Afr.j. pulil. sci. (1998), Vol. 3 No. 2, 29-48 
The Political Economy of Bank Failure 
and Supervision in the Republic of 
South Africa 
Charles C. Okeahalam* 
Abstract 
The failure of banks has financial, economic, social and political implications. 
Banks serve as deposit holders and financial intermediaries. As deposit holders 
they are the custodians of savings and via the market for capital, transfer the 
savings into investment or consumption. The particular role which banks play in 
the modern economy is significant and accordingly they are subjected to an 
extensive regulatory framework to ensure that they can continue to play the role 
for which they have been designed and to maintain confidence in the monetary and 
financial system. Despite these regulations (some would argue, because of these 
regulations) banks still become insolvent or fail to meet the conditions for 
maintenance or renewal of their licences. The final arbiter of this decision is 
usually the central bank. In the Republic of South Africa (RSA),' it has been 
suggested that the central bank - Reserve Bank of South Africa (RB) - has been 
unduly political in determining the manner in which it has applied banking 
regulation and conducted its role as lender of last resort. This paper contributes 
to this debate by discussing the manner in which the RB has performed its role and 
ways in which bank supervision in South Africa can be improved. 
Introduction 
The failure of banks has financial, economic and political implications. Banks are 
usually subjected to two types of regulation -economic and prudential. Broadly 
speaking the objective of economic regulation in banking is is to ensure social 
welfare rights. So economic regulation encourages higher competition (in commercial 
banks narrow spread between deposit and lending rates), less collusion and 
lower industry concentration. In practice, for example, economic regulation may 
1027-0353 © 1998 African Association of Political Science
30 Charles C. Okeahalam 
entail providing legal requirements which stipulate the minimum number of full or 
agency bank branches which a commercial bank must operate in particular areas. 
Prudential regulation is concerned with ensuring that depositors' funds are 
protected and the financial system is not compromised. This is done primarily by 
ensuring that banks are adequately capitalised by an appropriate amount and risk 
adjusted quality of equity. The prime practical example of prudential regulation, 
is that in accordance with the Basle Accord which has recently been further 
endorsed by the 25 Core Principles for Effective Bank Supervision 1997, banks 
may only lend up to a multiple of 12.5 of their risk adjusted equity capital. Of late, 
greater emphasis has been placed on prudential regulation with some even 
suggesting that economic regulation is inefficient and irrelevant. In South Africa, 
the regulatory process is allocated to the Reserve Bank (RB) and to the Registrar 
of Banks (RoB). Although overall responsibility for bank supervision (economic 
and prudential regulation) rests with the RB, day to day operational prudential 
regulation is the responsibility of the RoB. The RoB therefore is responsible for the 
day to day monitoring of the performance of banks. The RoB can use early warning 
models to determine the likelihood of failure of a bank and take appropriate action 
to forestall it. Depositors make explicit contracts with the financial institution in 
which they deposit their funds and implicit contracts with the regulator, who is also 
seen as the lender of last resort. Prior to the change of government in 1994, this 
principle appeared to work well. However, since the change of government this has 
not been the case and it has emerged that the RB has acted haphazardly and with 
partiality. It has been suggested that the role of the RB owes more to politics than 
it does to economics. This view is further accentuated by the track record which the 
RB has of coming to the rescue of financial institutions for political reasons. 
Ihe Second section provides a brief description of the banking industry in the 
RSA. The Third section discusses the role of the regulator and the too- big- to-fail- 
E"n C ' p l e - T h e F°urth section discusses recent incidents of bank failure in the RSA. 
e Fifth section assesses the ways in which the RB performed its prudential 
regu atory role and the political economy of the decision to rescue or not to rescue 
Dank or financial institution. Given the inadequacy and selective political 
nature of bank regulation in the RSA, the Sixth section suggests ways in which the 
ank regulation framework might be improved. The Final section concludes. 
of the South African Banking Industry 
1 
t h I a a ^a'r'y w e " developed banking sector which uses advanced 
si 1 °8^a n c l management information systems. At first blush, it appears fairly 
- A 1 C baking sector in that it is dominated by four major "core" banks 
memC ated B a " k S o f S o u t n A f r i c a L i m ited (ABSA), Standard Bank Invest- 
*30™'0" L ' m i t e d (Stanbic), First National Bank Holdings Limited (FNB) 
imited (Nedcor).2 Core banks are banking institutions whose failure
The Political Economy of Bank Failure and Supervision in SA 31 
would create systemic instability in the domestic banking system and the national 
economy. Since the authorities consider the continued existence of the core banks 
as essential to financial and economic stability, they will do all that they can to 
ensure that core banks do not fail. Because of the moral hazard of espoused 
unconditional support for core banks, it is unlikely that the authorities would wish 
to be explicit or unconditional in their support. Each of these banks has extensive 
branch networks. There is also a number of smaller banks which operate in specific 
market niches. 
As a result of apartheid, political pressure made many foreign banks close down 
and withdraw their RSA operations. After the 1994 elections, a number of foreign 
banking firms returned and by the end of 1997 there were 59 foreign banking firms 
with approved local representative offices in South Africa. This is up from 40 prior 
to the election. In addition, by the end of 1997, seven foreign banks had established 
branches. So far foreign entrants have concentrated primarily on the development 
of corporate relationships with multinationals and domestic companies interested 
in foreign direct investment. Accordingly, this increase in entry into the RSA 
banking market has increased competition in the corporate banking and stock 
brokering market segments of the sector, particularly since the deregulation of the 
Johannesburg Stock Exchange (JSE). 
