Financial Safety Nets and Bank Resolution Frameworks in Southern Africa IN FOCUS Summary of Key Issues and Challenges FINANCE, Geof Mortlock, Julian Casal, and Gunhild Berg COMPETITIVENESS & INNOVATION FINANCIAL STABILITY & INTEGRITY © 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 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 Table of Contents ACKNOWLEDGMENTS III INTRODUCTION 1 MACROFINANCIAL CONTEXT 2 ASSESSMENT OF RECOVERY, RESOLUTION, AND FINANCIAL SAFETY NET ARRANGEMENTS 2 Early Detection, Contingency Planning, and Intervention Arrangements 3 Recovery Planning Requirements for Banks 5 Resolution Arrangements, Strategies, and Crisis Management Preparedness 5 Domestic Coordination for Financial Crisis Management 6 Cross-Border Coordination for Financial Crisis Management 6 Emergency Liquidity Assistance 6 Deposit Insurance 7 Systemic Resolution Funding 7 CONCLUSION 8 LIST OF TABLES 8 Table 1. Indicative Triggers and Responses for a Supervisory Preventive and Corrective Action Framework 3 Table 2. Summary of Recommendations 9 FINANCIAL SAFETY NETS AND BANK RESOLUTION FRAMEWORKS IN SOUTHERN AFRICA: SUMMARY OF KEY ISSUES AND CHALLENGES | I II | CHAPTER TITLE 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. The report was prepared by Geof Mortlock An earlier version benefited from insights and (consultant) and Julian Casal and Gunhild recommendations made by Jan Nolte (formerly World Berg (both World Bank staff) with guidance Bank). It has benefited from comments from Barend from Douglas Pearce (practice manager), Paul Jansen, Pamela Lintner, Uzma Khalil (all World Bank), Noumba Um (country director, AFCS1), Mark and Constant Verkoren (International Monetary Fund). R. Lundell (country director, AFCS2), Sebastien Lastly, we also thank Aichin Lim Jones for design and Dessus (program leader), and Carolin Geginat production services. (program leader). FINANCIAL SAFETY NETS AND BANK RESOLUTION FRAMEWORKS IN SOUTHERN AFRICA: SUMMARY OF KEY ISSUES AND CHALLENGES | III IV | FINANCIAL SAFETY NETS AND BANK RESOLUTION FRAMEWORKS IN SOUTHERN AFRICA: SUMMARY OF KEY ISSUES AND CHALLENGES Introduction T his summary 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.1 Its purpose is to provide a high-level assessment of the development of financial safety nets and bank resolution frameworks in the region, to highlight deficiencies in the frameworks, and to recommend reforms to address the deficiencies. The summary is based on a World Bank study that provides a detailed cross-country assessment of financial safety net and bank resolution arrangements in the region.2 The study on which this summary is based Financial Stability Board’s (FSB) “Key Attributes assesses the financial safety nets and bank of Effective Resolution Regimes for Financial resolution framework arrangements in the eight Institutions” (Key Attributes), first published in countries on a range of topics. Those safety nets 2011 and revised in 2014, and the International and resolution arrangements include the following: Association of Deposit Insurers’ (IADI) “Core Principles for Effective Deposit Insurance Systems” • Early detection of emerging stress, contingency (Core Principles), first published in 2009 and revised planning, and intervention arrangements in 2014. The Key Attributes (KA) were developed • Recovery planning requirements for banks to address highly complex financial institutions and • Resolution arrangements, strategies, and crisis markets, which currently do not exist in most of the management preparedness; countries covered by this study. The KA should be • Domestic coordination for financial crisis applied proportionately to resolve banks in ways management that protect the critical functions of a country’s • Cross-border coordination for financial crisis financial system while safeguarding depositors and management taxpayers. As a result, not all elements of the KA • Emergency liquidity assistance are fully or even partially applicable to all countries. • Deposit insurance The recommendations summarized in this report • Systemic resolution funding recognize the need to apply relevant international The assessment made in the study closely standards practically and proportionately, adjusted followed relevant international benchmarks. The to the needs and circumstances of each country. two primary references for this assessment were the 1 This summary was prepared by Geof Mortlock (consultant) and Julian Casal and Gunhild Berg (World Bank staff) with guidance from Sebastien Dessus, Douglas Pearce, and Paul Noumba Um. 2 World Bank, “Financial Safety Nets and Bank Resolution Frameworks in Southern Africa: Key Issues and Challenges,” (report, World Bank, Washington, DC, 2019). FINANCIAL SAFETY NETS AND BANK RESOLUTION FRAMEWORKS IN SOUTHERN AFRICA: SUMMARY OF KEY ISSUES AND CHALLENGES | 1 Macrofinancial Context stabilize the financial system. For countries that have experienced bank failures on a systemic scale, the Developments in some southern African countries