the case of South Africa, Zambia, and Zimbabwe) dependency, and financial market participation. and Portugal (in the case of Mozambique) also have a These risks suggest the importance of the countries FINANCIAL SAFETY NETS AND BANK RESOLUTION FRAMEWORKS IN SOUTHERN AFRICA: KEY ISSUES AND CHALLENGES 11 across the region developing robust cross-border systems had to be restructured or resolved.13 Although cooperation and coordination arrangements in financial depth was limited, the consequences of the supervision, corrective action, recovery, ELA, and financial crisis were significant and long lasting. bank resolution. This risk is one of the critical themes Financial institutions became reluctant to lend, of this report. especially over the medium term. Customers became reluctant to open accounts, slowing down financial Recent experience with systemic banking crises in inclusion. Fiscal costs of resolving these crises were Sub-Saharan Africa is relatively limited. Except for high.14 Many businesses and households could not Nigeria in 2009, the last major banking crisis was withstand the losses. in the 1980s and 1990s when large parts of banking Figure 3: Nominal GDP and Population, Selected Countries Share of Sub-Regional GDP, by Country ZAMBIA ZIMBABWE $21,064.00 $16,620.00 SOUTH AFRICA $295,456.20 BOTSWANA NAMIBIA $15,581.10 $10,947.90 MOZAMBIQUE LESOTHO $11,014.90 $2,291.30 ESWATINI $3,720.60 Population (Millions) South Africa Mozambique Zambia Zimbabwe Namibia Botswana Population (Millions) Lesotho 1.3 55.9 Eswatini 0 20 40 60 Source: World Bank. World Development Indicators database, 2019. Note: GDP = gross domestic product. 13 During that period, nonperforming loans reached 45 percent of loans in Nigeria, 70 percent in Cameroon in 1989, 60 percent to 80 percent in Tanzania, 50 percent in Senegal, and 40 percent in Ghana. 14 Fiscal costs were 25 percent of GDP in Côte d’Ivoire and 10 percent of GDP in Tanzania. 3. FINANCIAL SAFETY NETS AND BANK RESOLUTION IN SOUTHERN AFRICA 12 Figure 4: Systemic Banking Crises in Sub-Saharan Africa, 1975–2011 7 6 5 4 3 2 1 0 1975 1980 1965 1990 1995 2000 2005 2010 Source: Reinhart and Rogoff, 2010; Laeven and Valencia, 2013. Financial systems in southern Africa do not currently countries in the region, recent reform efforts have yet exhibit features commonly observed as contributory to show concrete results. Significant reforms are under factors in past financial crises in other countries. way in Mozambique, Namibia, and South Africa, There has been no significant increase in credit in and smaller changes in existing frameworks are recent years, external financing for banks is limited being considered or have recently been implemented with domestic deposits remaining the principal source in Lesotho and Zimbabwe. Recent experience with of funding, and there are few complex financial bank failures in the region has also highlighted the products in the markets. Nevertheless, there have need to update existing frameworks, and several been many recent bank failures on the continent. The other countries are considering changes. Reforms most prominent failures include Crane in Uganda on resolution and financial safety net arrangements (9 percent of banking system assets), BIAC in are under way in some of the countries in the region, Democratic Republic of Congo (10 percent), Moza as discussed in this section. Reforms are also being Banco in Mozambique (9 percent), and three banks or have been implemented for banking supervision, in Kenya (5 percent). Those banks failed for various which provides a critical underpinning of financial and differing reasons; economic stresses triggered stability and the frameworks needed for the early the crisis in most cases, and they were compounded detection of bank stress and early intervention typically by poor governance and risk management arrangements. Box 3 provides a brief discussion of in the banks in question. Transmission channels also banking supervision frameworks and reforms in two take a long time to materialize, as exposures are countries in the region: Namibia and South Africa. rolled over and liquidity support is provided, which South Africa is in the process of significantly can increase the magnitude of the resulting crisis. modernizing its resolution framework through a new resolution bill, which will also introduce 3.2. Summary of Recent Reform Efforts deposit insurance. The resolution bill, which will While the modernization of financial safety nets and be introduced through an amendment to the 2015 bank resolution frameworks is a priority for many Financial Sector Regulation Act,15 is planned to be Parliament of South Africa, Financial Sector Regulation (FSR) Act, 2017. 15 FINANCIAL SAFETY NETS AND BANK RESOLUTION FRAMEWORKS IN SOUTHERN AFRICA: KEY ISSUES AND CHALLENGES 13 Box 3: Supervisory Capacity in Namibia and South Africa Namibia Namibia improved its level of compliance with the Basel Core Principles for Effective Banking Supervision (BCPs) between the 2006 and 2017, based on findings of the Detailed Assessment of Compliance conducted in 2017. Comprehensive regulatory regimes were introduced for market risk, country risk, consolidated supervision, and AML/ CFT (Anti-Money Laundering and Countering Financing of Terrorism Act of 2009), and effective information-sharing arrangements have been put in place with the South African Reserve Bank (SARB), among others. The Bank of Namibia employs separate on-site and off-site teams to assess the risks that banking groups are facing, the combination of which provides supervisory senior management with a good sense of the overall risk profile of each bank or banking group. Risk-based supervision was introduced in 2008. The assessment undertaken recommended to further strengthen the supervisory regime by consolidating risk methodologies and focusing more on forward- looking analyses. It also recommended to increase resources in the banking supervision department, particularly given additional responsibilities the department is scheduled to assume. The regulatory framework for consolidated supervision was assessed as comprehensive. However, it relies on data being provided by the nonbank financial institution supervisor, which has room for improvement given that risk-based supervision has not been fully embedded for nonbank financial institutions. Because nonbank financial institutions are critical in Namibia because of their size, the interconnected financial system, and the prevalence of financial groups, making this data reliable will be an important area of future work. The assessment also recommended improvements in the approach toward dealing with problem assets, provisioning, and reserves as well as the liquidity risk framework applicable to banks. South Africa South Africa has a high level of compliance with the BCPs based on the 2015 Detailed Assessment of Compliance.a The supervisory regime is based on strong relationships between the supervisory authority and bank boards and senior management, as well as with banks’ internal and external auditors. The Assessment also states that the registrar of banks (the head of banking supervision) and staff in the Bank Supervision Department (BSD) of the SARB are working under appropriate responsibilities and with adequate powers, holding banks to a high standard of corporate governance and risk management. South Africa has implemented Basel III requirements (a set of international banking regulations developed by the Basel Committee on Banking Supervision to promote stability in the international financial system). The BSD was assessed as having an appropriate level of resources with highly qualified staff, substantial specialist skills, improved supervisory techniques and tools and as having more frequent on-site assessments, including for in-depth reviews. BSD uses the SREP (supervisory review and evaluation process) cycle and risk rating system as a general framework, together with sector-wide approaches and thematic on-site reviews. In addition, the BSD conducts detailed and intensive off-site analysis, equipping the analysis with wide-ranging techniques and tools appropriate for oversight of risk profiles and operations of banks and banking groups in South Africa. One area noted for further work was the tools and techniques to assess and monitor spill-over risks to the banks from nonbanking activities in their financial groups. This area is especially important given the prevalence of conglomerate financial groups in South Africa. Another noted shortcoming was the lack of a resolution framework and, correspondingly, the incipient recovery and resolution planning of large banking groups. The assessment also recommended reviewing the supervisory approach after the organizational changes resulting from the Twin Peaks reformb are completed. The review will be necessary to ensure that prudential risks of the entire financial system are monitored and that conglomerate supervision is being appropriately undertaken. Also needed may be a more formal framework to detect and assess systemwide and cross-sectoral risks and its integration to supervision of individual financial groups and regulated financial institutions. a International Monetary Fund. 2015. South Africa: Financial Sector Assessment Program—Detailed Assessment of Compliance on the Basel Core Principles for Effective Banking Supervision. b Twin Peaks is model of financial regulation that splits regulation into two broad functions: market conduct regulation and pru- dential regulation. 3. FINANCIAL SAFETY NETS AND BANK RESOLUTION IN SOUTHERN AFRICA 14 introduced in the South African Parliament in 2019.16 regime for financial institutions, and the deposit Reform efforts have been ongoing since 2013. As insurance fund. Draft amendments propose to make part of the new bill, the South African Reserve Bank the central bank the statutory resolution authority (SARB) will be appointed as the resolution authority and provide for the introduction of new resolution for banks and for systemic nonbank financial powers in line with the KA. institutions and their holding companies. The absence of resolution funding is a critical It is proposed that the resolution authority in South weakness in Mozambique, particularly as the existing Africa will have comprehensive powers. These deposit insurance scheme cannot be used to facilitate powers will include (a) write down shareholders and resolution. This situation limits the options for the unsecured and uninsured creditors to absorb losses, (b) authorities and increases the reliance on public funds require the issuance of new shares, (c) transfer assets to finance the cost of winding up distressed financial and liabilities as part of a P&A transaction, (d) require institutions. As a result, the authorities are also a merger or amalgamation, (e) establish a bridge bank, considering reforms to the deposit guarantee fund and (f) convert unsecured and uninsured creditors’ and an expansion of its mandate to paybox plus. claims into equity (bail-in). Given that South Africa is Namibia has drafted amendments to the Banking a member of the G20, the aim is to bring the resolution Institutions Act 1998 that will establish a Special framework fully into line with the KA. Resolution Regime (SRR) for banks and bank South Africa is the only G20 country without explicit holding companies. The amendments are meant to deposit insurance. The scheme proposed as part of the be adopted in 2018/19. The SRR would provide bill will be a prefunded paybox plus deposit insurance the Bank of Namibia (BON) with a wide range of scheme, operated by a deposit insurance corporation powers for resolving the failure of a systemically to be established within, but operationally independent important bank or bank holding company. Those from, the SARB. All banks would be required to be powers would allow the BON to (a) write down members. The scheme is intended to be fully aligned shareholders and unsecured and uninsured creditors, with the IADI Core Principles. (b) require the issuance of new shares, (c) carry out a P&A transaction, (d) establish a bridge bank, (e) Mozambique lacks the legal instruments to resolve establish an asset management vehicle, and (f) bail failed banks, particularly the ability to write down in unsecured and uninsured creditors. The provisions existing shareholders.17 Mozambique passed a law aim to bring the SRR in line with the KA. establishing a deposit insurance scheme in 2010, but it lacks operational capacity and is critically Namibia has also drafted a deposit guarantee underfunded.18 As a result, Mozambique is reviewing scheme (DGS) bill. The DGS will be a paybox its existing legal and regulatory framework for bank scheme within the BON. All banks would be resolution and deposit insurance. This includes required to be members. Under the legislative amendments to the laws governing financial calendar, the DGS bill would become effective institutions, the central bank, the special insolvency after the SRR is in place. 16 At the time of writing, South Africa’s resolution bill was being reviewed by cabinet with the expectation that it would be passed into law by parliament in 2019. A consultation paper on the bill has been released. National Treasury, South African Reserve Bank, and Financial Services Board, “Strengthening South Africa’s Resolution Framework for Financial Institutions” (consultation paper, National Treasury and Financial Services Board, 2015). 17 When Mozambique’s fourth largest bank by assets (Moza Banco) failed in late 2016, the central bank placed it under temporary administration. It was eventually recapitalized by the central bank employee’s pension fund, which became the majority share- holder while existing shareholders retained a minority ownership. 18 The deposit insurance fund struggled to pay out depositors of a small bank (less than 1 percent of system assets) that was closed in November 2016. After almost a year of effort, it had only managed to reimburse half of depositors and eventually ceased re- imbursements. FINANCIAL SAFETY NETS AND BANK RESOLUTION FRAMEWORKS IN SOUTHERN AFRICA: KEY ISSUES AND CHALLENGES 15 Zimbabwe is one of the few countries in the region Africa). Foreign banks bring substantial benefits, with an established deposit insurance scheme. including risk diversification, deeper capacity for Resolution functions were recently transferred from lending and financial market development. However, the deposit insurer to the central bank, and updates to they also bring risks, including the risk of contagion the framework are envisaged with a view to adding from parent bank distress to the subsidiaries or capacity to develop a single customer view (SCV), branches in host countries. It is therefore essential least-cost testing, and P&A at the deposit insurance that there are robust frameworks in place for cross- agency. The effectiveness of the deposit insurance border cooperation and coordination between the scheme is limited, however, by the shortage of home and host countries for early intervention, ELA, hard currency in a U.S. dollarized economy. As a recovery and resolution. result, any type of payout would likely need to be Ongoing efforts to promote regional cooperation electronic and at a significant discount to the U.S. on cross-border bank supervision and resolution dollar nominal value of the deposit. have gained momentum in recent years. The FSB Lesotho is at a relatively advanced stage of Regional Consultative Group for Sub-Saharan assessing the parameters of a deposit insurance Africa regularly convenes policy makers to scheme and has developed a policy paper that sets discuss financial vulnerabilities and the effects of out proposals for a scheme. Lesotho has received financial regulatory reforms. The Association of TA for its design, but considerable work remains African Central Banks (AACB) brings together to be done. Enactment of legislation appears to be governors of central banks and has established many months or even years in the future. the Community of African Banking Supervisors (CABS), to convene all supervisory authorities in Botswana has not yet established a deposit insurance Africa. CABS has two established working groups: scheme. However, preliminary assessment of the (a) one on cross-border banking supervision, case for deposit insurance has been undertaken by the chaired by the SARB, and (b) another on cross– Bank of Botswana (BOB). A TA mission conducted border resolution and crisis management, which is by the IMF in 2017 recommended that Botswana chaired by the Central Bank of Nigeria. The work establish a deposit insurance scheme. plan for the latter calls for the formation of crisis Similarly, there is no deposit insurance in Zambia. management groups to exchange information and The 2017 FSAP noted that a draft deposit protection develop joint crisis management plans. In addition, law has been under preparation since the late 1990s representatives of various central banks have but has made no substantive progress. The report identified the need for regional crisis simulation noted that the draft is under review at the Bank exercises to improve cooperation. of Zambia (BOZ). Likewise, there is no deposit There is no established