Margins in the RSA banking market have historically been wide in comparison 
with those in other banking markets.-1 By maintaining very wide net interest 
margins, which have been facilitated by high real interest rates, the big four and the 
majority of other RSA banks have historically been able to report high profitability 
by international standards. Indeed, the influx of foreign banks and the nonintervention 
of the market has led only to a marginal reduction in profits of the big 
four banks. Furthermore, despite the periods of economic and political instability 
which prevailed prior to the elections of 1994, the major South African banks 
developed rapidly; capitalization improved, the extent and scope of use of 
information technology increased, risk management techniques and banking 
sector skills improved also. When foreign banks divested from the RSA, a small 
group of industrial (and in particular insurance) firms which already played a 
significant role in the RSA economy bought the assets of the divesting firms. 
This led to high concentration, which in turn increased the concentration of 
retail and commercial corporate lending to a greater extent than is usual in many 
other countries. The upshot of this is that the larger lending exposures of the banks 
are a greater proportion of capital reserves. The increase in competition has not yet 
reversed this. However, since the elections and the formal return of the RSA into 
international markets, the increase in capital market and exchange rate volatility 
and reluctance of the RB to decrease interest rates has squeezed industry margins. 
Increased competition has pushed down interest margins (difference between 
deposit and lending rates) which are now still on a declining trend and is a principle
32 Charles C. Okeahalam 
Table 1: Major Share holders of the Four "Core" Banks in South Africa 
ABSA Stanbic 
Sanlam(25.1) Uberty Life (39.9) 
Universal (25.0)a Old Mutual (20.5) 
Individuals (14.9) 
Other Corps (13.3) 
OldMuluaK 10)b 
SB Nominees (7.6)c 
FNB& Associates (4. l)d 
Gold Fields (9.1) 
SB Groups PF (5.0)e 
TransnetPF(4.3) 
San lam (1.6) 
Mine Official PF( 1.4) 
Slate St Bank Trust! 1 1) 
Eng Ind Prov Fund(0 8) 
Mine Employee PF (0 7) 
Notes: (a) Ofwhich the major shareholders are Rembrandt Holdings, Mine Employees 
Pension Fund and Sage Holdings. 
(b) Otherwise know as South African Mutual Life. 
(c) Standard Bank Nominees. 
(d) Rand Merchant Bank Holdings. 
(e) Standard Bank Group Pension Fund (PF). 
Source: Fitch-IBCA(1997). 
motivation of some of the larger groups in diversifying away from traditional 
banking products to other areas of financial services. Increased competition has 
also increased the demand for qualified bankers and pushed up the costs of such 
skills. Apart from narrowing margins, competition has clearly exposed the cost 
burden of the extensive branch networks of the big four banks. Indeed, 1996 
estimates indicate cost/income ratios, of the big four banks, of between 65% and 
M»% compared to estimates of 59-65% for most of the major banks in the countries 
mentioned below. The big four have instituted restructuring programmes to 
attempt to bring their costs down to international levels. Nedcor leads the way in 
this regard and analysts expectations are for a cost to income ratio of approximately 
If, "7 a n d F N B a n d S t a n b i c <with c o s t t o '"come ratios in 1996 of 66.8% 
and 67% in 1996 respectively) plan to get their ratios down to 60% by the year 2000 
A ii ^ reCently d i V u l g e d p l a n S t 0 m e r g e t h e f o u r seParate banks which it owns- 
At led Bank, Trust Bank, United Bank and Volkskas Bank into one operation This 
wil bring down its 1997 cost-to-income ratio of 67.2% the highest in the RSA 
anking industry. In addition, there has been a strategic shift in focus to grow other 
sources of revenue and to aggressively control costs by careful bank product 
arket segmentation and the increased use of technology to deliver the services 
FNB Nedcor 
Southern Life (20 4) 
Anglo American (24.4) 
De Beers (5.7) 
San lam (5.1) 
Old Mutual (53.4) 
Nominee Cos (32.8) 
Pension & Provident 
Funds (6 7) 
Other Insurers (2.4) 
Individuals (3.3) 
Other Corps (1.3) 
Non-residents (0.1)
The Political Economy of Bank Failure and Supervision in SA 33 
Ironically, the sanctions and commercial and trade boycotts have had hidden 
blessings for South African banks. They were able to avoid the problems of 
property loans and the LDC non-performing loan problem which was encountered 
by their counterparts in some other countries notably, the USA, UK and Japan. As 
a result, they avoided the large write-offs and high provision which banks in these 
other countries have faced. 
Apart from the big four there are other agents in the RSA banking sector. These 
smaller operators aim their savings and instalment finance products in different 
ways to individuals and the small, medium and micro enterprise (SMME) sector. 
These niche players have limited scope for competingwith the big four in terms of 
their capital bases and so have developed expertise in niche markets in geographic 
and service terms. To counter the obvious impact of scale dis-economies and 
efficiency costs, there have been mergers most notably between NBS (the fifth 
largest bank which enjoys a large market presence in the Kwazulu Natal province) 
and Boland Bank which has a large market presence in the Western Cape province. 
The new entity created from the merger will try to compete directly with the big 
four to form a "big five" category of core banks. Furthermore, Citizen Bank, Future 
Bank, and the Bophuthatswana Building Society (BBS) have merged to form 
Future Bank Corporation. This new bank is still relatively small and is primarily 
engaged in the provision of products to the black emerging market. In addition 
there are mutual banks which are basically former building societies which provide 
the opportunity for broader community involvement in the provision of credit and 
savings mechanisms via the mutual principle.4 Essentially, they have no paid up 
share capital and so are regulated under the Mutual Banks Act 1993 and are also 
subject to prudential regulations of the Banks Act 1990 as faced by all other types 
of bank in the RSA. 