disruption to economic activity, loss of savings, and have exacerbated economic and financial sector interruption to credit creation have had long-lasting risks. Macroeconomic risks vary considerably adverse effects on economic growth, employment, across the region, but include currency volatility, and poverty. This has been evidenced in East Asia and commodity price fluctuation, high inflation in Pacific, Europe and Central Asia, Latin America and some countries, relatively high fiscal deficits, high the Caribbean, South Asia, and Sub-Saharan Africa. interest rates, and the potential for cross-border capital flow reversals. Sovereign debt is emerging Effective early intervention in weak banks and as a key vulnerability in the region, particularly robust resolution frameworks and financial safety as the composition of that debt has shifted from nets in bank failures can help countries resolve concessional financing to market-based financing, bank distress quickly and cost effectively, with often denominated in foreign currency. Higher debt limited disruption to the economy and financial burdens and the increasing exposure to interest rate system. In contrast, countries with poorly developed and foreign exchange risks raise concerns about systems for detecting and responding to bank stress debt sustainability. As a result, more countries in the in a timely manner, and with inadequate resolution region have been classified as being at high risk of frameworks and financial safety nets, have generally debt distress. Sudden reversals in capital flows could experienced deeper and longer lasting economic add pressure to the currencies of many countries in impacts than countries with robust frameworks in the region. Recent developments have increased those areas. In this context, an assessment of the investor risk aversion and the potential for greater arrangements for early bank intervention, resolution, volatility in cross-border capital flows. and financial safety nets was undertaken for the eight countries comprising this study. Financial stability risks have increased in many countries in southern Africa. These risks include a rise in nonperforming loans (NPLs), a larger share Assessment of Recovery, of bank lending in foreign currency, and increased Resolution, and Financial Safety loan concentration (including to sovereign or Net Arrangements quasi-sovereign borrowers). Increases in NPLs Although the strengthening of financial safety reduce bank earnings, place pressure on capital, nets and bank resolution frameworks is a and constrain liquidity. NPLs also undermine credit priority for many countries in the region, recent growth as financial institutions tighten lending reform efforts have yet to show concrete results. conditions. Ultimately, high NPLs lead to bank Significant reforms are under way in Mozambique, stress that can undermine the stability of a country’s Namibia, and South Africa, and smaller changes financial system. Other elements of bank risk in existing frameworks are being considered also pose a threat to financial stability, including or have recently been implemented in Lesotho inadequate management of operational risk, interest and Zimbabwe. Recent experience with bank rate risk, and foreign currency risk. failures in the region has highlighted the need to Financial crises can have severe and lasting effects strengthen existing resolution and financial safety on economic activity and the welfare of firms net frameworks. Reforms are also being or have and individuals. Bank failures can result in large been implemented in banking supervision, which fiscal costs, have contagion effects on other banks, provides a critical underpinning of financial stability and undermine the stability of the financial system. and the frameworks needed for early detection of Financial crises are typically associated with a sharp bank stress and early intervention. However, as erosion of real economic activity and a significant discussed below, there are many deficiencies in increase in public debt as governments seek to early detection and intervention arrangements, bank 2 | FINANCIAL SAFETY NETS AND BANK RESOLUTION FRAMEWORKS IN SOUTHERN AFRICA: SUMMARY OF KEY ISSUES AND CHALLENGES recovery planning, bank resolution, and financial strengthen the capacity for the early detection of safety nets across the region. stress, especially through the further development of early warning indicators (EWIs) and stress testing Early Detection, Contingency Planning, arrangements. Such capacity should be strengthened and Intervention Arrangements as a matter of high priority for further developing a risk-based approach to supervision. The early detection of bank stress and accompanying early intervention arrangements A framework for preventive and corrective action are critical. This recognizes that the earlier bank is important for dealing with banks that have stress is detected and responded to, the greater is the breached supervisory requirements or are in prospect of restoring banks to financial soundness financial stress. The framework should have clearly and avoiding the costs associated with bank failures. specified triggers and corresponding supervisory To varying degrees, the supervisory authorities actions, with an escalation in supervisory actions have systems in place to detect emerging stress occurring as the triggers move from mild to serious in banks. This effort is mainly achieved through financial stress indications. Table 1 provides an routine off-site monitoring and on-site assessment indicative example of a supervisory preventive and processes. However, there is considerable scope to corrective action framework. Table 1. 