platform for exchanging insurance scheme in Eswatini and no progress has information and monitoring risks of cross-border yet been made to establish one. groups. Many large banking groups continue to be inadequately supervised, which potentially 3.3. International Cooperation on exposes the region to the risk of large cross-border Cross-Border Issues contagion. The absence of proper cross-border supervision and information on cross-border As noted elsewhere in this paper, the banking systems activity and exposures impedes effective group in the southern Africa region are characterized by oversight of cross-border banks, which features significant dominance of foreign banks, whether prominently in southern Africa. This absence also in the form of banks from South Africa having a creates risks of a build-up of intragroup exposures major presence in other countries in the region or and the potential bypassing of regulatory Europeans banks having a major presence in some requirements (for example, with respect to related of the countries (including Mozambique and South party and concentration limits). Recognizing 3. FINANCIAL SAFETY NETS AND BANK RESOLUTION IN SOUTHERN AFRICA 16 this, the AACB/CABS cross-border supervision work with the Partnership Making Finance Work working group has prioritized developing for Africa and GIZ (Deutsche Gesellschaft für comparable financial and prudential data on pan- Internationale Zusammenarbeit GmbH). African banks. Such development aims to improve In response to increased demand for guidance risk monitoring, decision making, and international and technical assistance, the FSB, supported by cooperation. AACB is receiving support from the WB and the IMF, has developed extensive FIRST (Financial Sector Reform and Strengthening guidance on bank recovery and resolution. FSAPs Initiative) and the WB to improve the availability and TA programs led by the WB and IMF have also and regular exchange of supervisory information, provided mechanisms by which countries’ financial to increase supervisory capacity, and to enhance safety nets and bank resolution frameworks can the effectiveness of cross-border supervisory be assessed and recommendations can be made to cooperation. The proposed project builds on strengthen them. FINANCIAL SAFETY NETS AND BANK RESOLUTION FRAMEWORKS IN SOUTHERN AFRICA: KEY ISSUES AND CHALLENGES 17 FINANCE, COMPETITIVENESS & INNOVATION INSIGHT | FINANCIAL STABILITY & INTEGRITY 4. KEY ISSUES AND CHALLENGES T his section sets out the main issues and challenges in the eight countries covered in the study. It draws on the main report, which describes the issues in detail. 4.1. Preventive and Corrective lack sufficient powers to remove shareholders from Action Frameworks a bank, even in a situation where the bank’s capital is negative. These gaps and deficiencies should Preventive and corrective action frameworks that be addressed as part of a broader strengthening of trigger supervisory action to deal with noncompliance recovery and resolution powers. or emerging stress in banks are a crucial element of the banking supervision framework. Here, a The supervisory authorities’ most significant gap distinction needs to be made between (a) preventive is the general lack of adequate preventive and and corrective action frameworks that allow for corrective action policies and of contingency supervisory discretion but provide for a structured plans for dealing with weak or noncompliant approach to assessing response options based on banks. Although the information is difficult to find triggers and (b) more rigid and prompt corrective from public sources, TA reports (for example, for action frameworks that have mandatory actions Botswana and Lesotho) and FSAP reports (for linked to statutory-based triggers. In this report, example, for Namibia and South Africa) highlight the term “preventive and corrective action” refers the need to develop preventive and corrective action to the former, in which a supervisory authority policy frameworks and contingency plans that have has a framework in place that sets out triggers better definitions of the triggers and associated and corresponding indicative responses, but that actions for each trigger (see table 2 for an example provides the supervisory authority with considerable of a preventive and corrective action framework). flexibility in its responses. The activation of banks’ recovery plans should In most respects, the supervisory authorities in be integrated into supervisory preventive and the countries included in this study have generally corrective action frameworks as one of the key satisfactory legal powers for undertaking preventive early-stage actions in addressing bank stress. Given and corrective actions. However, there are some the absence of recovery planning requirements in gaps and deficiencies in the powers, such as (a) most countries in the region, supervisory preventive poorly defined triggers for preventive and corrective and corrective action frameworks generally lack action powers, (b) the inability to replace directors this element. In addition, supervisory authorities and officers of a bank, and (c) the inability to extend need to further develop contingency planning to preventive and corrective actions to a regulated group identify the responses they would take during (as opposed to a licensed bank on a solo entity basis). situations of bank distress. Except for South Examples of poorly defined triggers for preventive Africa, contingency planning to deal with bank and corrective action include broadly expressed stress is significantly underdeveloped in the region. statutory phrases, such as a bank that is “conducting Supervisory authorities need to develop and keep its affairs in an unsound manner,” a bank that is under review contingency plans for dealing with a in “an unsound condition,” or a bank that is “in range of bank stress and noncompliance scenarios, violation of the [relevant] Act.” In some countries, and the authorities need to regularly test those plans such as Mozambique, the supervisory authorities so that they build their capacity for preparedness. FINANCIAL SAFETY NETS AND BANK RESOLUTION FRAMEWORKS IN SOUTHERN AFRICA: KEY ISSUES AND CHALLENGES 19 Table 2: Indicative Triggers and Responses for a Supervisory Preventive and Corrective Action Framework Stage Risk Indicative Triggers Typical Actions Normal Low • Capital ratio is above minimum tolerance level • Conducting normal supervisory risk (where the tolerance level is a specified margin assessment process above the minimum regulatory capital ratio). • Conducting regular reviews of the institution • Liquidity ratio is above minimum tolerance • Conducting review and analysis of prudential level (where the tolerance is above the data minimum regulatory liquidity requirement.) • Providing the assigned risk rating to the • Impaired loans are below a defined level institution (e.g., 1.0% of total loans). • Exposure concentration is below maximum tolerance level (a specified percentage below the maximum prudential limits). • Early warning indicators (EWIs) are all in the low risk (green) zone. Early Moderate • Capital ratio is below minimum tolerance • Conducting more frequent and targeted warning (but still above minimum regulatory ratio reviews by specialist risk teams requirement). • Imposing more frequent and additional • Liquidity ratio is below minimum tolerance reporting requirements (but still above minimum regulatory ratio • Having direct interaction and meetings with requirement). senior management and board • Impaired loans are between 1.0% and 2.0% • Providing written communication that of total loans. requires the institution to present a plan • Exposure concentration above maximum and time frame to restore compliance with tolerance level (but below the maximum identified deficiencies prudential limits). • Conducting more frequent monitoring and • Some EWIs are in low to moderate risk communication of measures taken by the (yellow) zone. institution Intensive Moderately • Capital ratio is below minimum regulatory • Using formal powers to issue directions oversight high ratio requirement but not less than 90% of • Conducting more frequent on-site visits, the regulatory minimum. meetings with board • Liquidity ratio is below minimum regulatory • Requiring revisions to business plans or ratio requirement but not less than 90% of governance arrangements the regulatory minimum. • Requiring recovery plans to be activated • Impaired loans are between 2.0% and 4.0% of total loans. • Requiring immediate steps to increase capital and liquidity • Exposure concentration is above the maximum prudential limits (but not more than • Placing restrictions on existing or planned 20% above). business activities, limiting balance sheet growth • Some EWIs are in high risk (red) zone and others are in moderate to high zone (amber). • Increasing capital and liquidity requirements, limiting capital distribution, and having stricter leverage limits • Engaging external specialists to assess certain areas, such as asset quality 4. KEY ISSUES AND CHALLENGES 20 Mandated High • Capital ratio is below minimum ratio • Using formal powers to issue directions action requirement (e.g., between 50% and 90% of • Requiring institution to present and execute a the minimum). remediation plan in short time frame and full • Liquidity ratio is below minimum ratio recovery plan activation requirement (e.g., between 50% and 90% of • Removing directors and management as the minimum). necessary • Impaired loans are between 4.0% and 6.0% • Having institution demonstrate recovery of total loans. actions or take formal enforcement actions • Exposure concentration is above the taken maximum prudential limits by more than 20%. • Preventing new lending and requiring • Most EWIs are in high risk (red) zone. reduction in operation expenses • Appointing a statutory manager or administrator if the supervisor has low confidence in the ability or willingness of management to restore the bank to financial soundness Nonviable • Capital is below 50% of minimum ratio • Resolution regime triggered requirement. • Liquidity is below 50% of minimum required level. • Recovery actions are assessed by supervisor as unlikely to restore the bank to viability. A further deficiency is the underdevelopment of effect of movements in interest rates and exchange EWIs and stress testing across most of the supervisory rates), and (c) liquidity stress tests. In addition, regimes (except, possibly, South Africa). Although reverse stress tests are becoming more commonly most supervisory agencies do undertake some form used, particularly for bank recovery planning. In all of stress testing of banks and have some EWIs in of the countries in the region more progress is needed place, these systems tend not to be well developed or in developing bank stress testing, both at systemwide integrated into the preventive and corrective action level and individual bank level. These tests need to frameworks. This matter warrants further attention. become a core element in the banking supervision Monitoring a range of EWIs can help to identify framework for assessing bank vulnerability to emerging stress in bank capital, liquidity, asset economic and financial shocks. Annex IV provides quality, market risks, and profitability at an early information on stress tests. stage. This monitoring should be done in respect of The preventive and corrective action arrangements the banking system as a whole and for individual lack regular testing by the supervisory authorities in banks. Annex III provides an example of EWIs. southern Africa. Some authorities have conducted For stress testing, supervisory authorities could be simulation exercises to test for responses to bank expected to conduct both top-down and bottom-up stress and failure, but most have not done so yet.19 stress tests of the banking system and individual Few, if any, have undertaken regular testing of their banks. Stress tests typically take several forms, corrective action capacity. A further gap is the absence including (a) macrofinancial stress tests (assessing of cross-border testing of preventive and corrective overall effects on the banking system and individual action arrangements, which is an important matter, banks), (b) single factor stress tests (assessing the given the dominant presence of South African banks in the region. Crisis simulation exercises facilitated by the World Bank were undertaken in Mozambique in July 2016, in South Africa (albeit 19 on cybersecurity) in June 2017, and in Zimbabwe in February 2018. FINANCIAL SAFETY NETS AND BANK RESOLUTION FRAMEWORKS IN SOUTHERN AFRICA: KEY ISSUES AND CHALLENGES 21 Mechanisms for cross-border cooperation and the next 12 months or so. The absence of effective coordination in the preventive and corrective action recovery planning requirements is a significant processes, particularly memoranda of understanding deficiency in the region and should be a matter of (MOUs) between supervisory agencies, appear only high priority. The supervisory authorities that have to deal with information exchange. At a minimum, not yet established recovery planning requirements jurisdictions that prepare contingency plans, should do so within the limits of their legal powers, resolvability assessments, and resolution plans for focusing initially on D-SIBs and then extending parent banks (as in the case of South Africa) should progressively to other banks. share them with the authorities in host jurisdictions Recovery planning should be closely integrated to clarify the intended approach for the parent into bank risk management frameworks, bank’s subsidiaries in the host jurisdictions. ICAAP (internal capital adequacy assessment Supervisory agencies need to develop their capacity process) requirements, bank liquidity planning to assess solvency, viability, and liquidity for arrangements, and business continuity planning preventive and corrective action, for ELA, and for requirements. Laws need to be upgraded resolution purposes. The South African supervisory to specifically establish recovery planning authorities have greater capacity in this regard than requirements for banks, including the ability do the supervisory authorities in the other countries of the supervisor to specify the minimum of the region. However, even South Africa has scope requirements, to require board sign-off, to require to further strengthen the frameworks needed to external audit or review, and to require banks to assess solvency, liquidity, and viability, especially undertake periodic testing of recovery plans. As under acute time pressure. has been done in many advanced and emerging economies, the supervisory authorities in southern Strengthening the supervisory capacity to Africa need to develop guidance for banks to undertake assessments of bank solvency, liquidity, help them prepare recovery plans. This guidance and viability requires developing data templates would usually cover the following: governance that banks can complete at short notice when arrangements for recovery plans (business-as- the supervisory authority requests information. usual governance and crisis response governance); The data templates need to contain enough data triggers for invoking recovery plans and recovery so that meaningful assessments of solvency and actions; restoration points for postrecovery viability can be made. Strengthening capacity will capital and liquidity; preparatory measures to also require methodologies for asset valuation, implement recovery actions; recovery options; including (a) conducting valuation under acute steps to implement recovery action; scenario time pressure (as is often the case in a financial requirements; and recovery plan review and testing crisis), (b) training supervision staff to undertake arrangements. Supervisory authorities will also these valuations, and (c) exercising the authority need to build capacity among their staff to review to outsource valuation to external firms. Solvency and provide feedback to banks on recovery plans and viability assessment will also need to be tested and to integrate the supervision of recovery plans regularly to build and maintain capacity among the into the broader on-site and off-site supervisory supervisory authorities. arrangements. 