Too-Big-To-Fail and Bank Failure 
While the core banks have performed well, on the whole their performance may be 
misleading given their dominant market position and the fact that in some ways 
they are protected by the twin doctrines of "too-big-to-fail" (TBTF) or "tooimportant-
to-fair (TITF).5 The principle underlying TBTF is that once a bank - 
usually a core bank - has reached a particular size, if it experiences any difficulties 
in meeting its liabilities, it should receive all the financial support which is 
available to make sure that it does not fail. Furthermore, all obligations to 
depositors, whether insured or uninsured will be protected by a government 
guarantee. In addition, professional creditors may also be protected but after 
liabilities to depositors have been met. However, equity holders, bond holders and 
senior management are not guaranteed any protection. There have been several 
non-core bank failures in the RSA which has led to debate as to the way in which 
the RB and RoB deal with these failures.
34 Charles C. Okeahalam 
From a depositor's point of view, the classification of a bank as a core bank 
presents implicit guarantees which non-core banks are unable to match; invariably 
depositors funds held in core banks are protected by the regulatory authority as a 
lender of last resort. The trade-off is usually marginally lower deposit rates at core 
banks given that depositors face lower risks by placing their deposits with core 
banks. It would also appear that in the long run, higher deposit rates are rarely 
sufficient to attract a sizeable enough demand for deposits in non-core banks. This 
is particularly the case given that economies of scale allow for competitive lending 
rates (with neutral credit rating) and the lender of last resort provision which is 
made more readily available to core bank than it is to non-core banks. 
Given the doctrines of TBTF and TITF, the regulation of core banks appears to 
be less problematic than the regulation of non-core banks. In South Africa, none 
of the core banks has ever failed, and the public are not privy to information with 
which to discern whether, either the TBTF or the TITF doctrines have actually been 
tested. The closest that South Africa has apparently come to the failure of a core 
bank, has been with regard to Volskas Bank which, although a leading bank at the 
time, could not readily be classified as either TBTF or TITF.6 At the other end of 
the scale, the failure of small banks carries a low probability of systemic risks 
therefore regulators are less likely to guarantee their survival in the event of default. 
The contagion impact of runs on small banks is unlikely to significantly destabilize 
the system since depositors will usually run to larger core banks. The regulator's 
cost-benefit analysis in such circumstances usually arrives at the conclusion that 
the taxpayer should not bail out a bank in difficulty unless there are considerations 
regarding aggregate financial and economic stability. This stance of the regulator 
has a market discipline impact in that it creates a disincentive to attempt to increase 
scale by taking aggressive deposit/lending margin strategies. While this maintains 
financial stability, it makes entry into the core bank category extremely difficult for 
non-core banks. Accordingly, a negative externality of such policy is the high 
concentration ratios normally found in commercial banking and its implications 
for competition, (Berger and Hannan 1989; Bentson and Kaufman 1996 and 
Okeahalam 1997). Furthermore, small community banks such as the Islamic Bank 
hold the deposits and provide a intermediation function in specific market niches 
which may not be covered by core banks. They may also help in the economic 
development process (Minsky, Papadimitriou, Phillips and Wray 1996) and the 
credit channel to sectors of the economy, (Samolyk 1994). The perception that the 
regulator is not sufficiently sensitive or at best has been selective in interpreting the 
rules which govern the decision to let a bank go under, or not, has received 
significant press attention in the RSA which, given its history, still provides very 
fertile ground for racial conspiracy theories in all aspects of economic and social 
life. The fact that failed institutions may not actually disappear entirely even when 
they fail (the exception is the Bank of Credit and Commerce International (BCCI))
The Political Economy of Bank Failure and Supervision in SA 35 
appears to be of little comfort to critics of the RB and the RoB regarding their 
handling of bank failures.7 All said and done however, small banks are not too 
difficult to either rescue or let fail, or restructure. It is the second tier bank group, 
which, should they fail, present bank regulators with the greatest policy difficulties. 
By definition, they are neither core banks nor are they small banks. So while 
they may not be TBTF they may be TITF. Their liabilities on their own, i.e. from 
one such banking firm, may not threaten the banking system significantly. 
However a bank run on such a firm may, via contagion, indeed lead to bank runs 
in other banking firms of similar size or characteristics with added risks of spillover 
into other institutions in different size cohorts. The cumulative impact of these runs 
may lead to a lack of confidence in the system which may be analogous in 
significance to the failure of a core bank. Strictly speaking, in theory, the systemic 
impact of cumulative banks failures may not be the same as that of the failure of 
core banks, even if the outstanding liabilities in both scenarios are the same. There 
are two views which can be taken. Firstly, what I term the bank "confidence" 
argument. Since banking is all about confidence in the system, the failure of a core 
bank represents a greater loss of confidence since depositors and creditors will 
believe that there is a fundamental flaw in the system since all things being equal 
a core bank will not be allowed to fail by the authorities. Secondly, the "multiplier" 
argument suggests that bank failure also indicates regulatory failure and carries 
with it the cost of potentially wider groups of depositors, creditors, and equity 
holders. The argument here is that the cumulative loss to depositors and importantly 
creditors and equity holders in institutions where the bank run did not start 
may have significant negative multiplier effects, not just in the monetary sector but 
also in the real economy. The moral dilemma, which also carries with it a moral 
hazard is that while rightly the regulator should not compensate equity holders in 
the event of wide spread bank failure, some banks which fail may indeed be 
adequately capitalised and are simply the industry victims of contagion. The US 
view as explained by Kaufman (1994) suggests that bank contagion systemic risk 
is highly unlikely, even where there is no deposit insurance and that truly solvent 
banks will not fail because of contagion. One way of dealing with this is to simply 
say, "tough", this is one of the risks which bankers should evaluate more carefully 
in determining whether the opportunity cost of capital justifies their investment in 
the sector (Clark 1996). The other view (popular in Europe and Japan) would be to 
take an agency - led case study approach to determine on a case by case basis, 
which banks (and possibly equity holders) should be bailed out and those which 
should not.8 
The Recent History of Bank Failure in the RSA 
Since 1990, a number of banks have failed in South Africa. The RB prefers to 
encourage other banks to come in and rescue them, and of late has become
36 Charles C. Okeahalam 
increasingly reluctant to offer support to failed banks. Liquidity and poor management 
have been the prevalent reasons for bank failure in RSA. This section 
discusses the recent bank failures. 
