Presentation to the Portfolio Presentation to the Portfolio Committee on Finance Committee on Finance

Annual Report 2006Annual Report 2006Bank Supervision DepartmentBank Supervision Department

Cape Town

7 August 2007

Mr Errol KrugerMr Errol Kruger

Registrar of BanksRegistrar of Banks

2

AgendaAgendaAgendaAgenda

IntroductionIntroduction Developments/activities in banking Developments/activities in banking

supervisionsupervision Developments related to banking legislationDevelopments related to banking legislation Salient information on the South African Salient information on the South African

banking sectorbanking sector Trends in South African banksTrends in South African banks

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The Bank Supervision Department executes the functions assigned to the Registrar of Banks under the Banks Act, 1990 and its mission is:

To promote the soundness of the banking system through the effective and efficient application of international regulatory and

supervisory standards.

IntroductionIntroductionIntroductionIntroduction

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Developments/activities in Developments/activities in banking supervisionbanking supervision

Developments/activities in Developments/activities in banking supervisionbanking supervision

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OutlineOutlineOutlineOutline

Core Principles for Effective Banking Core Principles for Effective Banking SupervisionSupervision

Development of bank directorsDevelopment of bank directors New Capital Accord (Basel II)New Capital Accord (Basel II) Compliance with anti-money laundering Compliance with anti-money laundering

legislationlegislation International supervisory interactionInternational supervisory interaction Proliferation of credit in South AfricaProliferation of credit in South Africa Combating illegal deposit takingCombating illegal deposit taking Training of Department’s staffTraining of Department’s staff OtherOther

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Core Principles for Effective Core Principles for Effective Banking SupervisionBanking Supervision

Core Principles for Effective Core Principles for Effective Banking SupervisionBanking Supervision

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Description ofDescription of the Core Principles for the Core Principles for Effective Banking SupervisionEffective Banking SupervisionDescription ofDescription of the Core Principles for the Core Principles for Effective Banking SupervisionEffective Banking Supervision

The Core Principles comprise twenty-five The Core Principles comprise twenty-five fundamental requirements, covering various fundamental requirements, covering various

components and aspects of a bank supervisory components and aspects of a bank supervisory system, that need to be complied with for a system, that need to be complied with for a

banking supervisor to operate effectively and for banking supervisor to operate effectively and for banks to operate in a safe and sound manner. banks to operate in a safe and sound manner.

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Background to Core PrinciplesBackground to Core PrinciplesBackground to Core PrinciplesBackground to Core Principles

Core Principles originally published in 1997

Core Principles Methodology - published in 1999 - allows for uniform assessment

Developed by the Basel Committee on Banking Supervision at request of G7 Finance Ministers

Developed in close cooperation with supervisors across the world

IMF and World Bank monitors implementation of Core Principles

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Uniqueness of the Core PrinciplesUniqueness of the Core PrinciplesUniqueness of the Core PrinciplesUniqueness of the Core Principles

The first comprehensive document dealing with banking supervision

Resulted in the establishment of first non-G10 Basel Committee working group, i.e. the Core Principles Liaison Group (renamed December 2006 as International Liaison Group - ILG)– Originally tasked to discuss and oversee the

application of Core Principles

– Developed into a high-level forum for the Basel Committee liaison with senior non-G10 supervisors, the IMF and World Bank

• South Africa active member of ILG

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Objectives of the Core PrinciplesObjectives of the Core PrinciplesObjectives of the Core PrinciplesObjectives of the Core Principles

Provision of sufficient powers, independence and resources to supervisory authorities

Provision of a roadmap for a sound supervisory framework

Strengthening legal framework Establishment of appropriate checks and

balances Establishment of good governance practices

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Myths of the Core PrinciplesMyths of the Core PrinciplesMyths of the Core PrinciplesMyths of the Core Principles