4.2. Recovery Planning Supervision authorities need to integrate the activation of recovery planning into the authorities’ The bank recovery planning arrangements across the preventive and corrective action frameworks. region are underdeveloped. South Africa appears to Specifically, supervisory authorities should identify be the only supervisory authority that has established the triggers for a bank to activate its recovery plan recovery planning requirements for banks, although and the specific recovery actions within the plans Namibia is expected to require recovery plans in and should integrate these into supervisory early 4. KEY ISSUES AND CHALLENGES 22 intervention arrangements. Supervision authorities The countries in question should review their should develop a program of regularly testing resolution laws and incorporate more precisely their preventive and corrective action frameworks, defined objectives, broadly aligned to those set including activation of bank recovery plans, so that out in the KA. A hierarchy of objectives could be they can build and maintain the capacity to respond considered to manage potential conflicts between to bank stress and distress situations. objectives (such as promoting stability in the financial system while seeking to avoid fiscal costs 4.3. Bank Resolution and risks). A ranking of objectives could involve the following: Resolution Authority, Objectives, Maintaining continuity of critical functions and Operational and Institutional services, maintaining the stability of the financial Independence, Access to Information system, and protecting insured depositors. In most countries the law does not explicitly specify • Subject to the above, avoiding adverse effects on a resolution authority. South Africa’s Parliament the economy and uninsured creditors. will be enacting a new resolution bill that will appoint the SARB as the resolution authority for • Subject to the above, minimizing fiscal risks and systemic banks and will formalize resolution costs and associated moral hazard. powers and responsibilities. Mozambique is also • Subject to the above, avoiding adverse effects on undertaking similar reforms to designate the the financial systems and economies of the home Bank of Mozambique as the resolution authority. or host countries affected. In Zimbabwe, the resolution functions were recently transferred from the deposit insurer to the Powers and Tools central bank. In other countries, the law does not Laws relating to bank resolution in southern Africa formally designate a resolution authority, although generally lack clearly defined triggers for entering it is generally clear which agency performs the a bank into resolution (for example, on the basis resolution function in each case (that is, the central of nonviability). Triggers often relate to different bank or supervisory authority). Laws need to types of situations or events including “insolvency,” be strengthened along the lines specified in the generally not defined; breach of prudential KA, with clearly defined resolution authorities, requirements; imprudent conduct; and capital with well-specified functions, and with robust deficiency. Laws need greater clarity, including accountability and transparency arrangements. clear triggers to enter a bank into resolution on the The specification of resolution objectives is basis of nonviability, with statutory criteria to enable generally inadequate in most countries’ laws. The nonviability to be clearly understood. Supervisory laws generally contain a broad set of purposes, but and resolution authorities need to develop in a they are typically confined to financial stability transparent manner more detailed administrative or the protection of depositors. They rarely guidance for the factors to be considered when include reference to other considerations, such as assessing bank solvency, liquidity, and viability. maintaining the continuity of critical functions Triggers for resolution must occur well before and services, seeking to minimize adverse impacts insolvency to avoid excessive disruption to the on the real economy, or seeking to avoid, where financial system and thus maximize the potential practicable, fiscal costs or risks. Similarly, the returns for creditors and limit the costs associated with resolution legislation in the countries studied does resolution. The inclusion of subtriggers should also be not generally include reference to avoiding adverse considered for categories of resolution powers once effects on the financial systems of other countries, entry into resolution has occurred. For example, the which is a significant omission given the degree of use of statutory bail-in (if adopted) could be subject cross-border banking activity in the region. FINANCIAL SAFETY NETS AND BANK RESOLUTION FRAMEWORKS IN SOUTHERN AFRICA: KEY ISSUES AND CHALLENGES 23 to a trigger that involves both the systemic effect of In general, the countries in the region lack sufficient the bank’s failure and the need to first have required powers to do the following: shareholders and subordinated creditors to absorb • Appoint an administrator to replace management losses to the full extent of their potential liability and override shareholders’ powers. before bailing in senior unsecured debt.20 • Establish and capitalize a bridge bank, and transfer In most cases, the laws limit resolution powers to some or all of a failed bank to a bridge bank. licensed banks. The laws do not explicitly enable resolution powers to be exercised for holding • Establish and fund an asset management company. companies or subsidiaries, which impedes effective • Issue capital instruments in a bank under resolution. group resolution. Moreover, the laws in most countries • Remove shareholders from an insolvent or in the study do not explicitly apply resolution powers otherwise nonviable bank or dilute shareholders’ to host jurisdiction branches of foreign banks. Because interests to reflect the assessed market value of of those omissions, many of the authorities in the their equity. region would be unable to implement group resolution comprehensively. The authorities in host countries • Implement a statutory bail-in of liabilities for would also be impeded in exercising resolution of which there is no contractual basis to convert to foreign branches in their jurisdiction where the home equity or write-down. resolution authorities have not implemented a group- • Apply a comprehensive moratorium or stay-of- based resolution to satisfactorily minimize adverse action. effects on the host country’s financial system and bank customers. Most of the countries in the region lack South Africa is implementing a set of comprehensive statutory powers to enable a host authority to legally reforms through a resolution bill that, once enacted, recognize and enforce actions of a home resolution will incorporate those kinds of resolution powers, authority. Having a power of this nature is important, broadly in alignment with the KA. Namibia is particularly in situations where the host authority is also embarking on legislative reforms to establish satisfied that the home authority’s resolution actions a comprehensive set of resolution powers aligned would meet the systemic stability and customer to those in the KA. To varying degrees, the other protection objectives of the host authority. The absence countries in the region have laws that fall well short of cross-border legal recognition and enforcement of what is needed for effective resolution and would powers should be remedied as part of a major upgrade appear to be several years away from being able to to resolution laws across the region. implement the needed reforms. A priority for these countries is to quickly develop policies and laws Most of the countries have only limited legal powers to ensure that, in due course, they align broadly to available for resolution. Most can issue directions to a the KA. However, this action needs to be done in a bank (which can be used to pre-position for resolution manner that suits each country’s circumstances and and to implement elements of a resolution), and most institutional arrangements. have some form of business transfer powers and powers to appoint an administrator or statutory manager to Safeguards assume control of a bank, but with significant gaps The laws in the countries in southern Africa generally or deficiencies in the laws. In most cases, the powers make no provision for safeguards in the exercise of for dealing with bank failure rely on court-based resolution powers, such as the “no creditor worse insolvency processes, with only limited scope for the off’’ safeguard referred to in the KA. Reflecting resolution authority to implement resolution options. this, there is no mechanism to compensate creditors As noted elsewhere in this report, statutory bail-in is a tool that is most likely to be applicable in countries where the systemic 20 banks are funded by substantial tranches of senior and subordinated unsecured nondeposit debt, in addition to deposit li- abilities. Bail-in is much less likely to be a viable option in countries where the banks are predominantly funded by deposits. 4. KEY ISSUES AND CHALLENGES 24 that are rendered worse off under a bank resolution undertake bank-specific resolvability assessments than in a conventional insolvency liquidation. This and to develop resolution plans. General supervision omission makes it difficult to implement some forms powers to obtain data from banks would likely enable of resolution without incurring considerable risks much of the data for resolvability assessments and of legal challenge, especially in the use of partial resolution planning to be acquired. Nevertheless, transfers of business to a bridge bank (where some almost of the relevant information and data for of the business is retained in the failed bank) or in a resolvability assessments and resolution planning statutory bail-in of creditors. will not be available through the normal information collected by supervisors. Accordingly, as appropriate, Sufficient safeguards against court intervention in the laws in the countries in question should be bank resolutions are lacking. In many countries, amended to empower the resolution authorities to judicial challenge to a resolution is a considerable risk, obtain information and data from banks, including as especially if the resolution resulted in an alteration of a group, for the purposes of resolvability assessments shareholder or creditor property rights. In such cases, and resolution planning. In addition, the resolution the judicial remedies may take the form of suspending, authorities should require banks to obtain external modifying, or terminating a bank resolution that audits or other forms of independent verification of the resolution authority was implementing or had this information and data. In addition, the laws should implemented. Such a situation might create attendant enable the resolution authorities to require banks (and disruption to creditors and other bank customers, wider financial conglomerates where applicable) interruption of critical functions and services, and to make specified changes to their organizational financial system instability. In recognition of these structure and operations, consistent with resolution adverse effects, international principles such as the plans, to facilitate cost-effective resolution. KA, advocate a constraint on judicial remedies, such that a court is empowered to award compensation only Beyond the need for stronger laws in this area, to creditors and others rendered worse off than under the authorities need to develop data templates for a conventional winding up (that is, the “no creditor the granular information needed for resolvability worse off” principle). Under such international assessment and resolution planning. Much of this principles, courts are not empowered to suspend, data is outside the normal range of information modify, or terminate a bank resolution. Resolution that supervisors routinely collect to assess a bank’s laws in the region’s countries need to be amended in financial and prudential condition; it relates more to line with such principles. the operational structure of a bank and banking group, the identification of specific critical functions and Reforms are well under way in South Africa, services, the extent and nature of the participation of and Namibia is also considering developing a bank in key financial systems and markets, and the new resolution laws that would, if implemented, nature of interdependencies between different legal incorporate safeguard processes. In the other entities in a banking group. Resolution authorities will countries, reforms have been undertaken in some need to develop data templates to capture information areas, but not comprehensively. Much work remains of this nature and work with the banks to build their to be done in this area across the region. internal capacity to generate such data. Resolution authorities will also need to build their internal capacity Resolvability Assessments and to interpret the information received and integrate it Resolution Planning into resolvability assessments and resolution plans. The laws in most countries do not explicitly provide Information on the extent of progress on resolvability for a resolution authority to obtain data from banks assessments and resolution planning in the region’s to undertake bank-specific resolvability assessments countries is limited. In Botswana and Lesotho, and resolution planning. This ambiguity potentially the authorities have not yet developed the policy impedes the ability of resolution authorities to frameworks for undertaking resolvability assessments FINANCIAL SAFETY NETS AND BANK RESOLUTION FRAMEWORKS IN SOUTHERN AFRICA: KEY ISSUES AND CHALLENGES 25 or developing resolution plans. In South Africa, • Domestic coordination arrangements the SARB has undertaken preliminary thinking • Cross-border coordination arrangements on these matters, but to our knowledge has not yet implemented resolvability assessments or resolution • Public communication strategies planning for systemic banks. Mozambique and In southern Africa, given the dominance of South Namibia have yet to undertake resolvability African banks, cross-border coordination is an assessments or resolution planning. It is unclear important element of resolution toolkits and bank- what the state of progress is in the other countries, specific resolution plans. This situation suggests but it seems unlikely that they have made much that the SARB, when it undertakes resolvability progress. This is understandable, given that these assessments and resolution plans for D-SIBs domiciled are highly complex areas; many G20 countries have in South Africa, needs to extend those frameworks to not yet made substantial progress in resolvability the cross-border operations of the banks and closely assessments and resolution planning. Nonetheless, coordinate with the host country authorities. This over the medium term, the authorities in the region coordination should include an assessment of the need to develop the frameworks for resolvability feasibility and efficacy of resolution options under assessments and resolution planning and then at single point of entry (SPE) and multiple points of least implement resolution plans for the D-SIBs in entry (MPE) models.21 their jurisdictions. Except for South Africa, resolution authorities have Resolution Strategies and Toolkits not yet begun to prepare resolution toolkits. This effort should be a key priority in the near term, given that the The respective resolution authorities need to prepare a development of resolution guidance is a foundation generic resolution “toolkit” as an important precursor for building capacity. Once the resolution toolkits to developing resolution plans for systemically have been developed, ongoing capacity building will important banks. Such a toolkit is fundamental to require regular testing. This testing should be done in building the capacity for bank resolution. It needs to conjunction with the other domestic authorities that cover several elements, including the following: have responsibilities for aspects of resolution, such • Identification of resolution strategies for a range as the finance ministries and securities regulators. In of bank failure situations, including closure the medium term, and ongoing, the authorities should and payout, P&A transactions, recapitalization undertake occasional cross-border crisis resolution through bail-in, recapitalization via bailout, and exercises to test their capacity to implement a bridge bank solutions coordinated resolution of banks with significant cross- border operations. • Criteria for selecting resolution strategies, including systemic impact assessment, contagion Resolution Funding risk, and resolution costs Existing arrangements for resolution funding are • Preparatory measures for different resolution inadequate in all southern African countries covered options, such as the arrangements for creating in this study. Except for Mozambique and Zimbabwe, bridge banks and the indicative terms sheets for no country in the region has established deposit capital instruments. insurance schemes. South Africa is planning to • Guidance on the step-by-step implementation for establish a scheme through legislation to be submitted each resolution option. Under an SPE resolution model, resolution involving recapitalization entails injecting capital at the level of the parent entity at 21 the top of the group. Capital can be introduced either through external capital sources or through bail-in, and it needs to be sufficient to recapitalize the parent entity and all bank entities in the group. Under an MPE model, capital injection (through external capital sources or bail-in) is done individually at each bank entity in the group. The two models have different advan- tages and disadvantages, which are discussed elsewhere in the report 4. KEY ISSUES AND CHALLENGES 26 to parliament in 2019. Namibia is also developing pool of funds for such events imposes significant legislation