Proposed Deposit Insurance Scheme to protect South African depositors

Although South Africa has a relatively strong banking sector which is well regulated, numerous banks have failed in the last three decades. 

Recent failures have again brought the subject of deposit insurance into the spotlight.

The South African Reserve Bank (SARB) and National Treasury are currently reviewing a deposit insurance scheme (DIS) in South Africa to address some of the issues when banks fail.

They want to establish a comprehensive regulatory framework to protect taxpayer funds and “reduce the high social and economic cost caused by failing financial institutions”.

A DIS will also bring South Africa in line with international best practice and other Group of Twenty (G20) countries.

It is proposed that the DIS should be established as a subsidiary of the SARB, making it a separate legal entity with its own legislative framework and governance requirements, but physically located in the SARB. 

The SARB released a discussion paper in May 2017 titled “Designing a deposit insurance scheme for South Africa” and according to the paper the main policy objective of a DIS for South Africa is to protect less financially sophisticated depositors in the event of a bank failure, thereby contributing to customer protection and enhancement of the stability of the South African financial system. 

By protecting the covered deposits in all banks, the DIS can also contribute to the development of a less concentrated banking sector and support financial inclusion and transformation of the sector, according to the SARB.

There are currently no explicit arrangements in place to protect depositors in the event of a bank failure. In the past, the government compensated depositors for their losses on a case-by-case basis.

This meant taxpayers had to bear the cost, albeit indirectly. 

According to the SARB government’s ability and willingness to pay for the cost of banks’ failures has diminished, and there is uncertainty about which depositors should be compensated in the event of a bank failure, the amount such compensation should be, and where the funding should come from.

The paper states that the DIS provides a mechanism to ensure a “pre-planned, orderly and efficient provision of protection rather than an unprepared scrambling for funds, haphazard policy decisions made under pressure and/or disorderly and non-transparent compensation arrangements”.

What will it mean for consumers?

Qualifying depositors would benefit from the DIS.

If a bank fails, depositors will initially be paid out within 20 working days after the closure of the bank for accounts where ownership is easily identifiable. 

The goal is to ultimately pay depositors within 7 working days, in line with international best practice. 

According to the DIS all qualifying deposits should be covered up to R100 000 per depositor per bank. This means that a bank will be able to consolidate or aggregate a single customer’s deposit balances held across the bank.

Qualifying deposits should include all the deposits held by banks, except the following categories: 

a. deposits by banks; 

b. deposits by the non-bank private financial sector, including money market unit trusts, non-money market unit trusts, insurers, pension funds, fund managers and other private financial corporate sector institutions; 

c. deposits by government, including local, provincial and national government, public financial sector entities, the Public Investment Corporation, other public non-financial corporations and monetary authorities; and 

d. bearer deposit instruments such as negotiable certificates of deposit (NCDs) and promissory notes (PNs). 

NCDs and PNs are excluded because they are financially sophisticated and these depositors are able to make informed investment decisions, in line with the goal of the DIS to protect “less financially sophisticated depositors”.

What it means for banks?

The proposal is that membership of the DIS should be compulsory and automatic for all registered banks, and the DIS should be consulted whenever an application for a new banking licence is received.

The approach would be that of a partially pre-funded DIS, with the SARB providing the required liquidity in a payout and additional emergency funding in the event of shortfalls. 

The recommended target size for the fund is 5% of covered deposits, which will be maintained on a continuous basis. 

The SARB is willing to consider lowering the cash reserve requirement (CRR) – the minimum amount of reserves a bank is required to maintain – from 2.5% to 2% of liabilities, as adjusted, which will release an amount roughly equal to the funding requirement of the DIS. 

Once this one-off adjustment is implemented, banks will be required to maintain a CRR of 2.0% and a separate DIS requirement of 5% of covered deposits. 

Conclusion

A DIS in South Africa will have consequences for both consumers and banks.

Consumers, especially less sophisticated depositors, must be protected and the stability of the South African banking system enhanced.

Therefore, the discussion documents have made it clear that the DIS should be designed in such a way that it does not place an excessive burden on the banking system. It should also not distort competitiveness in the banking sector or cause moral hazard to the extent it becomes a threat to financial stability.

Sources: 

South African Reservebank Financial Stability Department, “Designing a deposit insurance scheme for South Africa - a discussion paper”, May 2017

National Treasury, “Strengthening South Africa’s Resolution Framework for Financial Institutions”, August 2015

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