The Core Principles do not:

provide an instant “magic potion” for countries with inexperienced supervisors or weak supervisory regimes

repair economic/financial mismanagement

change (reduce) the responsibilities of the supervisory authority

guarantee that no bank will fail

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Revision of the Core PrinciplesRevision of the Core PrinciplesRevision of the Core PrinciplesRevision of the Core Principles

Significant developments in banking and bank regulation since 1997, inter alia:– Enhanced risk management

– Corporate governance issues

– Anti-money laundering and terrorist financing concerns

Lessons from the IMF/World Bank FSAPs – more precision required on certain issues

However, the objective was to update and not to “change the goalposts”

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Revision of the Core Principles (cont.)Revision of the Core Principles (cont.)Revision of the Core Principles (cont.)Revision of the Core Principles (cont.)

Establishment of the Basel Core Principles Reference Group

BCP Reference Group consisted of members from Basel Committee and International Liaison Group – South Africa participated

Revised Core Principles published in October 2006

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Compliance with revised Core PrinciplesCompliance with revised Core PrinciplesCompliance with revised Core PrinciplesCompliance with revised Core Principles

Bank Supervision Department performed a Core Principles self-assessment in 2006

Objectives of self-assessment– Benchmark South African banking system against

revised Core Principles

– Conduct comprehensive gap analysis

– Develop action plans to eliminate identified shortcomings

Project commenced first half 2006 - prior to finalisation of revised Core Principles, further changes therefore closely monitored and considered

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Compliance with revised Core Principles Compliance with revised Core Principles (cont.)(cont.)Compliance with revised Core Principles Compliance with revised Core Principles (cont.)(cont.)

Project team established to co-ordinate and steer assessments

Conservative approach, every compliance grading supported by one or more of:– Banks Act, 1990

– Regulations relating to Banks

– Supervisory process

Culminated in workshop attended by all staff

Project team continues to meet to assess implementation of action plans

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Development of bank directorsDevelopment of bank directorsDevelopment of bank directorsDevelopment of bank directors

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Individual banks’ induction and training Individual banks’ induction and training programmesprogrammesIndividual banks’ induction and training Individual banks’ induction and training programmesprogrammes

Department continued to focus on banks’ corporate governance processes in 2006

Department analysed banks’ induction and training programmes

– diverged significantly

Banks’ operations are unique, however bank directors should be exposed to homogenous development programmes

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Director development programme for Director development programme for banking sectorbanking sectorDirector development programme for Director development programme for banking sectorbanking sector

Department communicated divergence of induction and training programmes to The Banking Association South Africa– No bank-specific development programme available

Banking Association requested University of Pretoria to develop director development programme

Development programme consists:– Introductory course

– Governance-level risk management course

– Leadership forum – focus on “real-life” experience

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Director development programme for Director development programme for banking sector (cont.)banking sector (cont.)Director development programme for Director development programme for banking sector (cont.)banking sector (cont.)

Development programme satisfies needs of new and experienced directors

Comprehensive programme – provides solid foundation for new directors entering banking sector

Banks Act Circular 9/2006

– Banks’ chairpersons encouraged to utilise programme

– Development programme supplementary to individual banks’ internal programmes

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New Capital Accord (Basel II)New Capital Accord (Basel II)New Capital Accord (Basel II)New Capital Accord (Basel II)

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IntroductionIntroductionIntroductionIntroduction

Efficient management of capital essential for stability of individual banks and banking system

Capital management – part of overall risk management framework

Basel II – Basel Committee’s revised guidance on regulatory capital

Basel II to be implemented by all South African banks on 1 January 2008

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Accord Implementation ForumAccord Implementation ForumAccord Implementation ForumAccord Implementation Forum

Accord Implementation Forum (AIF) – body established to pursue sound and robust implementation of Basel II– South African Reserve Bank, all commercial banks,

National Treasury, South African Institute of Chartered Accountants and Banking Association