to establish deposit insurance. The other costs on banks and their customers and entails countries in the region have yet to establish deposit substantial opportunity costs because of the funds insurance schemes, although most intend to do so to being unavailable for other purposes, notably lending help strengthen their resolution arrangements. to bank customers. Further work in these areas will be necessary across the region as the authorities consider Southern African countries lack funding structures for the alternative funding options available. other forms of resolution, such as in systemic crises, and would rely on ad hoc public funding under current arrangements. For example, funding may be needed 4.4. Domestic and International for recapitalization (especially where statutory bail-in Cooperation and Coordination is not applied to some liabilities), liquidity support, Domestic and (especially) cross-border information guarantees, indemnities and the financing of transfers exchange arrangements are limited across the region. of assets, and liabilities from a failing bank to another Many supervisory authorities have the legal powers entity (for example, a bridge bank, existing bank, or to exchange bank-specific information with foreign an AMC). supervisory authorities. However, domestic and cross- There are no industry-financed resolution funds border powers to exchange bank-specific information or statutory systemic funding through temporary between supervisory or resolution authorities and government financing with ex post bank levies in place other agencies (for example, finance ministries and in any of the countries. Nor are there any proposals nonbank financial institution regulators) are limited. to implement such arrangements. TA programs in This limitation constrains a jurisdiction’s ability to some countries (for example, Botswana and Lesotho) coordinate bank recovery and resolution, particularly and FSAP reports (for example, Namibia) have where the supervisory and resolution roles are recommended that the countries establish either conducted by different agencies. Legal powers and industry-funded resolution funding schemes (beyond associated confidentiality requirements need to be deposit insurance) or a statutory framework enabling strengthened for bank-specific information exchange the government to provide resolution funding. The and cooperation between supervision and resolution statutory framework would be subject to robust authorities and other relevant domestic agencies, and safeguards, including defined preconditions and a between countries. statutory capacity for the government to recover any Most countries lack a financial stability committee public funding outlays (in net present value terms) (FSC) or a similar body to coordinate domestic from the banking industry. Those TA and FSAP crisis management. South Africa has a Financial reports also recommended that a statutory framework Stability Oversight Committee and a Financial Sector specify the objectives of and preconditions for any Contingency Forum and is planning to establish a use of public funding in bank resolution to minimize council of financial regulators. In Zimbabwe, an FSC moral hazard and excessive risk to the taxpayer. was established in 2012. In other countries, the absence For most countries with relatively small banking of an FSC is a significant gap in their frameworks for systems, the general view is that a postfunded dealing with systemic bank distress situations, given system—under which the government provides that the capacity to respond effectively to a systemic interim funding and then levies banks on an ex post crisis requires effective coordination between the basis to recover any funding outlays not reimbursed relevant agencies. More generally, the lack of effective from assets of the resolved bank—is a more efficient FSC arrangements impedes developing a coordinated and less burdensome way to fund systemic resolution approach to promoting financial stability. Accordingly, than a pre-funded scheme with ex ante levies on banks. it is recommended that FSC arrangements should be This postfunded system recognizes a low probability established in countries that do not currently have them. of systemic bank failures. Building a potentially large FINANCIAL SAFETY NETS AND BANK RESOLUTION FRAMEWORKS IN SOUTHERN AFRICA: KEY ISSUES AND CHALLENGES 27 Supervisory authorities have established MOUs 4.5. Deposit Insurance with their counterparts in other countries to facilitate Arrangements information exchange and cooperation. However, those memoranda mainly address supervision issues Of the eight countries covered in this study, only and do not specifically provide a basis for information two (Mozambique and Zimbabwe) have established exchange for cross-border recovery or resolution. a deposit insurance scheme. South Africa will Similarly, comprehensive MOUs have not been implement a deposit insurance scheme following developed at a domestic level between the relevant passage of its resolution bill in 2019. Namibia is agencies to deal with bank recovery and resolution currently establishing a deposit insurance scheme. issues. The absence of domestic and cross-border Zambia prepared a draft bill for a deposit insurance MOUs significantly impedes effective coordination scheme, but this draft apparently has not been enacted. and needs to be addressed as part of the wider effort to Botswana and Lesotho have received technical strengthen bank recovery and resolution arrangements. support that included recommendations (in 2016 and 2017 respectively) to establish deposit insurance Authorities in the region, potentially led by the schemes.22 Lesotho has undertaken some work in SARB given the prevalence of cross-border banks developing proposals for deposit insurance, but the headquartered in South Africa, should promote effort has not progressed to a public discussion paper dialogue on cross-border cooperation and coordination or formal proposal. on bank early intervention, recovery planning, ELA, and resolution. Initially, South Africa could host such The absence of deposit insurance in most of the an effort in the form of a policy dialogue or conference countries in the region presents a significant gap in of all relevant authorities to agree on the areas needing the financial safety net and increases the risk of retail cooperation and coordination. In addition, the region’s deposit runs in periods of banking system stress. The authorities could host a work session to establish the absence of deposit insurance increases the probability frameworks that include developing MOUs, creating of fiscal authorities coming under political pressure to policies to coordinate each stage of generic crisis bail out failing banks or to introduce ad hoc protection management, and identifying key elements needed for of deposits in cases of bank stress. The relatively high bank-specific cross-border coordination of recovery level of interconnectedness between banking systems plans and resolution plans. in southern African countries results in a significant risk of contagion should the parent banks fail or Except for South Africa and Namibia, which have become acutely distressed. The absence of deposit entered into supervisory groups (SG) or colleges and insurance in most countries in the region increases crisis management groups (CMG) for some D-SIBs, the risk of contagious runs triggered by distress in the the authorities lack formal coordination mechanisms. parent banks. This lack impedes effective cross-border coordination, especially in relation to the major South African Before deposit insurance is established, basic banks. Once suitable cross-border bank recovery and preconditions must be in place to reduce moral hazard. resolution MOUs have been established, the authorities A summary of the standard preconditions for deposit (led by the SARB) should establish a regional SG and insurance are listed in box 4. In addition, countries CMG covering the South African banks operating in must have a comprehensive insolvency law and the region. The SG and CMG would help to foster the efficient, well-resourced judicial systems to enable development of coordinated recovery and resolution banks to be liquidated in a timely manner and without plans for these banks. undue sacrifice of value or disruption to financial IMF TA reports provided to Botswana in March 2016 and Lesotho in February 2017 22 4. KEY ISSUES AND CHALLENGES 28 markets and the economy. To varying degrees, those • Strengthen insolvency laws and provide courts preconditions exist in the countries included in this with specialist resources needed to facilitate study. However, significant deficiencies and further efficient insolvency and liquidation proceedings. improvements are needed, including the following: • Strengthen cross-border cooperation and • Further develop accounting and auditing standards coordination to ensure effective regulation, and practice. supervision, and resolution. • Strengthen governance and risk management Addressing those improvements requires a frameworks in banks. comprehensive effort at the national level in the medium to long term. Subject to this effort, deposit • Further strengthen risk-based supervision, capital insurance schemes need to be established in the requirements, and corrective action frameworks. countries in question, in parallel with other reforms to • Establish more comprehensive recovery and strengthen the overall financial safety net. resolution arrangements. Box 4: Preconditions for Effective Deposit Insurance The International Association of Deposit Insurers’ (IADI) “Core Principles for Effective Deposit Insurance Systems” (2014) describe how the establishment and design features of deposit insurance depend on many preconditions. Without these, deposit insurance would be less effective and could create moral hazard. The preconditions include the following: • Macroeconomic environment. Macroeconomic conditions influence the effectiveness of markets, the ability of the financial system to intermediate resources, and economic growth. Persistent instability hampers the functioning of markets, and such conditions affect the ability of financial institutions to absorb and manage their risks. In periods of economic instability, market volatility can lead to destabilizing creditor runs (including depositor runs). • Financial system structure. The soundness of a financial system influences the appropriate design features of a deposit insurance system. Any assessment of a deposit insurance system should consider the health and structure of the financial sector and the range of possible demands on the deposit insurer. The existence of and nature of depositor preference is also relevant to consider when designing a deposit insurance framework. • Prudential regulation, supervision, and resolution. Strong prudential regulation and supervision help to ensure that an institution’s weaknesses are promptly identified and corrected. Implementation of corrective measures is monitored and, where deficient, early intervention and an effective resolution regime help to lower the costs associated with bank failures. Supervision helps to reduce moral hazard risks that would otherwise arise. An effective resolution regime is essential, including timely entry into resolution and the availability of a range of resolution options. • Legal framework. Deposit insurance systems cannot be effective if relevant and comprehensive laws do not exist or if the legal regime is characterized by significant inconsistencies. The legal framework has a significant impact on the activities of the deposit insurance system. A well-developed legal framework should incorporate a system of business laws, including corporate, insolvency, contract, creditor rights, consumer protection, anti-corruption and fraud and private property laws. • Accounting, disclosure, and auditing. Sound accounting and disclosure regimes are necessary for the effective evaluation of risks by deposit insurance systems. Accurate, reliable, and timely information can be used by management, depositors, the market, and authorities to make decisions regarding the risk profile of an institution and thereby increase market, regulatory, and supervisory discipline. A sound accounting and disclosure regime includes comprehensive and well-defined accounting principles and rules that command wide international acceptance. Effective auditing is essential to the verification of the accuracy of disclosures and compliance with accounting standards. FINANCIAL SAFETY NETS AND BANK RESOLUTION FRAMEWORKS IN SOUTHERN AFRICA: KEY ISSUES AND CHALLENGES 29 The only fully operational deposit insurance regime cost contribution to alternative forms of resolution, in the region, in Zimbabwe, needs considerable in case of a paybox plus model. strengthening to align with best practice.23 A recent Depositor preference is a related issue that warrants report identified the need to (a) establish an SCV, careful consideration in the countries covered by this (b) develop the systems and processes for prompt study. Most of the countries do not have depositor payout (with an ultimate target of payout within seven preference (that is, a law under which depositors days), (c) further enhance P&A capacity, (d) and meeting specified eligibility criteria rank ahead of ensure that there are robust domestic and cross-border other senior unsecured creditors in the liquidation of coordination arrangements.24 Contingency plans also a bank). The absence of depositor preference creates a need to be developed, and regular simulation testing heightened risk of depositor runs in periods of instability needs to be adopted to ensure that the deposit insurance and can make it more difficult to apply certain forms agency is capable of performing its functions to the of resolution, such as bail-in. Accordingly, questions standard required, both in the accuracy of payout and that warrant further assessment across the region are deposit account transfer and in the speed. as follows: Should some form of depositor preference In South Africa, the deposit insurance scheme is be established? If so, what form should it take? Should intended to be a paybox plus scheme and operated preference be limited to categories of depositors or independently from, but affiliated to, the SARB. This should it apply to all types of depositors? Authorities scheme will be pre-funded by regular levies on banks, should undertake an assessment of these matters as with back-up funding from the SARB. part of their review of resolution laws and depositor protection arrangements. Some of the countries in the region are likely to require technical support to establish or improve their deposit insurance arrangements. Key areas 4.6. Emergency Liquidity Assistance include (a) design of the policy framework and Existing laws across the region generally provide institutional arrangements, (b) mandate (for example, adequate powers for central banks to provide ELA paybox, paybox plus, or a more complicated risk to banks. However, in most of the countries the laws minimization), (c) types of deposits covered, (d) size lack clear objectives for ELA, such as an objective of insurance limit, (e) gross versus net payment, and relating to financial system stability. The laws are (f) funding arrangements (including the regular bank also unclear about the preconditions for providing levy arrangements, contingent funding line with the ELA and the central banks’ obligations to develop government or another party, and ex post additional clearly specified policies and procedures for ELA. bank levy arrangements). This impedes the transparency of ELA policies and Additional support may be needed for the design of accountability for ELA. the funding arrangements, including the scoping of Existing laws in the region do not provide for the required target size of the fund, the period to reach government indemnities when a central bank is the target size and the levies needed to establish this, required or encouraged by the government to provide plus supplementary credit lines with the government. ELA where there is inadequate collateral or where Operational support would include arrangements to there is material doubt over a bank’s capital adequacy. (a) enable an SCV, (b) facilitate prompt payout (that This gap is significant and could impede effective is, seven days or less), (c) facilitate P&A transactions, ELA, especially in situations where a bank that needs and (d) have a methodology to calculate the least- ELA is undercapitalized (but still solvent) and is either in recovery mode or being resolved. 23 World Bank, “Zimbabwe: Deposit Protection Corporation: Action Plan to Improve Its Compliance with the IADI Core Principles” (technical note, World Bank, Washington DC, January 2017). 24 SCV is the ability to identify eligible depositors for deposit insurance purposes and calculate, at any given time, the aggregate amount payable to each individual depositor including depositors with multiple bank deposits and joint accounts. 