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 FINANCIAL SAFETY NETS AND BANK RESOLUTION FRAMEWORKS IN SOUTHERN AFRICA: SUMMARY OF KEY ISSUES AND CHALLENGES | 3 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 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. In most respects, the supervisory authorities in the group. The most significant gap is the lack of region have broad satisfactory legal powers for adequate corrective action policies and procedures preventive and corrective actions, but there are and contingency plans for dealing with bank stress some deficiencies. In some cases, these deficiencies in almost all countries. Progress is needed to address include poorly defined statutory triggers for taking these deficiencies. Supervisory authorities should preventive and corrective actions, the inability to establish well-defined triggers for early intervention replace directors and officers, and the inability to for bank stress and noncompliance situations, with extend corrective action requirements to a regulated corresponding supervisory responses to the relevant 4 | FINANCIAL SAFETY NETS AND BANK RESOLUTION FRAMEWORKS IN SOUTHERN AFRICA: SUMMARY OF KEY ISSUES AND CHALLENGES triggers. These actions will help to provide a more powers, with most of the countries in the region structured and consistent approach to situations having only a relatively narrow range of resolution involving bank stress, inadequacies in bank risk tools available to deal with failing banks (such as management and governance, and noncompliance temporary administration, recapitalization, merger, with prudential regulation. In addition, it will reduce and liquidation). In most cases, existing law would the risk of regulatory forbearance and associated leave governments with little alternative but to bail moral hazard. Supervisory authorities also need to out D-SIBs. A broader range of resolution options develop and regularly test contingency plans for a is needed, including options that avoid or at least range of bank stress and noncompliance situations. minimize the need for fiscal support. Strengthening Such plans should be based on scenarios and set resolution powers is an important element in this, out the processes and types of actions required to as is establishing appropriate resolution safeguards, respond to the scenario in question. such as adopting legal arrangements to ensure that no creditor is left worse off under a bank resolution Recovery Planning Requirements for transaction than they would have been in a Banks conventional liquidation (the so-called “no creditor worse off” principle). With few exceptions (for example, South Africa), little progress has been made in implementing Accordingly, a fundamental review of bank bank recovery planning requirements. There is a resolution laws is needed in most of the countries need to implement recovery planning requirements in the region to ensure that the laws are broadly for at least the domestic systemically important aligned to international principles and good banks (D-SIBs) and to extend the requirements to practice. The FSB Key Attributes is the most relevant other banks over the medium term. Recovery plans international benchmark in this regard. It provides a should be integrated into banks’ risk management suitable set of guidance for the design of laws for frameworks and should be subject to regular bank resolution, including for objectives, triggers supervisory review. Once this action has been taken, for entry into resolution, legal powers for resolution, the triggers to activate a bank’s recovery plan should and safeguards. However, as noted previously in be integrated into supervisory corrective action this report, the World Bank notes the importance of frameworks. EWIs incorporated into bank recovery each country applying the Key Attributes and other plans should form part of the supervisory authority’s relevant principles proportionately, tailored to a system of early alerts. Bank recovery plans should country’s stage of development, nature of financial be tested regularly, as should supervisory authorities’ system, and institutional arrangements. corrective action frameworks. There is also a need to develop comprehensive bank resolution policies and toolkits. Currently, Resolution Arrangements, Strategies, the authorities