The failure of Alpha Bank in 1990 as a result of high level fraud, which was 
heightened by the risk exposure of its holding company Pinnacle Holdings, 
was the first of several bank failures in South Africa during the 1990s. As part of 
the rescue package, and RB injected R150 million into the bank, primarily to 
protect depositors. However this was not sufficient to resuscitate the bank and 
after four years of RoB curatorship the bank was placed in final liquidation in 
1994. 
Cape Investment Bank (CIB) was also the victim of fraud. In this case, it failed 
to disclose the significant number of non performing assets in its balance sheet until 
this was exposed when Prima Bank (which subsequently failed itself) withdrew 
from a takeover deal. This led to a liquidity problem which caused the bank 
to fai 1 in the second quarter of 1991. After protracted negotiations the RB provided 
R5 million to compensate depositors. 
Pretoria Bank had been poorly managed for a while before failing in July 1991. 
Top management believed that merging Pretoria Bank with Masterbond - a 
participation mortgage bond company - to form a company called Novabank 
would strengthen Pretoria Bank's balance sheet by providing high yield returns 
from the mortgage market in which Masterbond operated. However when 
Masterbond became unable to service its commercial paper and debenture obligations, 
which were the primary source of its funding, it collapsed. This caused the 
proposed joint venture to fail and closed the strategic rescue line of Pretoria Bank, 
which then failed. For reasons which are still unclear and indeed are at odds with 
its subsequent depositor compensation policy the RB repaid all the deposits which 
were placed with Pretoria Bank. 
Sechold Bank failed in December 1993 because of liquidity problems brought 
on after a wholly owned subsidiary Securities Equities Limited lost Rl 80 million 
in derivative trading positions. This resulted in a loss of depositor and investor 
confidence and resulted in significant erosion of the Sechold capital base. The RB 
extended some liquidity to Sechold while it was in curatorship and Investec Bank 
Holdings a leading merchant bank acquired 78% and managerial control. The 
extent to which depositors were indemnified is unclear. 
Prima Bank failed and was placed into liquidation in the second quarter of 1994 
It also had liquidity problems brought on by a large number of non-performing 
loans. The problems of Prima Bank were accentuated after the bank failed to 
recapitalise via a complex joint venture which was to have led to the establishment 
of a corporate entity called Merchant Bank of Africa (MIBA). MIBA was to have 
been established by a consortium of black businessmen called the South African 
Investment Corporation which would own 51 % and Prima Bank would own 49%.
The Political Economy of Bank Failure and Supervision in SA 37 
The recapitalised bank would have been used to increase black participation in the 
banking sector. After the joint venture failed because of insufficient capital, in line 
with section 311 of the Companies Act 1973, the Court agreed to a restructuring 
proposal in which Unibank transferred some of the assets of Prima Bank. A portion 
of the assets of Prima Bank was transferred to Unibank, while another portion was 
placed in an escrow type of account to compensate unsecured depositors. Unsecured 
depositors recouped 50% of their deposits. 
More recently a number of black managed and controlled banks have failed.9 In 
the last quarter of 1995, African Bank had liquidity problems and was placed under 
curatorship. During investigations, it emerged that poor management and inadequate 
capital were considered to be the main problems. As a result, a restructuring 
plan was implemented and the government agreed to a recapitalisation plan in 
which it which it guaranteed African Bank's non-performing assets. At the same 
time the major black industrial group New Africa Investments Limited (NAIL) and 
South Africa's fifth largest banking group NBS holdings made a successful bid for 
control of the Bank in the RSA. The holding company owns the majority of 
shares, and the agreement cedes management control to NBS for five years and 
R103 million was injected into the bank. This raised capital to R130 million. 
Curators were appointed by the RoB in September 1993 but this came to an end in 
March 1996. Although depositors did not suffer losses, the failure and restructuring 
of African Bank was particularly poignant since it was the first black owned and 
managed bank in South Africa. 
Soon after that, another small bank with black management failed. Community 
Bank also failed due to problems with liquidity. Its liquidity problems were the 
result of a very high expense to income ratio which were the result of inefficient 
management and inadequate returns on investment at branch level. In December 
1996, in agreement with the RoB curator, Unibank acquired Community Bank for 
R50m. Although the bank's strategic focus (low cost housing) remains, as part of 
the restructuring programme Unibank has significantly reduced the number of 
branches from 15 to 7. 
The Islamic Bank of South Africa (IBSA) is the most recent bank to fail in the 
RSA.10 It failed in November 1997 with debts of between R50 million and R70 
million and is currently under RoB curatorship-so the finer details of the cause of 
its failure and the exact position which the RB is going to take with regard to 
compensating depositors is unclear. However, it is emerging that bad management 
and improper accounting and management systems (some imply corrupt management) 
caused the bank to fail. Apparently, a large amount of insider unsecured 
lending has taken place which has resulted in a large proportion of non-performing 
assets in the balance sheet. In line with section 417 and 418 of the Companies Act, 
an investigation led by a commissioner appointed by the Master of the High 
Court with the support of the accounting firm Deloitte and Touche is currently
38 Charles C. Okeahalam 
underway. Meanwhile, the RB has agreed to compensate the investors up to a 
maximum of R50 000 per depositor. This covers 80% of depositors since the 
primary depositor base of ISBA is small depositors; mostly Muslim people who 
saw the IBSA as a community bank and saved their money there to make the Hadj 
pilgrimage to Mecca. Given the size of the bail out package, while the RB solution 
will compensate most depositors fully, it will not compensate all depositors fully 
so is seen as insufficient. Furthermore, it has been argued that the management of 
IBSA hid behind the self-regulatory position accorded to true Islamic banks, and 
that in any event, given that it was operating in South Africa it was unlikely to be 
able to operate as a true Islamic bank and that the RoB and the RB should therefore 
have been more vigilant. Accordingly, a series of court cases against the directors 
of IBSA has been lodged by depositors not fully compensated. There is also a 
significant debate as to the decision of the RB to only partially compensate 
depositors. This criticism of the RB is the result of further evidence of haphazard 
and inconsistent management of bank failure. 