4. KEY ISSUES AND CHALLENGES 30 Although details on ELA policy in the region are 100 percent reserves to support parity with the rand. not publicly available, central banks appear to have The central banks in these countries (Eswatini, underdeveloped ELA policies, procedures, and Lesotho, and Namibia) need to ensure that their indicative terms sheets. According to TA reports for ELA frameworks are designed within this constraint. Botswana and Lesotho (2016 and 2017) and FSAP Accordingly, several factors need to be considered, reports on some of the other countries, central banks including ELA funding for CMA host jurisdictions in need to establish clearly documented preconditions a form that does not impede the ability to maintain and terms and conditions for ELA if they are to avoid parity with the rand and any need to arrange currency ad hoc responses in periods of crisis. In Botswana swaps between countries in the CMA. in 2016 and Lesotho in 2017, no substantive ELA Coordination arrangements for ELA appear to be preconditions, terms, or conditions were in place. insufficient between central banks, supervisory Collateral arrangements require further attention agencies, ministries of finance, and resolution and documentation. Laws must ensure that banks’ authorities. Also, adequate coordination for ELA is loan portfolios can be used for collateral purposes lacking between central banks across the region in areas and that banks are pre-positioned to enable sale and such as home and host central bank responsibilities repurchase agreements to be in place and activated in group distress situations, cross-border access to quickly when needed. The capacity to undertake collateral, cross-border asset pledges, and parent bank valuations of collateral and to obtain legally robust guarantees. Currency swap arrangements between arrangements for accessing bank collateral, including the SARB and other central banks in the region also over bank loan portfolios, needs further development. warrant attention. In addition, there is inadequate specification of the Central banks appear not to be adequately testing their allocation of authorities’ respective responsibilities ELA capacity, including through regular cross-agency for viability assessment, systemic impact assessment, bank stress or failure simulation exercises. This testing and collateral valuation as part of the ELA framework. should be given appropriate priority in the efforts to Countries belonging to the Common Monetary Area strengthen crisis management preparedness. (CMA) for the South African rand are constrained in their ability to provide ELA, given the need for FINANCIAL SAFETY NETS AND BANK RESOLUTION FRAMEWORKS IN SOUTHERN AFRICA: KEY ISSUES AND CHALLENGES 31 FINANCE, COMPETITIVENESS & INNOVATION INSIGHT | FINANCIAL STABILITY & INTEGRITY 5. POLICY RECOMMENDATIONS C ountries in southern Africa need significant reforms to establish robust frameworks for the early detection of bank stress, recovery planning, preventive and corrective action, ELA, resolution planning, resolution measures, deposit insurance, and resolution funding (beyond deposit insurance). Considerable strengthening is also needed for the domestic and cross-border coordination frameworks across these areas. Capacity building is also a pressing area, particularly in the form of regular domestic crisis simulation exercises and occasional cross-border exercises. Technical support requirements will vary introduced, detailed resolution policies and practices considerably from country to country, taking into must be developed. And before the policies and account each country’s stage of development, practices are developed, bank-specific resolvability policy frameworks, internal capacity, and initiatives assessments and resolution plans must be developed. proposed or under way. Technical support also needs Accordingly, to identify the reforms needed, the to be considered for each country’s financial sector authorities in each country may need guidance on development programs. Technical support needs to developing appropriate sequencing of reforms that be coordinated with existing TA and FSAP programs consider the country’s current legal, institutional, and with the various TA providers. Each country and policy environment. will need a coordinated and prioritized strategy. Subject to those points, the main areas of focus for As important, the authorities receiving TA must reform and TA are likely to include the following: establish their internal capacity to follow through on the assistance provided. In that way, senior levels in • Early detection of bank stress and preventive each agency will claim ownership of the programs and corrective action. In most countries, the and TA providers will monitor the implementation of early detection of bank stress and preventive and post-TA work programs. corrective action need to be strengthened. Most of the countries in the region are likely to benefit The sequencing of reforms will be important. The from TA in this area. The matters on which TA particular sequence of reforms will vary depending might be helpful could include (a) developing on each country’s stage of development in economic and using EWIs, (b) interconnecting EWIs and policies, risk management arrangements for banks, triggers in a preventive and corrective action banking supervision, insolvency law, and many framework, (c) developing a structured framework other considerations. An example of the importance of triggers and response actions, (d) integrating of sequencing is deposit insurance. Before deposit bank recovery plan activation with supervisory insurance can be established, a country must first preventive and corrective action frameworks, establish a robust banking regulatory and supervisory (e) promoting amendments to laws to ensure framework, sound insolvency law, and high-quality the supervision authority has comprehensive bank governance and risk management practices, powers under a preventive and corrective action together with effective financial reporting and framework and that the penalties are appropriate, auditing standards. Another example of sequencing is and (f) developing a framework to regularly test in ELA. A country needs to establish comprehensive the preventive and corrective action arrangements. liquidity prudential requirements for banks, including minimum liquidity buffers and risk management • Recovery planning. In most countries in the region, requirements, before ELA policies are formalized TA might be helpful to assist supervisory authorities and announced. Likewise, before resolution laws are develop and implement recovery planning for FINANCIAL SAFETY NETS AND BANK RESOLUTION FRAMEWORKS IN SOUTHERN AFRICA: KEY ISSUES AND CHALLENGES 33 D-SIBs and eventually for all banks. Such TA would coordination between the central bank and other likely include assistance in the following areas: agencies (especially the supervision authority), (a) ensuring that supervisory authorities have the and (j) developing regular testing arrangements. necessary legal powers to require banks to prepare • Deposit insurance. Countries that do not have and regularly test recovery plans, (b) designing deposit insurance may need targeted TA for recovery planning regulatory requirements, (c) designing and implementing deposit insurance, integrating recovery plan activation into supervisory in combination with TA for establishing the preventive and corrective action arrangements, and preconditions for deposit insurance. In these cases, (d) designing recovery plan testing arrangements. the TA would likely be informed by the IADI Core TA might also be useful to assist authorities to Principles and cover various matters, including develop the frameworks required for supervisors the following: (a) design of an appropriate form to assess bank recovery plans and undertake of deposit insurance for the country (for example, comparative analysis. paybox plus); (b) architecture of the deposit • Resolution arrangements. In most countries in the insurance scheme, including the agency to perform region, TA might be helpful to develop resolution the functions and its governance and accountability frameworks that potentially include the following: arrangements; (c) functions of the deposit insurance (a) amendments to laws to establish a dedicated scheme and the legal powers required; (d) SCV resolution authority or expand the authority of the capacity; (e) payout and P&A capacity; (f) funding central bank or supervision authority to include options; (g) levy arrangements; and (h) recovery resolution; (b) the specification of statutory powers. For countries with deposit insurance, TA objectives and powers for resolution; (c) resolution might be needed for such matters as (a) ensuring safeguards; (d) funding for resolution beyond the capacity for SCV, (b) ensuring prompt payout deposit insurance and associated safeguards; (e) options and pre-positioning, (c) developing P&A resolution methodologies, policies, and toolkit; (f) options and pre-positioning, (d) providing a least- framework required for resolvability assessments cost assessment framework, and (e) coordinating and resolution planning; (g) data templates and with supervisory authorities and with cross-border reporting requirements needed for resolvability matters. TA might also be useful in helping to build assessments and resolution plans; (h) domestic capacity in the deposit insurance agency through coordination frameworks; (i) cross-border regular testing arrangements. coordination frameworks; (j) mutual recognition • Domestic coordination. In some countries, and enforcement frameworks for cross-border TA might be helpful to strengthen domestic resolution; (k) guidance on crisis management coordination for crisis management, including the groups; and (l) capacity-building and testing following: (a) establish an FSC or similar domestic arrangements. coordination body, (b) develop multilateral and • ELA. Depending on the country, TA for ELA bilateral MOUs, (c) develop a crisis management may be needed for the following: (a) specifying toolkit, and (d) develop arrangements for capacity the statutory objectives of ELA and incorporating building and testing. these into central bank laws, (b) strengthening the • Cross-border coordination. All countries in the central banks’ powers for ELA, (c) specifying the region need effective cross-border coordination for statutory preconditions for ELA, (d) developing bank recovery and resolution. TA might be useful the policy framework for ELA, (e) developing in various areas, including the development of (a) indicative terms and conditions for ELA, (f) multilateral and bilateral MOUs, (b) SPE and MPE specifying collateral requirements and pre- cross-border resolution frameworks, (c) crisis positioning, (g) developing the frameworks for management groups, and (d) testing arrangements. viability assessment, (h) developing collateral valuation methodology, (i) establishing appropriate A brief assessment of TA needs for each country in the region is summarized in annex I. 5. POLICY RECOMMENDATIONS 34 FINANCE, COMPETITIVENESS & INNOVATION INSIGHT | FINANCIAL STABILITY & INTEGRITY ANNEX I: POTENTIAL AREAS FOR TECHNICAL ASSISTANCE, BY COUNTRY BOTSWANA Topic Possible Technical Assistance Needs TA might be needed for the following: • Strengthen the legal powers relating to corrective action. • Develop a more structured and transparent approach to corrective action triggers and associated actions. Corrective • Integrate recovery planning activation into the supervisory authority’s corrective action framework. action • Further develop EWIs and link them to corrective action and recovery plan activation triggers. • Develop contingency plans for dealing with indicative examples of bank weakness and non-compliance. • Develop a program for regular testing of the corrective action framework. TA might be needed to help review the supervisory authority’s existing legal capacity to require banks to prepare and test recovery plans. TA might also help develop policy for recovery planning regulations (covering recovery plan triggers, restoration points, Recovery recovery options, recovery implementation and preparatory measures, governance arrangements for recovery plans, planning scenario development, recovery communications, and integration of recovery plans with banks’ risk management frameworks), for integrating recovery plan activation into corrective action arrangements, and for testing recovery plans. Guidance might help supervisors assess recovery plans, through both off-site and on-site methodologies. TA might help review and advise on amendments to laws on bank resolution to ensure that the laws are sufficiently comprehensive and aligned to the Key Attributes and have appropriate modifications for the country’s institutional framework and stage of development. Resolution TA might also be needed to help develop resolution policies, a resolution toolkit, a framework for resolvability assessment and resolution planning, and resolution testing. TA might also be needed to assist in cross-border resolution arrangements, especially SPE and MPE options, in conjunction with the home authorities. TA might be helpful to develop or refine domestic coordination arrangements for crisis management, including Domestic bilateral and multilateral crisis management MOUs, an FSC framework, and a program for domestic crisis simulation coordination exercises. TA might be helpful to develop home and host cross-border resolution frameworks, including offering guidance Cross-border on SPE and MPE options, bilateral and multilateral MOUs, and the eventual development of cross-border crisis coordination simulation exercises. TA might help review existing central bank law to ensure it is sufficiently comprehensive in statutory purposes of ELA, preconditions for ELA, ability to impose terms and conditions on ELA, and capacity for the central bank to lend on the basis of a government indemnity when insufficient collateral exists or the central bank is not satisfied with the bank’s ELA solvency or capital soundness. TA might help develop policies, procedures, and terms and conditions of ELA; collateral selection; collateral valuation; and solvency or capital adequacy assessments. TA might also be helpful for developing a framework of regular ELA testing. TA might be needed for the following: • Establishing a deposit insurance regime, including statutory purposes, institutional arrangements, legal powers, deposit insurance limit, deposit insurance coverage, funding arrangements, and interagency coordination • Developing the capacity for SCV and pre-positioning in banks for payouts and for P&A transactions Deposit • Developing prompt payout capacity within the deposit insurance agency insurance • Developing P&A arrangements • Developing a least-cost methodology • Developing, in conjunction with the supervision authority, defined triggers for handing responsibility to the deposit insurance agency • Developing the levy arrangements and supplemental funding structure with the government or other agency FINANCIAL SAFETY NETS AND BANK RESOLUTION FRAMEWORKS IN SOUTHERN AFRICA: KEY ISSUES AND CHALLENGES 35 ESWATINI Topic Possible Technical Assistance Needs TA might be needed to help with the following: • Strengthen the legal powers relating to corrective action. • Develop a more structured and transparent approach to corrective action triggers and associated actions Corrective • Integrate recovery planning activation into the supervisory authority’s corrective action framework. action • Develop EWIs and link them to corrective action and recovery plan activation triggers. • Develop contingency plans for dealing with indicative examples of bank weakness and noncompliance. • Develop a program for regular testing of the corrective action framework. TA might be needed to help review existing legal capacity for the supervisory authority to require banks to prepare and test their recovery plans.T A might also help develop policy for recovery planning regulations (covering recovery plan triggers, restoration Recovery points, recovery options, recovery implementation and preparatory measures, governance arrangements for planning recovery plans, scenario development, recovery communications, and integration of recovery plans with banks’ risk management frameworks), for integrating recovery plan activation into corrective action arrangements, and for testing recovery plans. Guidance might help supervisors assess recovery plans, through both off-site and on-site methodologies. TA might be needed to help review and advise on changes to the laws for bank resolution to ensure that the laws are sufficiently comprehensive and aligned to the Key Attributes, with appropriate modifications to suit the institutional framework and stage of the country’s development. Resolution TA might also help develop resolution policies, a resolution toolkit, a framework for resolvability assessment and resolution planning, and resolution testing. TA might also assist in cross-border resolution arrangements, especially SPE and MPE options, in conjunction with the home authorities. TA might help develop or refine domestic coordination arrangements for crisis management, including bilateral Domestic and multilateral crisis management MOUs, an FSC framework, and a program for domestic