Andrew Canter unpacks the future of banking in SA and how it will affect you

Alec Hogg went to visit Andrew Canter at his Futuregrowth offices to discuss the proposed changes to banking regulations in the form of the Banking Amendment Bill, how these will affect you and what the future of banking may begin to look like.

The undictated podcast is brought to you by Futuregrowth.

I like the look of your offices Andrew.

Thanks Alec.  We try to keep it homey here.

The subject that we need to discuss today is the proposed changes to the banking regulations.

The Government has introduced what’s called the Banking Amendment Bill to deal with how to resolve bad banks, and how to deal with bank failures in the future.  That follows on the global financial crisis where all hell broke loose, banks failed, and governments had to bail out banks with quite a lot of taxpayer money.  They don’t want to do that again.

In this country, Abil no doubt, has had an influence, too.

Abil was just the first test case.  This change in regulations has been rolling down the track at a slow pace.  The collapse of Abil and its curatorship is the test case now, to see how these things happen in practice rather than on paper.

Have we been following any particular country in the changes they’ve made?

My understanding is that the proposal of the Banks Amendment Bill follows the G20 countries’ framework with some minor tweaks that Treasury and SARB have proposed for the South African market.  Those are the bits, which are up for negotiation with existing lenders, because some things might be prejudicial to existing lenders (both senior as well as subordinate lenders) in the future.

How might this affect the investors in banks?

In the future, there’s going to be differentiation between depositors versus institutional investors who put in senior debt or subordinated debt, into banks.  It’s fair to say depositors have lost no money in South African banks for a long, long time except maybe, in the case of some big frauds that blew up.  Generally, depositors are very well protected as senior depositors have been in the past.  In the future, that’s going to change.  Depositors like to be treated as ‘super-senior’ and therefore, are given 100 cents on the Rand, presumably up to a number limit.  The rest of the lenders will be taking haircuts on capital, as we’ve seen with Abil, where they proposed that senior lenders get 90 cents on the rand. At this point, the debate is whether the subordinate lenders get anything.

Then it must also have an influence on ratings of banks and capital that the banks have to keep.

As part of the broad regulatory sweep in the world, banks are required to have more capital.  There are more rules and risk management happening.  If we take a view (as in the old days) that ‘banks are too big to fail, the government will bail out, and I don’t have to worry’, in the future it’s clear now that we have a model for ‘if the bank gets into trouble, you will lose the money’.  You have to change your pricing for that.  You have to assume that your loss – if the bank gets into trouble – is going to be higher than it was in the past.  If pre-financial crisis, you could get a home loan at prime minus one; now, it’s going to be prime plus one-half of prime plus one.  It’s going to be a sea change in how the consumer accesses finance and the relative cost-to-finance.

Do you think it’s going to make any difference to the way that banks lend?

I think it’s just goes to how they price the loans and their return on capital.  I don’t think it’s going to change the way lend although I must say, it opens up gaps for various kinds of alternative lenders.  While we think that African Bank proves that alternative lenders are going to fail; I think that the burden of regulation and the rising cost of capital is going to cause more alternatives, than just pop-ups.  We’ve seen peer-to-peer lending internationally.  We’ve seen all sorts of various kinds of alternative lending schemes from home finance, to car finance, to bicycle finance, to financing solar rooftop panels.  It might eat away at the banks’ market share.

I was thinking about securitisation as well.  S.A. Home Loans has done pretty well in South Africa, but it hasn’t really kicked on as aggressively as you might have thought.  Will this help?

With the financial crisis, people learned that securitisation structures, which looked robust and safe, actually weren’t ‘as safe as houses’ were.  You can’t run a securitisation structure that is making loans, unless you can access capital cheaply and I think that’s part of the challenge.  I think it will change over time.

Let’s get back to the valuations and ratings of banks from a shareholder’s perspective.  This has to have an influence, given that for the one part, the banks themselves have to have more capital.  Are you anticipating that ratings will improve, or not?

I don’t particularly have a view on the relative rankings of banks.  It became evident after 2008/2009 that the forces coming to operate on banks, would reduce returns on equity and therefore, their growth prospects and ratings did go down, and stayed down quite a lot.  I don’t think anything’s going to change in a hurry.  The global view is still, very much on the banking sector to be nearly a utility.  If you’re going to be a utility, you’re going to have regulatory profits.  If they can’t regulate them, they’re going to fine you to death.  I don’t see anything in the near term that will make banks huge profit engines.