The Role and Conduct of the Reserve Bank 
As can be seen above, several banks have failed in South Africa. On its own, as 
discussed elsewhere in this paper, as long as it does not threaten the system, bank 
failure is not necessarily a bad thing. Failure may be the result of sound competition: 
the result of healthy entry and exit in the sector. However, as Abraham and 
Settle (1992) show, since failure can be influenced by the regulatory regime, the 
role and decisions of the central bank (the usual regulator) need careful scrutiny. 
They are scrutinised by equity holders and management of banks to evaluate the 
extent to which they can devise and implement sufficiently aggressive strategies 
- the "upside" of moral hazard. The role of the regulator as explained earlier is also 
scrutinised by depositors who (depending on their risk preferences) wish to make 
an evaluation of the benefits of placing their deposits in different types of bank. The 
decisions of RB in bank failure management are analysed for consistency, and 
these decisions have been greatly criticised for being based more on politics than 
on appropriate central bank ethics. This is also very important because of the 
absence of a deposit insurance scheme in South Africa, as exists elsewhere." 
Although the RB view on deposit insurance has always been that it encourages 
moral hazard, the perception that the RB has been at worst politically selective, and 
at best negligent in performing its duties as a lender of last resort has led to calls 
tor the establishment of a deposit insurance scheme with clear guidelines and 
checks not only to avoid moral hazard but also to control the role of the RB and RoB 
with a clear legal framework for the regulation of banks and financial institutions 
and the management of crises within these sectors. 
This is important because there is now significant evidence to back the earlier 
perception that the RB has misused its position of lender of last resort and that in
The Political Economy of Bank Failure and Supervision in SA 39 
general it is an institution in need of reform. This section refers to the cases of bank 
failure above to discuss this latter perspective. 
After extensive enquiry, under the chairmanship of Judge Hennie Nel, and 
released in 1997, the First Report of the Commission of Inquiry into the Affairs of 
Masterbond Group and Investor Protection in South Africa (Nel Commission 
Report (NCR)), provides clear evidence to support the long held perspective that 
the RB and some of the auditing firms that have worked with the RB in evaluating 
banks have been at best, non-transparent, and at worst, dishonest. The primary 
remit of the Nel Commission was to evaluate the Masterbond crises.l: However, 
part of the broader terms of reference was to examine the extent of investor 
protection in the RSA. It was while exploring this wider term of reference that 
evidence to support the view of corrupt behaviour in the regulatory system was 
exposed. It appears that the RB has been corrupt and biased in its decisions to 
provide lender of last resort facilities to banks and that it has provided lifeboats to 
rescue particular banks without approval, full disclosure, or in contravention of 
proper practice. 
For example, as explained earlier in this paper Cape Investment Bank (CIB) 
failed in 1991. The SA Rail Commuters Corporation (SACC) had major deposits 
with CIB when it failed. When CIB faced difficulties RB granted a secret loan to 
CIB. However when CIB was put into liquidation by the RB, the SACC protested 
that the RB had protected its loan rather than depositors. However, it soon emerged 
that the loan to CIB was fictitious and that RB had not actually transferred any 
funds to CIB and had only made it appear that it had done so. 
In a different but related incident in contravention of the Financial Markets 
Control Act, the RB paid R5 million to Prima Bank to gain support for liquidating 
CIB, i.e., to allow CIB to fail. 
A secret Section 417 Commission of Inquiry which was held to find out why the 
R5 million was paid, clearly shows that the money was not actually transferred to 
the accounts of CIB, and that either the Governor of the RB or his officials were 
being economical with the truth. The RB has not yet explained its actions in this 
case. 
On other occasions between 1985 and 1995, the RB has apparently provided 
lender of last resort support to one of the core banks, ABSA, and one of its 
subsidiary companies, Bankorp. The Governor of the RB testified to another secret 
Section 417 Commission of Inquiry that all loans made by the RB to ABSA and 
Bankorp "were at all times recorded in the (Bank's) books regularly audited by the 
Bank's internal and external auditors and were included in the published financial 
statements of the Bank". However, once again it has emerged that no funds were 
actually paid to either ABSA or Bankorp and that six different groups of auditors 
collaborated with the RB to make it appear that funds were sent to the two banks." 
There have been other incidents from which the RB has emerged with its
40 Charles C. Okeahalam 
reputation further damaged. In one incident, inappropriate supervision and regulation 
allowed a senior manager (Albert Vermas), to use the Volkskas Bank to 
launder money and flout exchange control regulations. This led to the failure of a 
community development bank in the independent Ciskei homeland. The subsequent 
enquiry under the chairmanship of Justice Harms (The Harms Commission) 
arrived at the conclusion that the RB, RoB, and Receiver of Revenue (RoR) had 
been incompetent and that their negligence or compliance assisted Albert Vermaas 
to defraud the Ciskei Community Bank (CCB). 