AIF stakeholders intensified efforts during 2006

Department engaged actively with AIF working group chairpersons following November 2006 issuing of draft 3 of the proposed Regulations– Conclude high-priority issues to be incorporated in

draft 4 of Regulations

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Overview of Basel II approachesOverview of Basel II approachesOverview of Basel II approachesOverview of Basel II approaches

Basel I did not allow for different approaches

Basel II offers menu of approaches, particularly for credit risk and operational risk

Advanced approaches are subject to approval from the Department

– Applications to be processed during 2007

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Overview of Basel II approaches – Overview of Basel II approaches – Credit riskCredit riskOverview of Basel II approaches – Overview of Basel II approaches – Credit riskCredit risk

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Overview of Basel II approaches – Overview of Basel II approaches – Operational riskOperational riskOverview of Basel II approaches – Overview of Basel II approaches – Operational riskOperational risk

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ConclusionConclusionConclusionConclusion

Significant progress made with Basel II project

Supervisors worldwide face many challenges in ensuring effective and appropriate implementation for their respective countries

Chairman of Basel Committee

– Supervisors have utilised supervisory tools in the past which fortunately will still be relevant for Basel II implementation, such as sound judgement

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Compliance with Financial Intelligence Compliance with Financial Intelligence Centre Act, 1990Centre Act, 1990Compliance with Financial Intelligence Compliance with Financial Intelligence Centre Act, 1990Centre Act, 1990

Department performed review to verify compliance with requirements of Financial Intelligence Centre Act (FICA) – Largest 5 banks reviewed in 2005

– Similar review of remaining local banks and selected branches of foreign banks in 2006

All banks have made good progress in implementing anti-money laundering and counter-terrorist financing measures

Role of internal audit function proposed to be extended to include FICA requirements

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International supervisory interactionInternational supervisory interactionInternational supervisory interactionInternational supervisory interaction

Meetings held with supervisors in Argentina, Mauritius and Namibia

Department attended seminar hosted by Indonesian supervisory authorities

Department maintained participation in Basel Committee working groups and Financial Stability Institute training initiatives

Department participated in IMF and World Bank events

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Proliferation of credit in South AfricaProliferation of credit in South AfricaProliferation of credit in South AfricaProliferation of credit in South Africa

Public exposed to new names linked to banking services

Confusing, banking names linked to retail outlets, cellular phone service providers and others

Form – joint ventures or divisions of banks not stand-alone initiatives

Uncertainty as regards origin and soundness of above initiatives

Supervisory viewpoint – Department ensures prudent risk-management of above joint ventures or bank divisions

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Combating illegal deposit taking Combating illegal deposit taking Combating illegal deposit taking Combating illegal deposit taking

Department responsible for regulation and supervision of registered banks

Department not responsible for registering or supervising investment schemes

However, Banks Act – powers to control activities of unregistered persons conducting banking business

Approximately 40 unregistered businesses or investment schemes investigated by Department in 2006

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Training of Department’s staff Training of Department’s staff Training of Department’s staff Training of Department’s staff

IMF meeting on Financial Soundness Indicators in Brazil

Financial Stability Institute’s (FSI) International Banking Supervision seminar in Switzerland and subscription to FSI Connect – web-based training

Seminars of national supervisory authorities in the United Kingdom and United States

Ongoing Basel II training

Department hosted and presented Intermediate course in risk-based supervision, attended by SADC countries

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Other supervisory developments in 2006Other supervisory developments in 2006Other supervisory developments in 2006Other supervisory developments in 2006

Department attended International Conference of Banking Supervisors in Mexico

International Monetary Fund conducted Article IV consultation

Market-risk and liquidity risk management in South African banks

Joint Forum’s working stream on the supervision of financial conglomerates

Implementation of the Auditing Profession Act, 2005

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Developments related to Developments related to banking legislationbanking legislation

Developments related to Developments related to banking legislationbanking legislation

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IntroductionIntroductionIntroductionIntroduction

