A Financial Systems Resilience Index for South Africa: Joining the Twin Peaks Professor Christine Oughton SOAS University of London co12@soas.ac.uk KEY ISSUES FOR EFFECTIVE MACROPRUDENTIAL POLICYMAKING SARB CONFERENCE PROGRAMME 27 October 2017 I am indebted to staff in the Financial Stability Department for helpful comments and valuable assistance with data. Hugh Campell, Bonakele Hllonwane, Esti van Wyk de Vries deserve particular thanks for providing data on many variables. Thanks are also due to NEF for updated data on a number of variables for 2013 2014.
Outline 1. Introduction and Background 2. Concepts and Definitions 3. Influences on Financial System Resilience: Theory 4. Components of Financial Resilience Index: Data/Empirics 5. Implications for Regulation
1. Background UK Coalition government of 2010 targeted diversity in financial services as policy objective all banks had become alike Problem: no measure of Financial Diversity We constructed diversity index (2000 2011, updated to 2013, 2015) using firm level data for deposits and mortgage markets (Michie and Oughton) Relationship between diversity, stability and resilience, led to Financial System Resilience Index panel data for G7 countries, 2000 2012 (consultants to NEF (2015) Financial System Resilience Index) Now with South Africa
2. Concepts of Financial System Stability & Resilience Financial stability an important condition for sustainable economic growth, development and employment creation. SARB FSR 2016(1) Financial System Resilience The capacity of the financial system to adapt in response to both shortterm shocks and long term changes in economic, social and ecological conditions while continuing to fulfill its functions in serving the real economy NEF FSRI: Building a Strong Financial System 2015
Financial System Resilience System resilience is not simply the sum of each individual bank s stability or resilience systems theory Capacity of system to adapt rather than fixed, equilibrium concept evolutionary approach Relationship between resilience and competition depends on the type of competition: creating more banks that all do the same thing can increase risk bank diversification vs system diversity the regulator s dilemma
In a 2 asset system with a given probability of bank failure, individual bank risk is minimised by asset diversification, but when all banks diversity in the same way, systemic risk is not optimised it is better to have different types of banks with different objectives and strategies Beale, N et al (2011) Individual vs systemic risk and the Regulator s Dilemma, PNAS
3. Influences on System Resilience (NEF, 2015) Competition and Corporate Diversity (e.g. PLCs, mutuals, public savings banks) Interconnectedness and networks Size of Financial System Asset composition Liability composition Complexity and transparency Leverage
What is Diversity? i. Ownership and Corporate diversity ii. Competition price and product iii. Funding Model Balance Sheet Diversity & Resilience iv. Geographic Diversity
Why is it important? Systemic stability, resilience the regulator s dilemma Enhanced competition via different business models/species mixed oligopoly Some species (e.g. mutuals) less prone to shorttermism Some species more likely to be locally rooted and adapt to local environment e.g. financial inclusion
Diversity and Regulation Mixed oligopoly plcs, mutuals, cooperatives, public sector banks can lead to more competitive pricing and higher social welfare Mutuals and cooperatives have a stronger locally rooted base local banks in US less involved in sub prime Corporate Diversity helps resolve the regulator s dilemma It is important to have system diversity in balance sheet structure
Measuring Corporate Diversity (Based on Simpson s 1949 article in Nature) Different types according to different objectives Banks: shareholder owned profit maximisation Mutuals: owned by their members maximise welfare of members Public Savings Banks e.g. National Savings & Investment: government owned raise funds for government, encourage saving 11
Measuring Corporate Diversity Michie & Oughton (2013) Corporate Diversity Index Bio diversity Index: we define z corporate types or species and define the corporate diversity index as the share of deposits δ i that belongs to each type: We do the same for mortgages:
Chart 1. UK Ownership Index: Banks, Mutuals and NS&I 110 100 90 80 Deposits Mortgages 70 60 50 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015
Measuring Competition We use the standard Hirshman Herfindahl Index: The complement of HH gives a competitiveness index
101.00 Chart 2. UK Competitiveness Index: Mortgage Balances Outstanding and UK Deposits 100.00 99.00 98.00 97.00 96.00 95.00 Mortgages Deposits 94.00 93.00 92.00 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015
Measuring Balance Sheet Diversity and Resilience Based on Funding Gap and the concentration of loan/deposit ratios. The funding gap is: (Loans Deposits)/Loans The inverse funding gap spread is:
1.2 Chart 3. UK Major UK Banks and Mutuals Customer Funding Gap as a Proportion of Customer Loans and Advances 1 0.8 0.6 0.4 0.2 Maximum Median Minimum 0 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 0.2 0.4 0.6
Diversity of loan/deposit ratios Captured by a diversity index:
0.45 Chart 4. The Hirschman Herfindahl Index of Funding Model Concentration; the market concentration of loan to deposit ratios, UK 0.4 0.35 0.3 0.25 0.2 0.15 0.1 0.05 0 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015
We combine our funding gap spread index and our L/D diversification index to form a measure of financial resilience
Chart 5. UK Resilience Index Mortgages and Savings Markets 120 100 80 60 40 20 0 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015
Regional Diversity: Geography Firms located in different regional economies may pursue different strategies tailored to their local environment Co location in London leads to loss of regional diversity The distance of each firm s Head Office from London acts as a proxy for regional diversity Weighted by market share
160.00 Chart 6. UK Geographic Concentration of Head Offices and Strategic Decision Making 140.00 120.00 100.00 80.00 Deposits 60.00 Mortgages 40.00 20.00 0.00 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015
The Diversity Index Michie and Oughton D Index We combine our 4 aspects of diversity into a single D Index
Chart 9. UK Diversity Index for Financial Services (D Index): Ownership, Competitiveness, Resilience & Geographic Spread 110 105 100 95 90 85 80 Deposits Mortgages 75 70 65 60 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015
A Financial System Resilience Index for South Africa Corporate Diversity (e.g. PLCs, mutuals, public savings banks) Interconnectedness and networks Size of Financial System Asset composition Liability composition Complexity and transparency Leverage
Market Concentration C3 measured in assets South Africa has the most concentrated banking system as measured by C3 with the above 3 species. However, this ignores other public banks Recently, moderate improvement in concentration (C3), but still high
80 Chart 1 C3 Concentration Ratio Bank Assets % 70 60 50 40 30 Canada France Germany Italy Japan South Africa UK US 20 10 0 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014
Diversity South Africa has the least diverse banking system as measured by a simplified version of the Michie Oughton D Index: Share of retail deposits held by non plc banks However, this ignores smaller cooperatives, Stokvels etc.