crisis simulation coordination exercises. TA might help develop home or host cross-border resolution frameworks, including guidance on SPE and Cross-border MPE options, bilateral and multilateral MOUs, and the eventual development of cross-border crisis simulation coordination exercises. TA might help review existing central bank law to ensure that the law is sufficiently comprehensive in respective statutory purposes of ELA, the preconditions for ELA, the ability to impose terms and conditions on ELA, and the capacity for the central bank to lend on the basis of a government indemnity when insufficient collateral exists ELA or the central bank is not satisfied with bank solvency or capital soundness. TA might also help develop policies for preconditions and terms and conditions of ELA, collateral selection, collateral valuation, and solvency or capital adequacy assessment. TA might also help develop a framework of regular ELA testing. TA might be needed for the following: • Establishing a deposit insurance regime, including statutory purposes, institutional arrangements, legal powers, deposit insurance limit, deposit insurance coverage, funding arrangements, and interagency coordination • Developing the capacity for SCV and pre-positioning in banks for payouts and for P&A transactions Deposit • Developing prompt payout capacity within the deposit insurance agency insurance • Developing P&A arrangements • Developing a least-cost methodology • Developing, in conjunction with the supervision authority, defined triggers for handing responsibility to the deposit insurance agency • Developing the levy arrangements and supplemental funding structure with the government or other agency ANNEX I: POTENTIAL AREAS FOR TECHNICAL ASSISTANCE, BY COUNTRY 36 LESOTHO Topic Possible Technical Assistance Needs TA might be needed for the following: • Strengthen the legal powers relating to corrective action. • Develop a more structured and transparent approach to corrective action triggers and associated actions Corrective • Integrate recovery planning activation into the supervisory authority’s corrective action framework. action • Further develop EWIs and link them to corrective action and recovery plan activation triggers. • Develop contingency plans for dealing with indicative examples of bank weakness and non-compliance. • Develop a program for regular testing of the corrective action framework. TA might be needed to help review existing legal capacity for the supervisory authority to require banks prepare and test their recovery plans. TA might also help develop policy for recovery planning regulations (covering recovery plan triggers, restoration Recovery points, recovery options, recovery implementation and preparatory measures, governance arrangements for planning recovery plans, scenario development, recovery communications, and integration of recovery plans with banks’ risk management frameworks), for integrating recovery plan activation into arrangements for corrective action, and for testing recovery plans. Guidance might help supervisors to assess recovery plans, both through off-site and on-site methodologies. TA might help review and advise on changes to the laws on bank resolution to ensure that the laws are sufficiently comprehensive and aligned to the Key Attributes and have appropriate modifications for the country’s institutional framework and stage of development. Resolution TA might also be needed to help develop resolution policies, a resolution toolkit, a framework for resolvability assessment and resolution planning, and resolution testing. TA might also be needed to assist in cross-border resolution arrangements, especially SPE and MPE options, in conjunction with the home authorities. TA might be helpful to develop or refine domestic coordination arrangements for crisis management, including Domestic bilateral and multilateral crisis management MOUs, an FSC framework, and a program for domestic crisis coordination simulation exercises. TA might be helpful to develop home and host cross-border resolution frameworks, including offering guidance Cross-border on SPE and MPE options, bilateral and multilateral MOUs, and the eventual development of cross-border crisis coordination simulation exercises. TA might help review existing central bank law to ensure it is sufficiently comprehensive in statutory purposes of ELA, preconditions for ELA, ability to impose terms and conditions on ELA, and capacity for the central bank to lend on the basis of a government indemnity when insufficient collateral exists or the central bank is not satisfied ELA with the bank’s solvency or capital soundness.T A might help develop policies for preconditions and terms and conditions of ELA, collateral selection, collateral valuation, and solvency or capital adequacy assessment. TA might also be helpful for developing a framework of regular ELA testing. TA might be needed for the following: • Establishing a deposit insurance regime, including statutory purposes, institutional arrangement, legal powers, deposit insurance limit, deposit insurance coverage, funding arrangements and interagency coordination • Developing the capacity for SCV and pre-positioning in banks for payouts and for P&A transactions Deposit • Developing prompt payout capacity within the deposit insurance agency insurance • Developing P&A arrangements • Developing a least-cost methodology • Developing, in conjunction with the supervision authority, defined triggers for handing responsibility to the deposit insurance agency • Developing the levy arrangements and supplemental funding structure with the government or other agency FINANCIAL SAFETY NETS AND BANK RESOLUTION FRAMEWORKS IN SOUTHERN AFRICA: KEY ISSUES AND CHALLENGES 37 MOZAMBIQUE Topic Possible Technical Assistance Needs TA might be needed for the following: • Strengthen the legal powers relating to corrective action. • Develop a more structured and transparent approach to corrective action triggers and associated actions Corrective • Integrate recovery planning activation into the supervisory authority’s corrective action framework. action • Develop EWIs and link them to corrective action and recovery plan activation triggers. • Develop contingency plans for dealing with indicative examples of bank weakness and noncompliance. • Develop a program for regular testing of the corrective action framework. TA might be needed to help review the supervisory authority’s existing legal capacity to require banks to prepare and test recovery plans. TA might also help develop policy for recovery planning regulations (covering recovery plan triggers, restoration Recovery points, recovery options, recovery implementation and preparatory measures, governance arrangements for planning recovery plans, scenario development, recovery communications, and integration of recovery plans with banks’ risk management frameworks), for integrating recovery plan activation into corrective action arrangements, and for testing recovery plans. Guidance might help supervisors assess recovery plans, through both off-site and on-site methodologies. TA might be needed to help review and advise on changes to laws on bank resolution to ensure that the laws are sufficiently comprehensive and aligned to the Key Attributes and have appropriate modifications for country’s institutional framework and stage of development. Resolution TA might also be needed to help develop resolution policies, a resolution toolkit, a framework for resolvability assessment and resolution planning, and resolution testing. TA might also be needed to assist in cross-border resolution arrangements, especially SPE and MPE options, in conjunction with the home authorities. Domestic TA might be helpful to develop or refine domestic coordination arrangements for crisis management, including bilateral coordination and multilateral crisis management MOUs, an FSC framework, and a program for domestic crisis simulation exercises. TA might be helpful to develop home and to host cross-border resolution frameworks, including offering guidance Cross-border on SPE and MPE options, bilateral and multilateral MOUs, and the eventual development of cross-border crisis coordination simulation exercises. TA might help review existing central bank law to ensure it is is sufficiently comprehensive in statutory purposes of ELA, preconditions for ELA, ability to impose terms and conditions on ELA, and capacity for the central bank to lend on the basis of a government indemnity when insufficient collateral exists or the central bank is not ELA satisfied with bank solvency or capital soundness. TA might also assist develop policies for preconditions, and terms and conditions of ELA, collateral selection, collateral valuation, and solvency or capital adequacy assessment. TA might also be helpful for developing a framework of regular ELA testing. A deposit insurance scheme was created in 2010 by Government Decree No. 49. However, reports indicate that the scheme is not fully operational. This situation needs to be clarified. Subject to clarification, TA might be needed to do as follows: • Review existing law to ensure that it is sufficiently comprehensive, including for statutory purposes, institutional arrangements, legal powers, deposit insurance limit, deposit insurance coverage, funding arrangements, and interagency coordination. Deposit • Develop the capacity for SCV and pre-positioning in banks for payouts and for P&A transactions. insurance • Develop prompt payout capacity in the deposit insurance agency. • Develop P&A arrangements. • Develop a least-cost methodology. • Develop in conjunction with the supervision authority defined triggers for handing responsibility to the deposit insurance agency. • Develop levy arrangements and supplemental funding structure with the government or other agency. ANNEX I: POTENTIAL AREAS FOR TECHNICAL ASSISTANCE, BY COUNTRY 38 NAMIBIA Topic Possible Technical Assistance Needs TA might be needed to do the following: • Develop a more structured and transparent approach to corrective action triggers and associated actions. Corrective • Integrate recovery planning activation into the supervisory authority’s corrective action framework. action • Develop EWIs and link them to corrective action and recovery plan activation triggers. • Develop contingency plans for dealing with indicative examples of bank weakness and noncompliance. • Develop a program for regular testing of the corrective action framework. TA might help develop policy for recovery planning regulations (covering recovery plan triggers, restoration points, recovery options, recovery implementation and preparatory measures, governance arrangements Recovery for recovery plans, scenario development, recovery communications, and integration of recovery plans with planning banks’ risk management frameworks), for the integration of recovery plan activation into corrective action arrangements, and for the testing of recovery plans. Guidance might help supervisors assess recovery plans, through both off-site and on-site methodologies. TA might be needed to help develop resolution policies, a resolution toolkit, a framework for resolvability assessment and resolution planning, and resolution testing. In addition, recent draft amendments to the law to strengthen resolution powers and safeguards may benefit from review and further TA to ensure Resolution comprehensiveness and alignment with sound international principles and practice. TA might also help in cross-border resolution arrangements, especially SPE and MPE options, in conjunction with the home authorities. Domestic TA might be helpful to develop or refine domestic coordination arrangements for crisis management, including bilateral coordination and multilateral crisis management MOUs, an FSC framework, and a program for domestic crisis simulation exercises. TA might be helpful to develop home and host cross-border resolution frameworks, including offering guidance Cross-border on SPE and MPE options, bilateral and multilateral MOUs, and the eventual development of cross-border crisis coordination simulation exercises. TA might help review existing central bank law to ensure it is sufficiently comprehensive in statutory purposes of ELA, preconditions for ELA, ability to impose terms and conditions on ELA, and capacity for the central bank to lend on the basis of a government indemnity when insufficient collateral exists or the central bank is not satisfied ELA with the bank’s solvency or capital soundness. TA might help develop policies for preconditions and terms and conditions of ELA, collateral selection, collateral valuation, and solvency or capital adequacy assessment. TA might also be helpful for developing a framework of regular ELA testing. TA might be needed for the following: • Assisting in the development of the new deposit insurance scheme (based on the draft legislation already developed) • Developing the capacity for SCV and pre-positioning in banks for payouts and for P&A transactions Deposit • Developing prompt payout capacity within the deposit insurance agency. insurance • Developing P&A arrangements • Developing a least-cost methodology • Developing, in conjunction with the supervision authority, defined triggers for handing responsibility to the deposit insurance agency • Developing the levy arrangements and supplemental funding structure with the government or other agency FINANCIAL SAFETY NETS AND BANK RESOLUTION FRAMEWORKS IN SOUTHERN AFRICA: KEY ISSUES AND CHALLENGES 39 SOUTH AFRICA Topic Possible Technical Assistance Needs TA might be needed for the following: • Strengthen the legal powers relating to corrective action. But strengthening would need to be assessed following the enactment of the resolution bill. • Develop a more structured and transparent approach to corrective action triggers and associated actions. Corrective • Integrate recovery planning activation into the supervisory authority’s corrective action framework. Although action this integration needs to be assessed considering the recovery planning implementation in South Africa. • Further develop EWIs and link them to corrective action and recovery plan activation triggers. • Further develop contingency plans for dealing with indicative examples of bank weakness and noncompliance. • Develop a program for regular testing of the corrective action framework. The SARB has established recovery planning requirements for at least the systemic banks in South Africa. It is unlikely that the SARB will require TA on recovery planning, other than to develop a framework for recovery Recovery plan testing and to develop a cross-border coordination arrangement for SA banks in other countries. That planning arrangement would to enable the SARB to assist host supervisory authorities develop recovery planning requirements for SA banks in the host countries. Once the resolution bill has been enacted, the SARB might benefit from targeted TA in some areas, such as the following: • Resolvability assessments Resolution • Resolution planning • Development of cross-border resolution arrangements with host countries in which SA banks have systemic operations, including SPE and MPE resolution options Domestic TA is probably not needed at this stage, given the existing arrangements. coordination TA might be helpful to assist the SARB to promote a coordination framework for regional cross-border resolution Cross-border for SA banks in the region, including for SPE and MPE options, coordinating resolution planning, and developing coordination a program for cross-border crisis simulation exercises. TA might help review existing central bank laws to ensure it is sufficiently comprehensive in statutory purposes of ELA, preconditions for ELA, ability to impose terms and conditions on ELA, and capacity for the central bank to lend on the basis of a government indemnity where insufficient collateral exists or the central bank is not ELA satisfied with bank solvency or capital soundness. TA might also help develop policies for preconditions and terms and conditions of ELA, collateral selection, collateral valuation, and solvency or capital adequacy assessment. TA might also help develop a framework of regular ELA testing. Once the resolution bill has been enacted to establish the deposit insurance scheme (likely to be in 2019), authorities might benefit from targeted assistance in the following areas: • Developing the capacity for SCV and pre-positioning in banks for payouts and P&A Deposit • Developing prompt payout capacity within the deposit insurance agency insurance • Developing P&A arrangements • Developing a least-cost methodology • Transitioning eventually to a risk-based levy arrangement ANNEX I: POTENTIAL AREAS FOR TECHNICAL ASSISTANCE, BY COUNTRY 40 ZAMBIA Topic Possible Technical Assistance Needs TA might be needed to do the following: • Strengthen the legal powers relating to corrective action. • Develop a more structured and transparent approach to corrective action triggers and associated actions. Corrective • Integrate recovery planning activation into the supervisory authority’s corrective action framework. action • Develop EWIs and link them to corrective action and recovery plan activation triggers. • Develop contingency