Department continued to ensure legal framework remains relevant and current

Department reviews banking legislation– Banks Act, 1990

– Mutual Banks Act, 1993

– Regulations to above Acts

Incorporation of guidelines of Basel Committee and other international standard-setters, inter alia:– Basel II

– Core Principles for Effective Supervision

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Banks Act, 1990Banks Act, 1990Banks Act, 1990Banks Act, 1990

Banks Amendment Bill through a thorough consultation process in 2006

– Accord Implementation Forum

– Standing Committee approval

– Ministerial approval

During 2007 Bill approved by Cabinet and Portfolio Committee on Finance

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Regulations relating to BanksRegulations relating to BanksRegulations relating to BanksRegulations relating to Banks

Drafting of proposed Regulations managed via AIF structure

Draft 3 of proposed Regulations submitted to Minister of Finance in August 2006 for initial review

Revised draft discussed at Standing Committee meeting in first half 2007, subsequently revised and issued for public comment in first half 2007

Final draft to be tabled at August 2007 Standing Committee meeting for approval

Following above approval, to be submitted to Minister of Finance for consideration and ultimate approval

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Salient information on the banking sector Salient information on the banking sector May 2007May 2007

Salient information on the banking sector Salient information on the banking sector May 2007May 2007

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The banking system consists of:The banking system consists of:– Registered banksRegistered banks 2020– Mutual banksMutual banks 2 2– Local branches of foreign banksLocal branches of foreign banks 1414– Foreign banks with approvedForeign banks with approved

local representative officeslocal representative offices 4343

Salient information on the banking Salient information on the banking sector – May 2007sector – May 2007Salient information on the banking Salient information on the banking sector – May 2007sector – May 2007

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Salient information on the banking sector*Salient information on the banking sector*Salient information on the banking sector*Salient information on the banking sector*

* Excludes representative offices* Excludes representative offices

Dec

2005

Dec

2006

May

2007

Total assets (R billions) 1 677,5 2 075,1 2 221,5

Loans and advances (R billions) 1 338,3 1 721,9 1 880,9

Funding related liabilities to the public (R billions) 1 358,9 1 694,1 1 825,4

Non-bank funding (R billions) 1 101,5 1 353,2 1 471,5

Capital and reserves (R billions) 133,3 164,9 181,0

Capital adequacy ratio (%) 12,7 12,3 12,4

Return on equity – smoothed (%) 15,2 18,3 18,8

Return on assets – smoothed (%) 1,2 1,4 1,4

Efficiency ratio – smoothed (%) 66,3 58,9 57,2

Non-performing loans (R billions) 20,1 18,8 22,0

Non-performing loans as % of loans and advances 1,5 1,1 1,2

Specific provisions as % of non-performing loans 59,4 54,4 47,3

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Distribution of total banking sector Distribution of total banking sector assets (R billions)assets (R billions)Distribution of total banking sector Distribution of total banking sector assets (R billions)assets (R billions)

Dec

2005

Dec

2006

May

2007

Market Share %

May

2007

5 Largest banks 1 502,6 1 862,3 1 992,9 89,7

Standard Bank 436,3 530,6 564,4 25,4

Absa 358,6 446,4 483,3 21,8

FirstRand 307,3 388,2 414,9 18,7

Nedbank 303,2 379,3 399,5 18,0

Investec 97,1 117,8 130,9 5,9

Other 175,0 212,8 228,6 10,3

Total Banks 1 677,5 2 075,1 2 221,5 100

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Trends in South African banks Trends in South African banks December 2006December 2006

Trends in South African banks Trends in South African banks December 2006December 2006

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Balance-sheet structureBalance-sheet structureBalance-sheet structureBalance-sheet structure

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Aggregate balance sheet – R2 075,1 billionAggregate balance sheet – R2 075,1 billionAggregate balance sheet – R2 075,1 billionAggregate balance sheet – R2 075,1 billion