Bank Failure and Supervision in the RSA: The Way Forward 
When one reviews the way in which the RB has played its role as regulator and 
lender of last resort, one is led to one or all of the following conclusions. Firstly, 
that (in its current guise) the RB is politically biased and therefore is a potentially 
corrupting influence in the financial system. Secondly, it is a fairly incompetent 
organisation, and thirdly, that the prudential regulatory framework in the RSA is 
in need of reform. The recent history of perceived political bias in supervision and 
bank failure management undermines the prudential system. The allegation of 
corruption, while strong, can only meaningfully be countered by the acceptance of 
the charge of gross negligence and ineptitude. In either event, the regulatory 
framework needs to be reformed. 
The first step is to revisit the statutes governing prudential regulation. Greater 
emphasis will need to be placed on revising the legislation so as to limit the 
discretionary power of officials in the RB and RoB.14 The reform would allow for 
officials at the RB and RoB to retain discretion for marginal decisions but would 
greatly circumscribe their power with regard to decisions to either offer or decline 
lender of last resort life boats. Statutes governing the core banks (TBTF, and lilt) 
should also be reviewed. At all times, the possibility of encouraging moral hazard 
should be borne in mind. In this regard, the RSA may gain by taking a good look 
at the Financial Institutions, Reform, Recovery and Enforcement Act (FIRREA) 
1989. While FIRREA did not prevent high numbers of commercial bank failure in 
1990 and 1991 or the failure of the Bank Insurance Fund it augmented the authority 
of federal agencies to dig out potential problems, impose timely regulation-based 
restrictions and discipline bank officials who did not comply. Most importantly, it 
reduced the limitations on the discretion of the regulatory officials in application 
of the law. Furthermore, the regulatory framework has to become more unitary so 
that RoB and RB are placed under the same legislative umbrella to ensure that 
information asymmetries are reduced and that the agency costs associated with 
monitoring banks also decline. This however, should not be allowed to represent 
an excuse for collusion in corrupt behaviour at both establishments, as probably 
exists. 
Furthermore, a way forward may be for South Africa to adopt a scheme which
The Political Economy of Bank Failure and Supervision in SA 41 
is similar in essence to that which now prevails in the United States under the 
Federal Deposit Insurance Corporation Improvement Act (FDICIA) 1991 where 
rules have clearly been substituted for discretion." Indeed, under FIRREA (1989) 
five bank capitalisation categories were established: well capitalised; adequately 
capitalised; undercapitalised, significantly undercapitalised; and critically 
undercapitalised. If during evaluation, a bank falls into one of the three lower 
categories the FIRREA requires that without discretion it must submit an acceptable 
capital restoration plan within a specified time which is dictated by the extent 
to which it is undercapitalised. If a suitable capital restoration plan is not provided 
the bank will be subject to constraints on asset growth, non-traditional activities, 
transactions with affiliates and deposit rates of interest. Furthermore, critically 
undercapitalised banks must be closed immediately-although there is some latitude 
for discretion given the finality of this last step. Soyibo, et al (1997) illustrate 
how a deposit insurance scheme modelled to some extent on the US system works 
in Nigeria. 
In tandem with the introduction of legislation to reduce RB discretion, the RSA 
needs to carefully consider the introduction of a deposit insurance scheme. The US 
has had a Federal Deposit Insurance Corporation since 1933 and its experience is 
once again valuable for the situation in the RSA. Firstly, US experience supports 
the assertion that deposit insurance is capable of encouraging moral hazard and 
secondly, on its own, it is not capable of preventing bank failure. However, by the 
introduction of risk-adjusted deposit insurance premiums and risk-adjusted capital 
requirements, the FDICIA (1991) has reduced the moral hazard deficiencies of 
excessive risk taking and forbearance which the previous Act had. Accordingly it 
can serve as a good model. 
A further area of reform is the regulatory role of the core banks. The core banks 
do already play a regulatory role in the RSA banking market. This needs to be 
encouraged further. Indeed, proponents of "free" banking such as Gorton and 
Mullineaux (1987), Dowd (1994 and 1996) would argue that the market regulatory 
function should be further emphasized and that the leading members of the Council 
of South African Bankers (COSAB) should develop a greater regulatory presence 
to provide liquidity, governance, and market discipline. The problem with this free 
market solution is that it is at odds with the role which the RB has played to date, 
and increases the likelihood that senior members of such a club might attempt to 
replicate the RB's position in order to maintain the status quo. 
Given the benefit of the doubt, although highly unlikely, some of the RB 
decisions of the past may have been based on ignorance. If so, there is a need for 
education of regulatory officials to keep them abreast of developments and make 
them capable of tracking the behaviour of bank officials. This is particularly 
important as banking has become more complex with the increased use of 
derivative instruments, off-balance sheet techniques, and cross-border deals.
42 Charles C. Okeahalam 
Finally, since liquidity has been the apparent reason for the majority of bank 
failures, there is a need to examine leverage and risk-adjusted capital requirements 
carefully.16 
Conclusions 
By being inconsistent in performing its regulatory duties the RB leaves itself open 
to the charge that it is partial to certain interest groups and prejudicial to others. For 
the reasons cited above, the perception is that the RB may be using its position to 
maintain the economic status quo by preventing the emergence of other players in 
the banking industry. However, in some ways this all pales in comparison with the 
view that the behavior of the RB undermines confidence in the RSA banking 
industry, the financial system, and the economy in general. This is a major 
allegation given South Africa's pressing social and economic problems, 
which call not only for significant foreign investment, but also for an increase in 
the domestic savings rate. This latter requirement is unlikely to manifest itself if 
depositors believe that clear prudential regulations and guidelines governing the 
institutions holding their funds are not being implemented or that there is bias in 
the system. 