in the region lack sufficiently and Crisis Management Preparedness well-developed policies and procedures for bank Apart from Namibia and South Africa, where resolution, including guidance on selecting resolution reform efforts are under way, the framework for options and steps to implementing each resolution the resolution of nonviable banks is inadequate option. The lack of resolution tools constrains across the region. In most of the countries in the the ability of authorities to respond quickly and study, the law does not specify a resolution authority effectively to bank distress and failures. Accordingly, with explicit responsibility and accountability for establishing resolution policies, procedures, and bank resolution, and specification is inadequate processes should be a high priority, both within the for resolution objectives. Bank resolution laws in resolution authorities and across the other relevant southern Africa lack clearly defined triggers for entry agencies (especially the finance ministries). Once into resolution (for example, based on the concept of these arrangements have been established, the nonviability). The laws also lack sufficient resolution authorities should develop the frameworks needed FINANCIAL SAFETY NETS AND BANK RESOLUTION FRAMEWORKS IN SOUTHERN AFRICA: SUMMARY OF KEY ISSUES AND CHALLENGES | 5 to undertake bank-specific resolvability assessments agency and define the matters on which coordination and develop resolution plans, focusing initially on is needed, and on the modality of coordination. D-SIBs and then progressively extending to other These arrangements should be strengthened through banks of significance. For subsidiaries or branches regular crisis simulation exercises led by the of foreign banks, resolution plans would ordinarily resolution authorities. The exercises should include be developed by the parent resolution authority for participation of all other relevant agencies, such as the parent banking group in close coordination with finance ministries, securities regulators, and deposit the host authorities. In parallel, the host authorities insurance agencies. would develop resolution plans for the subsidiary or branch in their jurisdiction in a manner compatible Cross-Border Coordination for Financial with the parent bank resolution plan. The host Crisis Management authorities also need to consider contingent stand- alone resolution plans for subsidiaries and branches Cross-border coordination also needs to be in their respective jurisdictions in the event that strengthened. Cross-border coordination is a the actions of the parent resolution authority do significant issue, given that South African banks not adequately meet the host jurisdiction’s needs. have a systemic presence in various countries in the As discussed subsequently, the extensive degree of region, as do some foreign banks domiciled outside cross-border banking in the region accentuates the the region, which increases the risk of inter-country need for well-developed arrangements for cross- financial contagion. No adequate platform exists border cooperation and coordination. within the region for the exchange of information and monitoring of risks of cross-border groups, and many large banking groups continue to be Domestic Coordination for Financial inadequately supervised. Supervisory authorities Crisis Management have established MOUs with their counterparts in Domestic coordination arrangements for bank other countries to facilitate information exchange resolution need to be strengthened in the region. and cooperation, but the MOUs mainly relate to Although coordination arrangements are in place supervision issues and do not specifically provide for wider financial stability purposes in some for the coordination of cross-border recovery of the countries in the region, few have robust or resolution. Authorities in the region, led by coordination arrangements in place for handling the South African Reserve Bank, should seek to bank distress and failure situations. The absence establish robust cross-border cooperation and of domestic coordination arrangements creates coordination arrangements for bank resolution and difficulties for an effective whole-of-government crisis preparedness, supported by MOUs and bank- response to bank distress and failure given the specific crisis management groups. important responsibilities that various government agencies in any country have for such events. It Emergency Liquidity Assistance also creates difficulties when government agencies need to closely cooperate and coordinate with each Existing laws across the region generally contain other in resolving a bank or dealing with a systemic adequate powers for central banks to provide financial system crisis. For those countries that emergency liquidity assistance (ELA) to banks. currently lack a suitable coordination body, such as However, in most of the countries the laws lack a financial stability committee or council of financial clear objectives