It sounds like a structural change.

Absolutely, and it should be.  The catchphrase is the socialisation of losses and the privatisation of profits, which was the problem that led up to 2008.  Of course, that is a sea change.  The taxpayer no longer wants to bear that risk.

Philosophically though, and just to build on what you were saying a moment ago, it’s moving in the right direction, surely.

Yes, I think it is.  What we saw was excessive and a change was necessary.   The costs and damages done were necessary.  I say this with some trepidation because I’m not a lover of the banking sector, but you can go too far with these things.  We can end up with a situation where access to finance literally starts to dry up in an economy.  If the Abil workout is mismanaged, it could (1) cause reputational damage to the Reserve Bank and (2) to the banking sector.  That would mean higher costs of capital, less access to capital, and less lending by the banks because of rising costs.  You can go overboard with regulation and costs, to the extent that you’re actually, stifling the economy in terms of access to capital being critical to the development of an economy.

That’s a balancing act.

Broadly speaking, we’re moving close to the end game of the right direction.

Looking at it overall, we kind of know which way the regulations are going to be changing.  Do you feel that we’ve now gotten to the point where even the regulators themselves are saying ‘okay, enough and no further’?  Might this just be the start of further momentum in that area?

As I said, I think we’re near the end game – globally speaking.  Of course, in South Africa, the Amendment Bill still has to be finalised and institutional investors are still, very worried about some elements of the Bill.  Bank curatorship under the Banks Amendment Bill: the curator can do anything he wants.  He can say ‘well, we owed you one million, but we’ve just decided it’s R400, 000.00 now’ or ‘by the way, we have all these assets and we’re just going to sell them to a new entity at whatever price we determine.  We can change contracts.  We can unilaterally change anything without even referencing the existing funders of that bank’ and that’s a bit hard to swallow.  Even knowing that it’s necessary to move fast and efficiently, the ‘oh, I’m sorry.  You have absolutely no rights in a curatorship’ is a hard pill for the current funders to swallow.  That part of the negotiation has to happen.

It’s six months on, since Abil collapsed.  With the benefit of hindsight, would the new regulations have avoided that catastrophe?

No.  There are half a dozen ways to kill a bank.  One of which, is with bad lending practices.  Regulation wasn’t going to solve that.  That’s business practice.  Bad liquidity management, bad asset liability management, and fraud kills banks, so Regulation doesn’t solve these things.  Regulation seeks to monitor the general balance sheets of banks to make sure that they are robust enough to sustain losses.

When is all of this, likely to influence the banking sector in South Africa?

It’s already been happening.  Bank spreads on their listed bonds, has been rising.  It’s not catastrophic.  It’s 10 to 30 basis points, but it is rising.  It is influencing them.  I think that five years ago, before the crisis, institutional investors would have been happy to buy 10 or 15-year bonds from banks and I think more people are probably realising that you can’t take a 15-year view of a bank.  You should only lending the money for five years.  That affects the banks’ ability to make a long-term loan for infrastructure projects, for example.  Can a bank make a 20-year loan for a power deal if they can only access five-year finance from the market?  That could be a problem as well and that is already happening now.  They’re slow moving and and the trend has already been happening.  The ratings agencies have stepped in and downgraded the banks for the evolution of the picture of how bank failures will happen.  Banks will be resolved instead of being liquidated and it’s all coming through the system.

The process sounds as though, in time, mortgage loans will become more expensive as well, if the banks are only borrowing five years, and lend it out over 20 years.

That’s right.  Maybe it makes sense for an institutional investor like us, to say ‘hey, you only do mortgage lending.  You only do one thing.  You do it really well.  Frankly, I’d rather you do mortgage finance and I’ll give you money to do mortgage finance’ rather than give it to a bank.  I would have a better line of sight to a specialist lender and maybe I’ll even have a lower cost funding for that specialist lender.

Andrew Canter is the Chief Investment Officer at Futuregrowth and this undictated special podcast was brought to you by Futuregrowth.