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Compliance with liquidity ratios biggest risk for South African banks in Basel III

The implementation of Basel III in the global banking sector will require greater management of risk and capital, according to a report by US based consulting group Bain. However, in the local context, one of the biggest risks facing South African banks is compliance with new liquidity ratios, which could increase funding costs for banks by as much as 30%.

Under current plans, liquidity requirements for banks will be tightened through the introduction of two minimum standards (ratios) for funding liquidity. The Liquidity Coverage Ratio (LCR), which is designed to ensure that a bank can withstand an acute stress scenario for one month, requires that the stock of high quality, liquid assets exceeds net outflows over a period of 30 days and will come into effect from 1 January 2015.

The biggest impact from the LCR will be increased pressure on profitability and Return on Equity. Banks may have to increase their liquid asset holdings, which will in turn reduce asset yields, while the additional resources required to track these ratios will impact operating costs. A potential knock-on effect may be increased customer pricing, whilst a redesign of business models and portfolio focus may also be required.

Furthermore, growth in unsecured lending has already accelerated, which, whilst being high yielding, increases the potential for bad debts going forward. There is also a lack of supply of high quality liquid assets, partly due to the size of the South African market and the ratings of issuers.

The Bain report is correct in highlighting that the management of risk and capital must be at the heart of banks’ strategies in the future. South African banks will need to proactively and more effectively manage liquidity and minimise costs if they are to mitigate the impact of such reform.

From a risk management and systemic stability perspective, Basel III is a positive step for the banking sector. However, since South African banks were not exposed to toxic assets, are well capitalised, generally well run from a liquidity risk management perspective, not overly reliant on offshore funding and have only a small portion of funding arising from structured products, the necessity for the new regulations from a purely local context could be questioned.

A further requirement – the Net Stable Funding Ratio (NSFR) – will be introduced as a minimum standard from 1 January 2018 and considers a longer time horizon of one year, requiring a minimum amount of stable sources of funding relative to the liquidity profile of assets, as well as off-balance sheet commitments. The NSFR will essentially calculate how the funding at banks is guaranteed; taking account of stress scenarios, although how this will be applied is unclear at present.

Similarly to the Liquidity Coverage Ratio, meeting the NSFR requirement will place pressure on profitability and interest margins. Given the structural funding challenges faced in the South African economy, sourcing stable funding will increase funding costs, whilst the lack of appropriate funding levels may hamper credit extension, which is already under pressure. The availability of the required stable funding in South Africa to meet these requirements will also be a challenge.

Paul Greeff.

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