90 Chart 2 Corporate Diversity: % of Retail Deposits Held by Non PLC Banks 80 70 60 50 40 30 Canada France Germany Italy Japan South Africa UK US 20 10 0 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015
Interconnectedness and Networking Bank lending to other financial corporations as proportion of GDP Foreign Claims as a proportion of GDP There has been a marked fall in interconnectedness in South Africa after the global credit crunch in 2007
70 Chart 3 Lending to Other Financial Corporations, Excluding Banks, as % of GDP 60 50 40 30 20 Canada France Germany Italy Japan South Africa UK US 10 0 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014
Moreover, South African banks are not significantly exposed to more foot loose nonresident deposits
180 Chart 4 Banks' Foreign Claims as % of GDP 160 140 120 100 80 60 40 Canada France Germany Italy Japan South Africa UK US 20 0 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015
Financial System Size Total bank Assets as % of GDP Household Debt as % of Gross Disposable Income South Africa performs comparatively well on both measures Household debt increased in the run up to 2007, but has since stabilised
700 Chart 5 Total Bank Assets to GDP % 600 500 400 300 200 Canada France Germany Italy Japan South Africa UK US 100 0 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015
180 Chart 6 Household Debt to Gross Disposable Income % 160 140 120 100 80 60 40 Canada France Germany Italy Japan South Africa UK US 20 0 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015
Asset Composition: Does the financial sector serve the real economy? Share of lending to non financial sector (real economy credit) i.e. loans to non banks firms and consumers (excluding mortgages) This indicator has been improving for South Africa, on trend and is now above 50%
80.0 Chart 7 Real Economy Credit Ratio % of bank loans to non financial firms and for consumption 70.0 60.0 50.0 40.0 30.0 20.0 Canada France Germany Italy Japan South Africa UK US 10.0 0.0 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014
Liability Composition Measure of broad non core liabilities Harutyunyan et al (2015) IMF WP/15/1 foreign deposits and funds raised by issuing debt securities, loans and Money Market Fund (MMF) shares and certain types of restricted deposits Proportion of board non core liabilities to total liabilities This indicator is low for South Africa cf the G7, but there has been a moderate increase on trend
100.00 Chart 8 Broad Non Core Liabilities Ratio % 90.00 80.00 70.00 60.00 50.00 40.00 30.00 France Germany Italy Japan South Africa UK US 20.00 10.00 0.00 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013
Complexity and Transparency Derivatives exposure (insufficient data) Securitisation a proxy for complexity and opaqueness in the financial system Due to regulation this measure has been falling in most countries post the financial crisis, including in South Africa where the indicator is comparatively low
50 Chart 9 Securitisation Outstanding as % of GDP 45 40 35 30 25 20 15 Canada France Germany Italy Japan South Africa UK US 10 5 0 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014
60 Chart 11 Ratio of Bank Assets to Equity 50 No. of Times 40 30 20 Canada France Germany Italy Japan South Africa UK US 10 0 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015
Leverage Banks capital (equity) to assets ratio Indicator for South Africa has changed little over time and is around the G7 average
90.00 Chart 12 Financial System Resilience Index 80.00 70.00 60.00 50.00 40.00 30.00 Canada France Germany Italy Japan South Africa UK US 20.00 10.00 0.00 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014
Financial System Resilience Index After standardisation the indicators were combined to form a single index with equal weights South Africa is ranked 6 th but is in a close knit cluster of countries with an index value around 65 Areas of concern market concentration and lack of financial corporate diversity
Implications for Regulation 1. Promoting competition via encouraging new entrants 2. Promoting diversity of financial corporations with different objectives also promotes competition regulation from within e.g. mutuals, cooperatives, Stokvels 3. This second policy strand also promotes macroprudential stability i.e. it helps solve the regulator s dilemma it joins the twin peaks 4. It (2) can also assist with the promotion financial inclusion
References: Beale, N, Rand, DG, Battey, H, Croxon, K, May, R and Nowak, M (2011) Individual versus systemic risk and the Regulator s Dilemma, Proceedings of the National Academy, August 2, vol 108, no 31, 12647 12652. Harutyunyan, et al (2015) Shedding Light on Shadow Banking, IMF Working Paper, WP/15/1, No. 1, 2015, IMF Washington. Michie, J and Oughton, C (2013) Measuring Diversity in Financial Services Markets: A Diversity Index, Centre for Financial and Management Studies Discusssion Paper No. 113, April, CeFiMS, SOAS, University of London. NEF (2015) Financial System Resilience Index, nef May, 2015, London. Michie and Oughton were consultants to this project. A revised version is forthcoming by NEF. SARB (2016) Financial Stability Review, No. 1 2016, SARB, Pretoria.