In summary, this paper suggests that while the banking industry in the RSA is 
relatively sophisticated by international standards, and given the presence of the 
JSE (at the time of writing the tenth largest in the world by market capitalization) 
there is a requirement for the regulatory framework to be improved. The history of 
bank failures in South Africa and the ways in which the RB and RoB have managed 
these events to date, suggests that fundamental reform of the regulatory framework 
is required. Two important steps are required. Firstly, without encouraging moral 
hazard, there is a need to reduce the discretionary power of the RB and RoB by the 
enactment of legislation which sets parameters within which the regulators can 
operate. Secondly, for this to be effective the RSA needs to establish a deposit 
insurance corporation. Although the banking industry in the US and the RSA are 
very different, with regard to both key reforms, the experience of the USA in 
applying FIRREA (1989) and FDICIA (1991) should be very useful. These 
reforms are made ever more urgent given the significance of the RSA in the 
economic and financial affairs of the Southern Africa Development Community 
(S ADC) region. In addition it has emerged that unsound and imprudent lending and 
ineffective prudential monitoring and supervision of compliance with bank prudential 
regulations contributed to the recent South-East Asia economic crises and 
created opportunities for speculative attacks on currencies in that region. Given 
this fact, as the countries within the SADC region attempt to integrate, there is a 
need for the monetary and financial authorities of the region to ensure that there is 
effective adherence to prudential rules, harmonization of supervision and monitoring 
and no opportunities for regulatory arbitrage.17
The Political Economy of Bank Failure and Supervision in SA 43 
Notes 
* Professor of Banking and Finance, University of Namibia and Banking and 
Financial Institutions Advisor to the Bank of Namibia. This paper was 
presented at a conference on "Financial Institutions in the Political Economy: 
Case Studies from Pre-Colonial, Colonial and Post-Colonial Africa" Rosendal, 
Norway 11-14 June 1998.1 am grateful for the comments of the participants and 
of one of the discussants — Thandika Mkandawire. I am also grateful for data 
and information from Mark Young of Fitch IBCA (Pty) Ltd Johannesburg. The 
views expressed in this paper are entirely those of the author and do not 
represent the views of the Bank of Namibia. The usual disclaimer applies. 
1. The terms RSA and South Africa are used interchangeably throughout the 
paper. 
2. It has also been suggested (Dowd, 1996), that espoused or not, the implicit 
contract between core banks and the authorities creates moral hazard. As an 
indirect form of compensation for their privileges core banks have duties such 
as using their dominant industry positions to assist the regulator in monitoring 
the banking system by imposing market regulations and serving as clearing 
houses. See Dowd (1994) for more on the market based regulatory role and 
bankers clubs. 
3. Net interest margins for the big four have narrowed from an average of 4.5% 
in 1993/4 to an average of 4.1% in 1996/7. According to data from the credit 
rating agency Fitch IBCA, South Africa, this still compares favourably with the 
averages of the top four banks ranked by assets in other countries: Australia 
(3.3%) France (1.7%), Germany (1.5%), Japan (1.2%), UK (2.3%), and the 
USA (1.2%). The big four have achieved strong growth in assets and equity and 
their profitability ratios (return on assets (ROA) and return on equity (ROE) 
have so far been stable at rates which are higher than those recorded for the big 
four banks in the countries listed above. 
4. There are currently five registered mutual banks. However Community Bank, 
founded in July 1994, experienced liquidity problems soon after, and has been 
placed under curatorship. In terms of the Supervision of Financial Institutions 
Rationalisation Act 1996 (Act No. 32 of 1996), the Venda Building Society 
(previously registered in Venda, a former homeland that was amalgamated 
with South Africa after the elections) became a mutual bank with effect from 
July 1996. The remaining three are Credit and Savings Help Bank, GBS Mutual 
and TNBS Mutual which is now under provisional registration. 
5. There are several recent examples of the application of the TBTF principle. In 
Japan, the Ministry of Finance considers the top twenty-one largest banks as 
TBTF and has intervened with rescue packages and restructuring strategies for 
three banks recently; Hanwa Bank in November 1996, Nippon Credit Bank in 
February 1997 and Hokkaido Tokashuku in April 1997. In Europe, particularly
44 Charles C. Okeahalam 
in France and the Scandinavian countries the TBTF principle has been applied 
to prevent systemic risk. 40% of banking assets in France are owned by the 
state. Some of the core banks for example Credit Lyonnais, Banque National 
de Paris (BNP) and Societe General have been, or are still state-owned, and thus 
would be all deemed to TBTF. In Norway, Fokus Bank was rescued by the 
deposit insurance corporation and the establishment of a Government Bank 
Investment Fund. In Finland, the Government used FMK 20 billion (at that time 
equal to 4.1% of the country's GNP) to establish the Government Guarantee 
Fund in April 1992. This avoided a bank capitalisation crises. In Sweden, the 
government has intervened several times in Nordbanken, (which is 71% state 
owned) to prevent it from failing. A bank support programme costing approximately 
3% of GDP was introduced in 1992. The TITF principle accords banks 
higher status than they would otherwise receive if size is used as the only 
variable when rendering "core" bank status. These are normally banks which 
have had a long track record as a major domestic bank and which may still be 
significant in certain sections of the industry. In this vein, Garderner and 
Molyneux (1997) suggest that in the UK, Lloyds Bank - the UK's fifth largest 
bank - is more likely to be protected than Abbey National Bank - which is a 
recently converted building society. In Germany, Westdeutsche Landesbank is 
the third largest bank by asset size, however it is not considered one of the three 
core banks. These are Deutsche Bank, Dresdner Bank and Commerzbank. In 
the same spirit, with regard to South African banks, one could suggest that 
Investec Bank Holdings (which is consistently rated by the international rating 
agencies and the professional magazine "The Banker' as the best managed and 
capitalised bank in South Africa"), may now have entered the TITF category. 