for ELA. They also lack clarity regulators, such a committee should be established on the preconditions for providing ELA and on with a mandate for coordinating the response to bank the obligation of central banks to develop clearly distress and failure. Supporting this, a memorandum specified policies and procedures for ELA. This of understanding (MOU) or similar document should limits transparency of, and accountability for, ELA be developed to set out the responsibilities of each policies and practices. Moreover, few central banks 6 | FINANCIAL SAFETY NETS AND BANK RESOLUTION FRAMEWORKS IN SOUTHERN AFRICA: SUMMARY OF KEY ISSUES AND CHALLENGES in the region have developed internal guidance or liquidation of a bank) is a related issue that warrants documentation needed for effective use of ELA. careful consideration. The absence of depositor Only limited progress has been made to establish preference, which is the case in most of the the legal and operational pre-positioning in banks countries covered in this study, creates a heightened required to enable central banks to use the banks’ risk of depositor runs in periods of instability and loan portfolios as ELA collateral. Central banks can make it more difficult to apply certain forms have done little testing of ELA arrangements. of resolution, such as bail-in. Depositor preference Moreover, cross-border coordination arrangements can assist in the practical implementation of bail-in for ELA are under-developed. In particular, for given that it lowers the probability of retail deposits countries in the Common Monetary Area (CMA) being subject to a bail-in (provided that the bank in for the South African rand, consideration should be question has a substantial proportion of unsecured given to the funding mechanisms and currency swap funding in the form of wholesale deposits and arrangements needed to facilitate ELA in a manner unsecured bonds) and thereby makes bail-in more that does not undermine the parity of exchange politically acceptable. It also reduces the amount of rates. Progress in all these areas is needed. compensation that might need to be paid under the “no creditor worse off” principle to the extent that Deposit Insurance retail deposits are excluded from a bail-in. The lack of deposit insurance in most southern Systemic Resolution Funding African countries presents a significant gap in the financial safety net. Two countries, Mozambique Deposit insurance, if appropriately funded, and Zimbabwe, have a deposit insurance scheme provides a mechanism for funding the repayment in law. However, in substance, those arrangements of insured deposits and can be used to contribute are practically nonexistent given that Zimbabwe to wider resolution funding, subject to safeguards is currently experiencing a liquidity crisis and to protect the fund. However, for the resolution of Mozambique’s deposit guarantee fund lacks a D-SIB or in a systemic financial crisis, a wider operational capacity and funding to substantively source of resolution funding is likely to be needed. protect depositors. Moreover, those deposit For example, funding might be needed to recapitalize insurance arrangements also lack the technical a bank, capitalize a bridge bank, fund the transfer of capacity to be effective in a banking crisis, given liabilities to one or more banks, or provide payments their inability to make prompt payouts or facilitate under guarantees and indemnities. A source of purchase and assumption transactions in a bank resolution funding beyond deposit insurance is resolution. therefore required for such situations. None of the countries in the region have yet established The absence of deposit insurance increases the satisfactory resolution funding arrangements for risk of retail deposit runs during banking system systemic bank resolutions or wider systemic crises. stress. Moreover, without deposit insurance, fiscal The absence of such arrangements increases the risk authorities have an increased probability of coming of ad hoc and potentially expensive fiscal funding, under political pressure to bail out failing banks with attendant risks for sovereign debt stress and or to introduce ad hoc protection for deposits in moral hazard risk. Accordingly, the authorities need cases of bank stress. Establishing formal deposit to consider the alternative funding mechanisms for insurance that is funded through levies on banks and these situations. Prefunding arrangements, through supported by supplementary lines of credit from the regular levies on banks, could be considered, government is an important step in reducing these but would be expensive and would represent a risks. Depositor preference (that is, a law under significant loss of funding from the banking system which depositors that meet eligibility criteria rank that could otherwise be used for lending. A more ahead of other senior unsecured creditors in the efficient and cost-effective option is likely to be FINANCIAL SAFETY NETS AND BANK RESOLUTION