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Composition of liabilities – R2 075,1 billionComposition of liabilities – R2 075,1 billionComposition of liabilities – R2 075,1 billionComposition of liabilities – R2 075,1 billion

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Composition of non-bank deposits – Composition of non-bank deposits – R1 353,2 billionR1 353,2 billionComposition of non-bank deposits – Composition of non-bank deposits – R1 353,2 billionR1 353,2 billion

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Composition of non-bank deposits Composition of non-bank deposits according to maturity – R1 353,2 billionaccording to maturity – R1 353,2 billionComposition of non-bank deposits Composition of non-bank deposits according to maturity – R1 353,2 billionaccording to maturity – R1 353,2 billion

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Composition of total assets – R2 075,1 billionComposition of total assets – R2 075,1 billionComposition of total assets – R2 075,1 billionComposition of total assets – R2 075,1 billion

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Total loans and advances – R1 735,8 billionTotal loans and advances – R1 735,8 billionTotal loans and advances – R1 735,8 billionTotal loans and advances – R1 735,8 billion

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Composition of loans and advances – Composition of loans and advances – R1 735,8 billionR1 735,8 billionComposition of loans and advances – Composition of loans and advances – R1 735,8 billionR1 735,8 billion

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Capital adequacyCapital adequacyCapital adequacyCapital adequacy

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Capital-adequacy ratio – 12,3 per centCapital-adequacy ratio – 12,3 per centCapital-adequacy ratio – 12,3 per centCapital-adequacy ratio – 12,3 per cent

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Distribution of banks in terms of capital Distribution of banks in terms of capital adequacyadequacyDistribution of banks in terms of capital Distribution of banks in terms of capital adequacyadequacy

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Qualifying capital and reserves – Qualifying capital and reserves – R153,3 billionR153,3 billionQualifying capital and reserves – Qualifying capital and reserves – R153,3 billionR153,3 billion

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Risk profile of on and off-balance-sheet Risk profile of on and off-balance-sheet itemsitemsRisk profile of on and off-balance-sheet Risk profile of on and off-balance-sheet itemsitems

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ProfitabilityProfitabilityProfitabilityProfitability

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Composition of the income statementComposition of the income statementComposition of the income statementComposition of the income statement

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Interest margin – 3,4 per centInterest margin – 3,4 per centInterest margin – 3,4 per centInterest margin – 3,4 per cent

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Growth in staff expenses, number of Growth in staff expenses, number of employees and number of branchesemployees and number of branchesGrowth in staff expenses, number of Growth in staff expenses, number of employees and number of branchesemployees and number of branches

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Efficiency ratio of the banking sector – Efficiency ratio of the banking sector – 58,9 per cent58,9 per centEfficiency ratio of the banking sector – Efficiency ratio of the banking sector – 58,9 per cent58,9 per cent

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Efficiency of banking institutions Efficiency of banking institutions according to asset valueaccording to asset valueEfficiency of banking institutions Efficiency of banking institutions according to asset valueaccording to asset value

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Profitability (12-month smoothed average)Profitability (12-month smoothed average)Profitability (12-month smoothed average)Profitability (12-month smoothed average)

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Liquidity riskLiquidity riskLiquidity riskLiquidity risk

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Statutory liquid assets (actual versus Statutory liquid assets (actual versus required) – R96,3 billion vs R86,6 billion required) – R96,3 billion vs R86,6 billion Statutory liquid assets (actual versus Statutory liquid assets (actual versus required) – R96,3 billion vs R86,6 billion required) – R96,3 billion vs R86,6 billion

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Deposits from banks’ ten largest Deposits from banks’ ten largest depositors - R389,4 billion (as percentage depositors - R389,4 billion (as percentage of total funding – R1 694,1 billion)of total funding – R1 694,1 billion)