plans for dealing with indicative examples of bank weakness and noncompliance. • Develop a program for regular testing of the corrective action framework. TA might help review existing legal capacity for the supervisory authority to require banks to prepare and test their recovery plans. TA might also help develop policy for recovery planning regulations (covering recovery plan triggers, restoration Recovery points, recovery options, recovery implementation and preparatory measures, governance arrangements for planning recovery plans, scenario development, recovery communications, and integration of recovery plans with banks’ risk management frameworks), for integrating recovery plan activation into corrective action arrangements, and for testing recovery plans. Guidance might help supervisors assess recovery plans, through both off-site and on-site methodologies. TA might help review and advise on changes to the laws for bank resolution to ensure that the laws are sufficiently comprehensive and aligned to the Key Attributes, with appropriate modifications to suit the institutional framework and stage of development of the country. Resolution TA might also help develop resolution policies, a resolution toolkit, a framework for resolvability assessment and resolution planning, and resolution testing. TA might also help assist with cross-border resolution arrangements, especially SPE and MPE options, in conjunction with the home authorities. Domestic TA might help develop or refine domestic coordination arrangements for crisis management, including bilateral and coordination multilateral crisis management MOUs, an FSC framework, and a program for domestic crisis simulation exercises. TA might help develop home or host cross-border resolution frameworks, including guidance on SPE and Cross-border MPE options, bilateral and multilateral MOUs, and the eventual development of cross-border crisis simulation coordination exercises. TA might help review existing central bank law to ensure it is sufficiently comprehensive in statutory purposes of ELA, preconditions for ELA, ability to impose terms and conditions on ELA, and capacity for the central bank to lend on the basis of a government indemnity when insufficient collateral exists or the central bank is not satisfied ELA with bank solvency or capital soundness. TA might also help develop policies for preconditions and terms and conditions of ELA, collateral selection, collateral valuation, and solvency or capital adequacy assessment. TA might also help develop a framework of regular ELA testing. TA might be needed for the following: • Establishing a deposit insurance regime, including statutory purposes, institutional arrangements, legal powers, deposit insurance limit, deposit insurance coverage, funding arrangements and interagency coordination • Developing the capacity for SCV and pre-positioning in banks for payouts and for P&A transactions Deposit • Developing prompt payout capacity within the deposit insurance agency insurance • Developing P&A arrangements • Developing a least-cost methodology • Developing, in conjunction with the supervision authority, defined triggers for handing responsibility to the deposit insurance agency • Developing the levy arrangements and supplemental funding structure with the government or other agency FINANCIAL SAFETY NETS AND BANK RESOLUTION FRAMEWORKS IN SOUTHERN AFRICA: KEY ISSUES AND CHALLENGES 41 ZIMBABWE Topic Possible Technical Assistance Needs TA might be needed to do the following: • Strengthen the legal powers relating to corrective action. • Develop a more structured and transparent approach to corrective action triggers and associated actions. Corrective • Integrate recovery planning activation into the supervisory authority’s corrective action framework. action • Develop EWIs and link them to corrective action and recovery plan activation triggers. • Develop contingency plans for dealing with indicative examples of bank weakness and noncompliance. • Develop a program for regular testing of the corrective action framework. TA might be needed to review existing legal capacity for the supervisory authority to require banks to prepare and test their recovery plans. TA might also help develop policy for recovery planning regulations (covering recovery plan triggers, restoration Recovery points, recovery options, recovery implementation and preparatory measures, governance arrangements for planning recovery plans, scenario development, recovery communications, and integration of recovery plans with banks’ risk management frameworks), for integrating recovery plan activation into corrective action arrangements, and testing recovery plans. Guidance might help assist supervisors assess recovery plans, through both off-site and on-site methodologies. TA might be needed to review and advise on changes to the laws for bank resolution to ensure that the laws are sufficiently comprehensive and aligned to the Key Attributes, with appropriate modifications to suit the institutional framework and the country’s stage of development. Resolution TA might also help develop resolution policies, a resolution toolkit, a framework for resolvability assessment and resolution planning, and resolution testing. TA might also assist in cross-border resolution arrangements, especially SPE and MPE options, in conjunction with the home authorities. Domestic TA might help develop or refine domestic coordination arrangements for crisis management, including bilateral and coordination multilateral crisis management MOUs, an FSC framework, and a program for domestic crisis simulation exercises. TA might help develop home or host cross-border resolution frameworks, including guidance on SPE and Cross-border MPE options, bilateral and multilateral MOUs, and the eventual development of cross-border crisis simulation coordination exercises. TA might help review existing central bank law to ensure it is sufficiently comprehensive in respective statutory purposes of ELA, preconditions for ELA, ability to impose terms and conditions on ELA, and capacity for the central bank to lend on the basis of a government indemnity when insufficient collateral exists or the central ELA bank is not satisfied with bank solvency or capital soundness. TA might also help develop policies for preconditions and terms and conditions of ELA, collateral selection, collateral valuation, and solvency or capital adequacy assessment. TA might also help develop a framework of regular ELA testing. • Reforms are intended to implement regulations under the Banking Amendment Act 2015 and to develop Deposit SCV capacity, least-cost test capacity, and P&A capacity. A World Bank technical note made extensive insurance recommendations for improving the deposit insurance arrangements, including SCV capacity, payout functionality, P&A capacity, and domestic coordination arrangements—especially with Zimbabwe. Note: ELAs = emergency liquidity assistance; EWIs = early warning indicators; FSC = financial stability committee; IADI = International Association of Deposit Insurers; MOUs = memoranda of understanding; MPE = multiple points of entry; P&A = purchase and assumption; SARB = South African Reserve Bank; SCV = single customer view; SPE = single point of entry; TA = technical assistance. ANNEX I: POTENTIAL AREAS FOR TECHNICAL ASSISTANCE, BY COUNTRY 42 FINANCE, COMPETITIVENESS & INNOVATION INSIGHT | FINANCIAL STABILITY & INTEGRITY ANNEX II: IADI “CORE PRINCIPLES FOR EFFECTIVE DEPOSIT INSURANCE SYSTEMS” T he International Association of Deposit Insurers (IADI) and the Basel Committee on Banking Supervision (BCBS) issued the “Core Principles for Effective Deposit Insurance Systems” (Core Principles) in June 2009 and revised them in November 2014. The Core Principles are used by jurisdictions as a benchmark for assessing the quality of their deposit insurance systems and for identifying gaps in their deposit insurance practices and measures to address them. The Core Principles are also used by the International Monetary Fund (IMF) and the World Bank (WB) to assess the effectiveness of jurisdictions’ deposit insurance systems and practices. The Core Principles comprise 16 principles: coordination arrangements should be in place among deposit insurers in relevant jurisdictions. Principle 1: Public Policy Objectives Principle 6: Deposit Insurer’s Role The principal public policy objectives for deposit in Contingency Planning and Crisis insurance systems are to protect depositors and Management contribute to financial stability. These objectives should be formally specified and publicly disclosed. The deposit insurer should have in place effective The design of the deposit insurance system should contingency planning and crisis management policies reflect the system’s public policy objectives. and procedures to ensure that it is able to effectively respond to the risk of, and actual, bank failures and Principle 2: Mandate and Powers other events. The development of system-wide crisis preparedness strategies and management policies The mandate and powers of the deposit insurer should be the joint responsibility of all safety- should support the public policy objectives and be net participants. The deposit insurer should be a clearly defined and formally specified in legislation. member of any institutional framework for ongoing Principle 3: Governance communication and coordination involving financial safety-net participants related to systemwide crisis The deposit insurer should be operationally preparedness and management. independent, well-governed, transparent, accountable, and insulated from external interference. Principle 7: Membership Principle 4: Relationships with Other Membership in a deposit insurance system should be Financial Safety Net Providers compulsory for all banks. To protect depositors and contribute to financial Principle 8: Coverage stability, there should be a formal and comprehensive Policy makers should define clearly the level and framework in place for the close coordination of scope of deposit coverage. Coverage should be activities and information sharing, on an ongoing limited, credible, and cover most depositors but leave basis, between the deposit insurer and other financial a substantial amount of deposits exposed to market safety-net participants. discipline. Deposit insurance coverage should be Principle 5: Cross-Border Issues consistent with the deposit insurance system’s public policy objectives and related design features. Where there is a material presence of foreign banks in a jurisdiction, formal information sharing and FINANCIAL SAFETY NETS AND BANK RESOLUTION FRAMEWORKS IN SOUTHERN AFRICA: KEY ISSUES AND CHALLENGES 43 Principle 9: Sources and Uses of Funds Principle 13: Early Detection and Timely Intervention The deposit insurer should have readily available funds and all funding mechanisms necessary to The deposit insurer should be part of a framework ensure prompt reimbursement of depositors’ claims, within the financial safety-net that provides for including assured liquidity funding arrangements. the early detection of, and timely intervention in, Responsibility for paying the cost of deposit troubled banks. The framework should provide for insurance should be borne by banks. intervention before the bank becomes nonviable. Such actions should protect depositors and contribute Principle 10: Public Awareness to financial stability. To protect depositors and contribute to financial Principle 14: Failure Resolution stability, it is essential that the public be informed on an ongoing basis about the benefits and limitations of An effective failure resolution regime should enable the deposit insurance system. the deposit insurer to provide for protection of depositors and contribute to financial stability. The Principle 11: Legal Protection legal framework should include a special resolution regime. The deposit insurer and individuals working both currently and formerly for the deposit insurer in the Principle 15: Reimbursing Depositors discharge of its mandate must be protected from liability arising from actions, claims, lawsuits, or The deposit insurance system should reimburse other proceedings for their decisions, actions, or depositors’ insured funds promptly, to contribute omissions taken in good faith in the normal course to financial stability. There should be a clear of their duties. Legal protection should be defined in and unequivocal trigger for insured depositor legislation. reimbursement. Principle 12: Dealings with Parties at Principle 16: Recoveries Fault in a Bank Failure The deposit insurer should have, by law, the right to The deposit insurer, or other relevant authority, recover its claims in accordance with the statutory should be provided with the power to seek legal creditor hierarchy. redress against those parties at fault in a bank failure. ANNEX II: IADI “CORE PRINCIPLES FOR EFFECTIVE DEPOSIT INSURANCE SYSTEMS” 44 FINANCE, COMPETITIVENESS & INNOVATION INSIGHT | FINANCIAL STABILITY & INTEGRITY ANNEX III: EARLY WARNING INDICATORS E arly warning indicators (EWIs) are used by supervisory authorities and banks’ management and boards to identify early signs of emerging stress. For banks, EWIs are often linked to risk appetite For supervisory authorities, EWIs are used to monitor statements and are monitored regularly by bank individual banks and the banking system, particularly boards and management to identify early indications to detect emerging stress points and vulnerabilities. of deteriorating risk so that adjustments can be EWIs can be linked to the triggers in supervisory made to the tolerances for risks. EWIs are also preventive and correction action frameworks to take used by banks with their contingency plans, such as preparatory initiatives in anticipation of potential recovery plans, capital contingency plans, liquidity breaches of triggers. They are typically selected contingency plans, and business continuity plans, to for their predictive capacity to enable supervisors provide early alerts for remedial actions. to proactively address emerging risks in individual banks and banking systems. Table 3: Examples of Early Warning Indicators (EWIs) for Capital, Asset Quality, and Liquidity Risk Area EWIs • Rapid lending growth • Deteriorating asset quality • Weakening profitability, narrowing of margins • Shift in assets to higher risk-weighted credit exposures Capital • Rapid growth in off-balance sheet credit exposures and in market risks and operating risks • Increase in exposure concentration • Increase in lending to related parties • Deterioration in quality of governance • Deterioration in risk management • Weakening asset prices • Deteriorating household incomes • Deteriorating business incomes Asset quality • Increasing interest rates • Increasing household and business leverage • Decrease in credit risk management • Increase in lending relative to other banks • Shortening of liability maturities • Lengthening of asset maturities • Increase in maturity mismatches • Weakening depositor confidence Liquidity • Increasing rate of depositor withdrawal • Increase in risk premium on funding • Tightening in interbank funding • Decline in credit rating FINANCIAL SAFETY NETS AND BANK RESOLUTION FRAMEWORKS IN SOUTHERN AFRICA: KEY ISSUES AND CHALLENGES 45 FINANCE, COMPETITIVENESS & INNOVATION INSIGHT | FINANCIAL STABILITY & INTEGRITY ANNEX IV: STRESS TESTING S tress tests are used to assess the vulnerability of a bank or the banking system to a range of economic and financial shocks. There are several forms of stress tests, but the main types are summarized here. Single Factor Sensitivity Tests Single factor sensitivity tests evaluate the effect Scenario-based Stress Tests on capital and liquidity of movements in specific variables, such as interest rates, exchange rates, Scenario-based stress tests involve selecting a given and asset prices, in isolation from broader shocks. scenario and assessing the effects on a financial Commonly used stress tests of this nature include institution’s profits, capital, and liquidity, among parallel and nonparallel shifts in the yield curve to other matters. These tests tend to be the most assess the effect of interest rate shocks on net profits commonly used forms of stress tests because they are and capital. Similarly, sensitivity stress tests are more comprehensive than single factor sensitivity often used to assess the effects on profits and capital tests and they seek to capture the interconnectedness arising from increases or decreases in bilateral or of the different factors at play in a broad-based trade-weighted exchange rates. Other forms of scenario. They represent a closer approximation of single factor sensitivity tests can include shocks to real-world economic and financial shocks than is asset prices, such as residential property, commercial possible in limited-scope sensitivity tests. property, or rural property to assess the effect on Scenario-based stress tests involve a combination asset quality, profits, and capital. of economic and financial shocks based on a These stress tests isolate the effects of financial shocks macrofinancial scenario and where the shocks to on asset quality, profits, and capital (and sometimes variables