6. Volskas Bank was acquired by ABSA as part of a recapitalisation exercise, 
after a crises prompted by non-performing assets. 
7. When a bank faces difficulties, it is usually restructured through the injection 
of capital to the equity base by the new acquiring group, or the government. Its 
liabilities are then incorporated into the consolidated balance sheet of the new 
restructuring group, which may then take on the task of handling nonperforming 
loans, (if that is the cause of the problem). For example, in the RSA, 
Volkskas Bank by ABSA, African Bank by NBS, and internationally, Barings 
Bank by ING Bank of Netherlands. It would appear that perceptions of where 
ultimate control and ownership rests is of more importance to critics. 
8. This is the approach which has been adopted in Indonesia in light of the Asia 
crises of 1997 which removed US$52 billion from the Jakarta Stock Exchange 
- some of which was from the banking and financial services sector. An 
Indonesia Bank Restructuring Agency (IBRA) has been established to evaluate 
banks on a case- by-case basis. This is the same method that is being used by 
the Nigeria Deposit Insurance Corporation (NDIC) as part of the "sanitisation"
The Political Economy of Bank Failure and Supervision in SA 45 
of the domestic banking sector. See Soyibo, Alashi, and Ahmad (1997) for 
further details. 
9. The way in which these banks have been treated by the RB, in comparison to 
how other banks which failed earlier were treated, has created significant and 
at times emotional criticism of the role of the RB. For example after comparing 
some of the earlier actions of the RB, such as the rescue of Volkskass Bank and 
Bankorp, Mashele (1997), suggests that the RB's recent bank failure policy is 
designed to prevent, or at best delay for as long as possible, the emergence of 
a black capital class. 
10. Haron (1996) and others have suggested that Islamic banks should be considered 
as a different sector from conventional banks since they have different 
objectives, rely on different economic concepts and different sets of operations. 
However, as with conventional banks the demand and savings deposit facilities 
at Islamic Banks carry the unqualified obligation to pay currency or its 
equivalent on demand or within the stipulated time frame governing the 
depositor agreement. The principle of fair practice in dealing with shareholders, 
depositors, and customers plays a significant self regulatory role in 
management practice at Islamic banks so less formal external regulation of the 
type found in conventional banks is required. However there is much debate 
regarding the ability to truly practise Islamic banking in a secular state or a state 
in which Islamic Shari 'a Law is not the legal basis. Iqbal and Mirakhor (1987). 
11. A detailed and comprehensive proposal to establish a deposit insurance scheme 
in the RSA was discussed in September 1996 by the Standing Committee for 
the Banks Act 1990. The RB Governor's Committee approved the proposal on 
21 October 1996 and it has been submitted to the Minister of Finance who is 
considering it. 
12.Masterbond - a mortgage finance company - owed Bankorp Rl.l billion. 
When Masterbond collapsed, the loan asset portfolio failed to perform and 
Bankorp failed. As part of the rescue package the RB provided Bankorp with 
an interest free loan of R 1.1 billion. This loan was provided in secret. It only 
emerged, when, as part of the rescue package, ABSA agreed to acquire 
Bankorp. The RB track record of not actually providing life boats which it 
announces, makes it difficult to determine the true size of the life boat. However 
on the assumption that funds were actually transferred, critics suggest that 
given the size and secrecy of the life boat, there is no way of establishing 
whether or not the package compensated depositors and equity holders of 
Masterbond and Bankorp - which it should not, and whether or not shareholders 
in ABSA such as the life insurance and pensions investment group Sanlam 
(see Table 1) received tax benefits from the lifeboat - which they should not 
have. The Masterbond case is currently in the courts. 
13. The internal and external auditors of the RB, ABSA, and Bankorp all collabo-
46 Charles C. Okeahalam 
rated in the deception. This finding has not only further damaged the RB's 
credibility but has also damaged the credibility of auditing practice in the RSA. 
Given the importance of auditing in the determination of true financial values, 
the implications of reduction in auditor credibility are not trivial, see Menon 
and Williams (1991). This view is echoed by Justice Nel who states that "The 
standards set by the Reserve Bank by its philosophy that "the end justifies the 
means" and the apparent acceptance thereof by the auditors concerned ... could 
only have had a negative influence on the auditing profession in SA. 
14. This should not be confused with interference in monetary policy - an area in 
which the RB has an enviable track record. The irony is that some of the RB's 
hard work in this area is periodically undermined by its poor track record in 
prudential regulation. There is debate as to whether or not open market 
operations and changes in bank required reserve ratios which central banks use 
as part of prudential regulation create a negative externality, Bentson and 
Kaufman(1996) or reduce negative externality, Dowd (1996. 
15. As Shull (1996) states "FDICIA coupled the reaffirmation of public interest 
banks and the augmentation of supervision with the requirements that rules be 
substituted for discretion in evaluating bank condition and dealing with weak 
institutions ... FDICIA further limits supervisory discretion on a case by case 
basis through what has been termed prompt corrective action involving the 
imposition of escalating constraints on undercapitalised banks". 
16. The current thinking on leverage and risk-based capital requirements are as 
follows. Leverage requirement refers to the ratio of tangible equity capital to 
total assets. Tangible capital is primarily equity (Tier 1) capital, does not 
include intangibles such as goodwill, and should be differentiated from Tier 2 
capital such as subordinated debt, loan loss allowances and preferred stock. 
Risk-based capital requirements make it necessary to weight credit risk in 
specific types of assets on bank balance sheets and in off—balance sheet items 
such as standby letters of credit. In the USA, the FDICIA also requires the 
regulatory authorities to back-up the above risk-based capital analysis with 
interest rate, concentration, and non-traditional activity risk analysis. 
17. A system by which banks attempt to have themselves regulated by what they 
perceive to be the most liberal regulatory authority. 
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