FRAMEWORKS IN SOUTHERN AFRICA: SUMMARY OF KEY ISSUES AND CHALLENGES | 7 a statutory framework that sets out the purposes, and risk management practices in banks based on preconditions, and conditions of a publicly funded effective financial reporting and auditing standards. resolution framework, with initial funding coming Another example of sequencing is ELA. Before from the government. Under such a framework, the ELA policies are formalized and announced, it government would recover funding outlays from is important to establish comprehensive liquidity the assets of the resolved bank. Any shortfalls in requirements for banks, including minimum liquidity recoveries would be funded through ex post levies buffers, liquidity risk management requirements and on banks so that the government recovers the full regular stress testing of banks’ liquidity. Likewise, amount of funding outlays in net present value the introduction of resolution laws needs to occur terms over a specified period. This option should be before detailed resolution policies and practices considered by the countries’ respective authorities are developed. In turn, those resolution policies (principally the finance ministries). and practices need to be in place before bank- specific resolvability assessments and resolution Conclusion plans are developed. Accordingly, the authorities need to establish carefully designed programs for Countries in southern Africa need to undertake the sequenced introduction and implementation of significant reforms to strengthen bank resolution policies across all these areas. frameworks, financial safety nets, and crisis preparedness. Reforms need to focus on establishing Technical support requirements will vary robust frameworks for the early detection of bank considerably from country to country, considering stress, bank recovery planning, supervisory corrective their stage of development, policy frameworks, action, ELA, resolution strategies and bank-specific internal capacity, and initiatives proposed or resolution plans, deposit insurance, and resolution under way. Technical support would also need to funding. The domestic and cross-border coordination be considered for each country’s financial sector frameworks need considerable strengthening across development programs. It will also need to be these areas. Capacity building is also a pressing area, coordinated with existing technical assistance (TA) particularly in the form of regular domestic crisis and Financial Sector Assessment Program (FSAP) simulation exercises and occasional cross-border initiatives and with the various providers of TA. A exercises. To various degrees, technical assistance coordinated and prioritized strategy will be needed will be needed to support most of the countries in the for each country. As important, authorities receiving region in these efforts. TA must have established internal capacity and project governance arrangements to follow through The sequencing of reforms is important. The on the assistance provided. In that way, each agency’s order of reforms will vary depending on a country’s senior level staff members would appropriately have stage of economic and financial sector development, ownership of the relevant work, and TA providers the quality of risk management arrangements would monitor post-TA work programs to ensure in banks, the adequacy of banking supervision, that the programs are effectively implemented. the adequacy of insolvency law, and many other considerations. Deposit insurance is an important The main recommendations resulting from example of sequencing. It is essential that, before the study are set out in table 2. These general deposit insurance is established, a country has recommendations are for the entire southern Africa first established the prerequisites for deposit region, and the recommendations vary in relevance insurance. Those prerequisites include a robust depending on the country. banking regulatory and supervisory framework, sound insolvency law, and high-quality governance 8 | FINANCIAL SAFETY NETS AND BANK RESOLUTION FRAMEWORKS IN SOUTHERN AFRICA: SUMMARY OF KEY ISSUES AND CHALLENGES Table 2. 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: SUMMARY OF KEY ISSUES AND CHALLENGES | 9 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 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 10 | FINANCIAL SAFETY NETS AND BANK RESOLUTION FRAMEWORKS IN SOUTHERN AFRICA: SUMMARY OF KEY ISSUES AND CHALLENGES 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 Note: ELAs = emergency liquidity assistance; EWIs = early warning indicators; FSB = Financial Stability Board; IADI = International Association of Deposit Insurers; LT: long term, within the next three to five years; MOUs = memoranda of understanding; MT = medium term, within the next three years; SARB = South African Reserve Bank; ST = short term, within one year. FINANCIAL SAFETY NETS AND BANK RESOLUTION FRAMEWORKS IN SOUTHERN AFRICA: SUMMARY OF KEY ISSUES AND CHALLENGES | 11