are integrated in a manner that broadly on liquidity). In turn, the tests can help formulate resembles historical patterns of actual economic and prudential requirements for risk management, such financial shocks. The factors included in a typical as prudential regulations on net open currency scenario-based stress test can include the following: positions, interest rate exposure, and exposures to • Contraction in real GDP and other proxies for asset categories. However, single factor sensitivity economic activity, such as economic output tests are of limited use for comprehensively evaluating by sector, manufacturing output, consumption the potential vulnerability of financial institutions expenditure, and so forth to economic and financial shocks because they • Increase in unemployment and underemployment assume that all other variables, other than the ones (and hence a strain on borrower debt servicing being tested for, remain stable. They do not reflect capacity) the real-world impact of economic and financial shocks because they ignore the interconnectedness • Increase in individual and business bankruptcies of shocks and second-round effects. For a more (and therefore borrower default) meaningful and comprehensive assessment to be • Contraction in real incomes of the household and undertaken, stress tests need to broader, generally business sectors (and hence adverse implications anchored to a particular scenario, and based on an for borrower debt servicing capacity) integrated approach where the interplay of different variables is captured, albeit relatively simplified, in • Decline in asset prices, with impacts on bank the stress testing framework. collateral values and on the value of investment FINANCIAL SAFETY NETS AND BANK RESOLUTION FRAMEWORKS IN SOUTHERN AFRICA: KEY ISSUES AND CHALLENGES 47 assets of insurers and wealth management vehicles and liabilities, are assessed by reference to specified (and therefore implications for loss given default shocks, isolated from an assessment of wider [LGD] and investment losses) economic shocks that might affect asset quality, net • Shifts in interest rates and the exchange rate, income, and capital. For example, shocks can affect commensurate with the primary shock cash inflows because of increases in NPLs, reduced growth in new deposits, reduced reinvestment • Liquidity shocks that are designed to be consistent of existing deposits, and so forth. They can also with the primary shock (for example, reduced cash include shocks to cash outflows because of increased inflows caused by increases in nonperforming withdrawals of deposits. Specified assumptions will loans [NPLs], reduced cash inflows arising from also be made to changes in the maturity profile of reductions in new deposits, and increased cash assets and liabilities (such as a shortening in the outflows because of higher-than-normal deposit average maturity of new deposits) and to the behavior withdrawals) of depositors and other providers of funding. These Scenario-based stress tests can also feature individual stress tests are often used by banks and supervisors counterparty failures, such as large exposure to assess whether a bank’s holdings of high-quality counterparties associated with industries that, in the liquid assets (HQLA) are sufficient to withstand a scenario, are assumed to be experiencing adverse range of liquidity shocks. They are also used to test a effects of the economic and financial shocks. bank’s liquidity coverage ratio (LCR) under assumed stress conditions. Reverse Stress Tests Although these tests are typically applied to banks, Reverse stress tests specify the magnitude and nature especially in the context of testing LCR, a modified of economic or financial shocks required to cause form of liquidity stress testing can be applied to other an entity or group to breach capital or liquidity financial institutions, including insurers and wealth requirements or to default on financial obligations. management vehicles. These stress tests are not yet commonly applied by supervisory authorities or banks. However, with the For insurers, liquidity stress can arise from higher- increasing importance of recovery and resolution than-normal claims, as well as cancellations of planning, and therefore the focus on nonviability, policies (for a short-term insurer, if policyholders reverse stress testing is likely to become more decide to cancel existing policies because of commonly used by supervisory authorities in the concerns over the claims payment strength of that future. They will be particularly helpful in calibrating insurer). Liquidity pressures can also arise from the magnitude and dynamic of economic and financial stressed asset markets, where investment assets fall shocks needed in scenarios within banks’ recovery in value and may also become less liquid in nature plans to result in a breach of recovery plan triggers (for example, harder to liquidate in the financial and hence the activation of the recovery plan. markets). This pressure has the potential to affect an insurer’s capacity to meet its financial obligations. Liquidity Stress Tests In wealth management vehicles, liquidity pressures Liquidity stress tests involve an assessment of the can arise from investors seeking to withdraw funds liquidity impact of shocks to financial institutions from investment vehicles because of concerns over (especially banks). There are two main kinds of adverse market conditions and possible further liquidity stress tests, as discussed here. downside rise to their investment portfolios. Isolated Liquidity Stress Tests Liquidity Stress Testing as Part of a Broader Scenario Test In isolated liquidity stress tests, a financial institution’s cash inflows and outflows, and changes In a macrofinancial scenario stress test, liquidity to the maturity profile and composition of assets pressures can be incorporated into the test alongside ANNEX IV: STRESS TESTING 48 the stresses to credit risk, market risks, and investment round effects and the behavioral reactions of financial risks. Some of the liquidity stress will arise directly institutions. Where a financial institution’s PDs and from the impact of credit risk and market risk because LGDs appear to be an outlier to historical norms or to of reduced cash flows from the loan portfolio and other financial institutions, the supervisory authority changes in net interest income from the assumed may adjust the institution’s PDs and LGDs using a movement in interest rates. These are part of an PD and a LGD that are closer to historical norms or integrated stress test, in which the impact of financial industry averages. and economic shocks will flow to different parts of Bottom-up Stress Tests a financial institution’s balance sheet and income statement—and therefore cash flows and HQLA. In contrast, a bottom-up stress test is undertaken In addition, a macrofinancial stress test will also by individual financial institutions using their own typically include shocks to funding, such as assumed internal models for calculating PD and LGD, based higher levels of deposit withdrawals, a reduction in on historical data. This test generally disregards new deposits, a shortening of deposit maturities, and the impact of second-round effects and behavioral reduced interbank lending. impacts arising from other financial institutions. Bottom-up stress tests are based on each institution’s Again, the liquidity implications of macrofinancial chosen scenario unless a generalized scenario is stress tests will be most acute for banks, given the imposed on the institutions by the supervisory nature of their balance sheets. The implications will authority (which is often the case). Bottom-up stress be less pertinent for insurers and wealth management tests are helpful in identifying potential impacts on vehicles. However, liquidity stress tests can be individual financial institutions but are less useful for incorporated into macrofinancial stress tests that system-wide impact assessment because of a lack of will have implications for insurers and wealth consistency in modelling for PD and LGD. Unless management entities, such as through the effects the PD and LGD for each institution are reviewed of falls in investment portfolios and the behavioral by the supervisory authority and adjusted where changes to decision making by policyholders and they appear to be out of line with historical norms or investors. industry averages, bottom-up stress tests tend to be Top-Down Versus Bottom-Up Stress Tests less useful as a means of comparing the impacts of stress events on a range of financial institutions than Scenario-based stress tests can either be top down or is the case with top-down stress tests. bottom up, or a combination of both. A Balanced Approach Between Top Down and Top-Down Stress Tests Bottom Up A top-down stress test is one that is run by a central Reflecting the pros and cons of the two approaches, bank or supervisory authority on a common scenario, central banks and supervisory authorities often adopt applied across a category of financial institutions. a blend of top-down and bottom-up approaches Its primary purpose is to assess the potential to stress testing, with a view to using the tests to vulnerability of the financial system to specified assess the potential effects of defined economic and economic and financial shocks. Probabilities of financial shocks on individual financial institutions default (PD) and LGD are assessed institution by and the financial system. They are typically based institution using either the data generated by each on a common scenario, with PDs and LGDs being institution from its own models or by applying the drawn from individual financial institutions and supervisory authority’s model to generalized data on then recalibrated as appropriate, drawing on the historical PD and LGD; then the data are aggregated supervisory agency’s model, to ensure a reasonable across the financial system, considering second- degree of consistency across financial institutions. FINANCIAL SAFETY NETS AND BANK RESOLUTION FRAMEWORKS IN SOUTHERN AFRICA: KEY ISSUES AND CHALLENGES 49 SECTION TITLE 50 FINANCE, COMPETITIVENESS & INNOVATION INSIGHT | FINANCIAL STABILITY & INTEGRITY ANNEX V: SUMMARY OF BANK RESOLUTION (BR) AND DEPOSIT INSURANCE (DI) IN SOUTHERN AFRICA Risk Area Botswana Eswatini Lesotho Mozambique Namibia South Africa Zambia Zimbabwe Reserve Responsible for BR BOB CBS CBL BOM BON SARB, MoF BOZ Bank BR alternatives Closure & liquidation Yes No TBC Yes Yesc Yesc Yes Yesc Temp. administration Yes TBC Yes Yes Yes Yes Yes Yes Purchase & assumption No No No No b No No b No Yes Good bank/bad bank e No No No No b No No b TBC Yes Merger & acquisition No Not clear No No b No No b Not clear Yes Bridge bank No No No No b No No b Not clear Yes Bail-in No No No No b No No b Not clear No Not Not Not Not Nationalization Not explicitly Not explicitly Not explicitly Not explicitly explicitly explicitly explicitly explicitly Degree of protection of the Inadequate Not clear Limited Inadequate Limited Limitedb Limited Not clear supervisor Specific legislation for systemic Yes, but Yes, but Not clear Nob Not clear Yes Not clear Not clear cases? limited limited Explicit deposit insurance Noa No Noa Yes Noa Noa No Yes Deposit Agency Deposit Institution responsible for DIS N/A N/A N/A Guarantee TBD affiliated with N/A Protection Fund SARB Corporation Type of mandate N/A N/A N/A Payboxd N/A N/Ad N/A Paybox plus Bank representatives on DI N/A N/A N/A Yes N/A N/A N/A Yes Board? Insured amount in US$ (and as N/A N/A N/A 300 (84%) N/A N/A N/A 500 (52%) percentage of GDP per capita) Insured/total deposits N/A N/A N/A 10 N/A N/A N/A - Fixed premium rate (per N/A N/A N/A TBC N/A N/A N/A 2 thousand) Maximum risk adjusted rate N/A N/A N/A TBC N/A N/A N/A - Operational expenses (in US$ and as percentage of premium N/A N/A N/A TBC N/A N/A N/A 3m (24%) income) Funds/total deposits N/A N/A N/A <0.1% N/A N/A N/A 0.3% Does it contribute to BR processes? N/A N/A N/A No ,b d N/A No , b d N/A No Does it cover public institutions? N/A N/A N/A Yes N/A N/A N/A Yes Target fund N/A N/A N/A No N/A N/A N/A No FINANCIAL SAFETY NETS AND BANK RESOLUTION FRAMEWORKS IN SOUTHERN AFRICA: KEY ISSUES AND CHALLENGES 51 Notes: 3m = 3 million US dollars; DIS = Deposit Insurance Scheme; N/A=Not applicable; SARB = South Africa Reserve Bank; TBC= To Be Confirmed. a The national authorities are currently considering incorporating this into their legal framework. b Deposit insurance is implicit as the government has, in the past, reimbursed small depositors following a bank failure. South Africa and Namibia are of establishing a formal deposit insurance scheme, which will provide capped and funded protection to eligible small depositors. In South Africa, deposit insurance will be partly funded by premiums from banks and a back-up facility from SARB. c Closure and liquidation require court approval. d The national authorities are considering moving to paybox plus. e Good bank/bad bank (GB-BB) is a specific case of purchase & assumption (P&A). The “good bank” contains the privileged liabilities and assets with economic value whereas the “bad bank” receives the remaining assets and liabilities. The good bank is transferred to one or more solvent institutions willing to acquire it, enabling it to maintain banking services and the jobs. The bad bank is left to its owner and is liquidated. The difference between P&A and GB-BB is that P&A may only include the assumption of assets and liabilities but not necessarily in the same amounts nor in the form of a business unit. GB-BB requires creating a business unit with assets and liabilities for the same amount. The existence of P&A does not necessarily allow for GB-BB. ANNEX V: SUMMARY OF BANK RESOLUTION (BR) AND DEPOSIT INSURANCE (DI) IN SOUTHERN AFRICA 52 FINANCE, COMPETITIVENESS & INNOVATION INSIGHT | FINANCIAL STABILITY & INTEGRITY REFERENCES AND OTHER READINGS This paper and the study on which it is based drew on a wide range of sources. The main reference material is set here. General References Basel Committee on Banking Supervision (BCBS). 2015. “Guidelines for Identifying and Dealing with Weak Banks.” BCBS, Basel, Switzerland. Financial Stability Board (FSB). 2014. “Key Attributes of Resolution Regimes for Financial Institutions.” FSB, Basel, Switzerland. International Association of Deposit Insurers (IADI). 2014. “Core Principles for Effective Deposit Insurance Systems.” IADI, Basel, Switzerland. Laeven, Luc, and Fabián Valencia. 2012. “Systemic Banking Crises Database: An Update.” IMF Working Paper WP/12/163, International Monetary Fund, Washington, DC. Reinhart, Carmen, and Kenneth Rogoff. 2008. “This Time Is Different.” Working paper no. 13882, National Bureau of Economic Research, Cambridge, MA. World Bank. 2018. FinStats. Internal World Bank database. Country-Specific References For each country, references were made to relevant legislation and regulations pertaining to bank resolution and financial safety nets. In addition, the following specific material was referred to. Botswana Bank of Botswana. 2012. “Financial Sector Development Strategy 2012–16.” International Monetary Fund (IMF). 2017. “Technical Assistance Report—Banking Sector Safety Net and Crisis Management.” IMF Country Report no. 17/49. IMF, Washington, DC. Eswatini World Bank. 2017. Financial Sector Development Implementation Plan, FIRST Initiative Lesotho International Monetary Fund (IMF). 2017. “Technical Assistance Report—Banking Crisis management and Financial Safety Nets.” IMF, Washington, DC. World Bank. 2013. “Lesotho #10272—Financial Sector Development Strategy.” World Bank, Washington, DC. Mozambique International Monetary Fund (IMF). 2010. “Republic of Mozambique: Financial Sector Assessment— Financial System Stability Assessment.” IMF Country Report No. 10/12. IMF, Washington, DC. FINANCIAL SAFETY NETS AND BANK RESOLUTION FRAMEWORKS IN SOUTHERN AFRICA: KEY ISSUES AND CHALLENGES Namibia Financial Stability Policy Framework for Namibia, Bank of Namibia, Namibia Financial Institutions Supervisory Authority International Monetary Fund (IMF) and World Bank. 2018. “Technical Note: Bank Resolution and Crisis Preparedness.” Namibia Financial Sector Assessment Program, IMF and World Bank, Washington, DC. Namibia Ministry of Finance. 2011. Namibia Financial Sector Strategy: 2011–2021: Towards Achieving Vision 2030. Namibia Ministry of Finance, Windhoek. South Africa Designated Institutions Resolution Bill—Working Draft—February 2017 International Monetary Fund (IMF). 2015. “Financial Safety Net, Bank Resolution and Crisis Management Framework.” IMF Country Report No. 15/53, IMF, Washington, DC South African Reserve Bank (SARB), Financial Stability Department. 2017. “Designing a Deposit Insurance Scheme for South Africa—A Discussion Paper.” SARB, Pretoria. Zambia International Monetary Fund (IMF) and World Bank. 2017. “Financial Sector Assessment Program: Financial System Stability Assessment.” IMF and World Bank, Washington, DC. Zimbabwe World Bank. 2017. “Deposit Protection Corporation: Action Plan to Improve Its Compliance with the IADI Core Principles.” Technical note. World Bank, Washington, DC. REFERENCES AND OTHER READINGS 54