Letter from... South Africa

Bernardt van der Linde considers how strict banking regulation has instilled confidence in South Africa's financial system

'Liduduma lidlule! The thunder will pass. We can say to our people:

Our finances are in order, our banks are sound.' These were the words of South African Finance Minister Trevor Manuel in his recent medium term budget speech.

The credit crisis that originated in the United States has now spread like a virus - affecting banking and financial systems in Europe, Britain, South Korea and even Iceland. Several banks have required massive new capital injections initially led by sovereign wealth funds but governments have also stepped in to guarantee deposits, provide capital and buy instruments from these troubled institutions.

Despite this turmoil, South African banks have not required any financial assistance over the past 12 months. Recently the World Economic Forum rated its banks the 15th most secure out of 134 countries rated, beating even Switzerland (16th), Germany (39th), the US (40th) and Britain (44th). 'That is a very important accolade,' Manuel said. But how has South Africa managed to buck the trend?

Manuel and fellow economists believe that strict bank regulation has instilled confidence in the country's financial system, and Manuel is full of praise for the South African Registrar of Banks, Errol Kruger. What has also worked well is that the Reserve Bank, which is the central bank of the Republic of South Africa, retains bank supervision. This is in contrast to Europe and the US where fragmented regulation means problems may not be spotted early enough.

Michael Jordaan, CEO of First National Bank, credits broader exchange controls with insulating South Africa from the global financial crisis. And Nazmeera Moola, head of macro strategy at Macquarie First South, says: 'Exchange controls have limited our exposure to foreign assets - we have big, stable, conservative banks and our market just doesn't have access to the really silly products that have caused this mess.'

On the funding side, less than 5% of the funding of South Africa's banks is foreign. Even if Europe's banks, for example, ceased all loans to South Africa's banks the effect would be tiny. Exchange controls also limit the development of markets in credit derivatives because regulators won't allow exposures that might mean money flowing out of South Africa.

Although South Africa has an advanced banking system comparable to developed countries, local banks have continued with a 'vanilla' mortgage model. Mortgages have mostly been carried on the balance sheet of the originating bank and not repackaged and sold as exotic instruments with different tranches like those crippling American banks.

For accounting purposes these vanilla loans are recognised at amortised cost less a provision for bad debts based on a dynamic provisioning model, contrasting with repackaged instruments, which are marked to market.

In 2002, South Africa had a minor banking crisis sparked by the micro-lending industry. More than 20 smaller banks disappeared either through takeovers or liquidations while many chose to relinquish their licences because the market had lost confidence in them. The crisis also affected larger banks, as clients pulled deposits and liquidity dried up.

This led to a more conservative approach by the banks and the formation of the National Credit Act, which aims to stop high-risk and unaffordable lending.

In a recent report, JP Morgan attributed South Africa's relative safety to the tightening in monetary policies since 2006. 'The developed world has had its oxygen supply shut off resulting in recession as the banking system has failed to provide liquidity,' it said.

'South Africa's money market has been unaffected with ample domestic liquidity, while developed money markets have frozen up. JIBAR has not budged versus LIBOR which has spiked.'

Yet while South Africa's financial system and banks remain healthy, the country will not be able to escape the global recession. Expected GDP growth rates have reduced from more than 4% to 3.7% for the coming year. Just 3% is predicted thereafter.

Bernardt van der Linde is a research accountant for PSG Limited and a former PwC chartered accountant