Deposits from banks’ ten largest Deposits from banks’ ten largest depositors - R389,4 billion (as percentage depositors - R389,4 billion (as percentage of total funding – R1 694,1 billion)of total funding – R1 694,1 billion)

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Anticipated maturity of short-term funding Anticipated maturity of short-term funding – R384,8 billion (as percentage of total – R384,8 billion (as percentage of total funding – R1 694,1 billion)funding – R1 694,1 billion)

Anticipated maturity of short-term funding Anticipated maturity of short-term funding – R384,8 billion (as percentage of total – R384,8 billion (as percentage of total funding – R1 694,1 billion)funding – R1 694,1 billion)

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Derivative contractsDerivative contractsDerivative contractsDerivative contracts

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Turnover in derivative contracts – Turnover in derivative contracts – R2 618,2 billionR2 618,2 billionTurnover in derivative contracts – Turnover in derivative contracts – R2 618,2 billionR2 618,2 billion

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Total unexpired derivative contracts – Total unexpired derivative contracts – R9 272,2 billionR9 272,2 billionTotal unexpired derivative contracts – Total unexpired derivative contracts – R9 272,2 billionR9 272,2 billion

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Credit riskCredit riskCredit riskCredit risk

70

Total banking-sector overdues – Total banking-sector overdues – R18,8 billionR18,8 billionTotal banking-sector overdues – Total banking-sector overdues – R18,8 billionR18,8 billion

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Net overdues (R8,5 billion) as Net overdues (R8,5 billion) as percentage of net qualifying capital percentage of net qualifying capital and reserves (R153,3 billion)and reserves (R153,3 billion)

Net overdues (R8,5 billion) as Net overdues (R8,5 billion) as percentage of net qualifying capital percentage of net qualifying capital and reserves (R153,3 billion)and reserves (R153,3 billion)

72

Composition of overdues – R18,8 billion Composition of overdues – R18,8 billion (as percentage of loans and advances –(as percentage of loans and advances –R1 735,8 billion)R1 735,8 billion)

Composition of overdues – R18,8 billion Composition of overdues – R18,8 billion (as percentage of loans and advances –(as percentage of loans and advances –R1 735,8 billion)R1 735,8 billion)

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Analysis of overdues – R18,8 billion Analysis of overdues – R18,8 billion Analysis of overdues – R18,8 billion Analysis of overdues – R18,8 billion

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Coverage ratio (specific provisions and Coverage ratio (specific provisions and security as percentage of gross overdues)security as percentage of gross overdues)Coverage ratio (specific provisions and Coverage ratio (specific provisions and security as percentage of gross overdues)security as percentage of gross overdues)

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Large exposures (granted – R511 billion and Large exposures (granted – R511 billion and utilised – R266 billion) percentage of net utilised – R266 billion) percentage of net qualifying capital and reserves – R153,3 billionqualifying capital and reserves – R153,3 billion

Large exposures (granted – R511 billion and Large exposures (granted – R511 billion and utilised – R266 billion) percentage of net utilised – R266 billion) percentage of net qualifying capital and reserves – R153,3 billionqualifying capital and reserves – R153,3 billion

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Asset performanceAsset performanceAsset performanceAsset performance

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Currency riskCurrency riskCurrency riskCurrency risk

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Maximum effective net open foreign-Maximum effective net open foreign-currency position as percentage of net currency position as percentage of net qualifying capital and reservesqualifying capital and reserves

Maximum effective net open foreign-Maximum effective net open foreign-currency position as percentage of net currency position as percentage of net qualifying capital and reservesqualifying capital and reserves

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Position in foreign-currency instruments Position in foreign-currency instruments US$14,9 billion vs –US$14,6 billionUS$14,9 billion vs –US$14,6 billionPosition in foreign-currency instruments Position in foreign-currency instruments US$14,9 billion vs –US$14,6 billionUS$14,9 billion vs –US$14,6 billion

80

Thank you Thank you for your attentionfor your attention

Thank you Thank you for your attentionfor your attention