An argument for abolishing the South African Reserve Bank – FMF’s Lehumo Sejaphala

The South African Reserve Bank’s (SARB) mandate to protect the currency’s value and stimulate economic growth is scrutinised. The SARB’s interventions, including changes in the repo rate and Quantitative Easing, are criticised for potentially exacerbating economic challenges. The author argues for a money supply increase aligned with actual economic growth, highlighting concerns about the SARB’s role as the lender of last resort. The recent shift from fractional reserve banking to a tiered floor system is discussed, raising questions about the fairness of banking practices and the potential impact on individuals in times of economic uncertainty.

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The case for abolishing the South African Reserve Bank

By Lehumo Sejaphala*

On the face of it, the South African Reserve Bank (SARB) performs an important function which cannot be dispensed with – a function which is nevertheless superfluous when interrogated closely. This function is derived from section 224 of the Constitution and is stated as follows:

The primary object of the South African Reserve Bank is to protect the value of the currency in the interest of balanced and sustainable economic growth in the Republic.

This mandate is not only superfluous, but since led to a situation where the SARB provides solutions to its own self-created problems. This is done six times a year by the SARB’s Monetary Policy Committee through changes in the repo rate, and sometimes, Quantitative Easing (QE) – the two single most magic instruments at the disposal of central bankers used to either tighten or loosen the money supply in the economy (often without any meaningful corresponding economic activity). In South Africa, like many other jurisdictions across the globe, this has been justified by central bankers and their sympathisers as means of stimulating economic activity – or in the words written in the Constitution, “protecting the value of the currency in the interest of balanced and sustainable economic growth”. 

This objective is problematic because the supply of money in any sound money economic system should be determined primarily by the demand of borrowers to take out bank loans, not a group of “towering intellectuals”. In turn, this will ensure that there is a correlation between available bank reserves (deposits at the central bank) [assuming that the central bank is not abolished] and commercial bank lending/deposits. As Werner and Ryan-Collins et al (2012) have argued, “when such demand is low, because the economy is weak and hence interest rates are also driven down to zero, the relationship between available bank reserves and commercial bank lending/deposits can break down entirely”. 

However, in line with its primary mandate of protecting the value of the currency and additional mandate of stimulating economic activity, the SARB almost always runs the risk of flooding the banks with additional liquidity, either via QE or its continuous increase of the repo rate. The additional liquidity created in this manner ends up in circulation, thus eroding the purchasing power of the very same currency which the SARB is constitutionally mandated to protect. In the second instance, the SARB’s mandate is inherently problematic because it assumes that money especially fiat currency has an intrinsic value. However, money is simply an economically justifiable right to receive goods for services rendered. In other words, in a market economy money, like prices, simply conveys an underlying message – that is, the level of economic activity in a specific geographic area.

It is not a precondition to produce goods and services – hence societies used the barter system to trade with each other before the creation of money. This is why the central bank’s money creation exercise to stimulate economic active hardly ever works. As I have argued elsewhere, the money supply should be increased only in conjunction with economic growth. In other words, if the economy grows by 2%, the money supply should be increased only by 2% to create an equilibrium.

In the third instance, it is common cause that the South African has not grown by more than 3% per annum in more than a decade. So, there can be no “balanced and sustainable economic growth” to speak of. The economy must grow, or show signs of growth, before we can have a meaningful discussion about “balanced and sustainable economic growth” whatever that means. What is even more concerning about the SARB’s mandate is its additional objective which accords it the exclusive right of serving as the lender of last resort to provide liquidity assistance [to commercial banks] in exceptional cases. One of these exceptional circumstances is a bank run — “which occurs when too many customers withdraw all their money simultaneously from their deposit accounts with a banking institution for fear that the institution may be, or will become, insolvent”. The most recent devasting bank runs occurred during the 2007-2008 global financial crisis. This resulted in many commercial banks requiring bailouts to honour their liabilities to their customers in the US, for example. 

At the heart of bank runs is usually a system called fractional reserve banking which requires commercial banks to hold a certain amount of their deposits as non-loanable funds. Up until June 2022 when the SARB abandoned this Monetary Policy Framework in favour of the so called surplus or tiered floor system, the reserve ration in South Africa was 7.5% – meaning that banks could use the balance of deposits above the reserve ratio to make loans to the public. Some scholars have argued that the loans arising from this arrangement were  created out of thin air, while others have equally maintained that the loans were funded by the deposits received by banks. And that it is for this reason that banks run into financial difficulty, particularly when deposits are withdrawn. But that is besides the point, the point is, faced with such a calamity, commercial banks have a lender of last resort to run to – that is the central bank which can either provide bailouts or use the funds from Deposit Insurance Corporations to help them settle their liabilities. 

To be fair, banks are required to contribute something towards such Deposit Insurance Corporations. In the US for example, the Federal Deposit Insurance Corporation (FDIC) guarantees that every insured deposit will be paid back regardless of the financial condition of the bank. To pay for this protection, each bank is assessed a specified percentage of its total deposits. The problem, however, is that the percentage is the same for all banks regardless of their previous record or how risky their loans. As Griffin has argued, under such conditions, it does not pay to be cautious:

The banks making reckless loans earn a higher rate of interest than those making conservative loans. They also are far more likely to collect from the fund, yet they pay not one cent more. Conservative banks are penalized and gradually become motivated to make more risky loans to keep up with their competitors and to get their “fair share” of the fund’s protection.

Moral hazard is ultimately built right into the system – thereby increases the likelihood that what is being insured against will happen. This indeed goes against everything insurance underwriters will be willing to stand for. Moreover, the banks do not necessarily pay this assessment. As with all other expenses, the bulk of the cost ultimately is passed on to their customers in the form of higher service fees and lower interest rates on deposits. The South Africa equivalent of the US’s FDIC is the newly established Corporation for Deposit Insurance – a subsidiary of the SARB which will operate almost like the FDIC. Against this backdrop, an important question to grapple with is whether ordinary persons like you (the reader) and I enjoy the same privilege? Asked slightly differently, if you woke up the next morning to receive an email from your employer that you have been retrenched for operational requirements, who will you approach for “liquidity assistance” to continue to honour your financial obligations until you can land another job in a jobless economy like ours. After all, commercial banks are required to run credit checks before extending loans which often involve the borrower providing proof of a stable monthly income and a high credit score – the two stringent but necessary requirements which commercial banks are not subjected to during bailouts.

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*Lehumo Sejaphala, a contributing author for the Free Market Foundation, holds a BA Law and LLB degree from Wits University and is currently studying for an LLM. He runs an online blog platform called the Voiceless and has contributed articles to the Mail & Guardian, City Press and IOL