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A Financial Systems Resilience Index for South Africa: Joining the Twin Peaks
Professor Christine OughtonSOAS University of London
KEY ISSUES FOR EFFECTIVE MACROPRUDENTIAL POLICYMAKINGSARB 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 short‐term 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
Beale, N et al (2011) Individual vs systemic risk and the Regulator’s Dilemma, PNAS
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
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 short‐termism
• 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
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Measuring Corporate DiversityMichie & 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 δi that belongs to each type:
We do the same for mortgages:
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2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015
Chart 1. UK Ownership Index: Banks, Mutuals and NS&I
Deposits
Mortgages
Measuring Competition
We use the standard Hirshman‐Herfindahl Index:
The complement of HH gives a competitiveness index
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2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015
Chart 2. UK Competitiveness Index:Mortgage Balances Outstanding and UK Deposits
Mortgages
Deposits
Measuring Balance Sheet Diversity and Resilience
Based on Funding Gap and the concentration of loan/deposit ratios. The funding gap is:
(Loans – Deposits)/LoansThe inverse funding gap spread is:
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2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015
Chart 3. UK Major UK Banks and Mutuals Customer Funding Gapas a Proportion of Customer Loans and Advances
Maximum
Median
Minimum
Diversity of loan/deposit ratios
Captured by a diversity index:
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2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015
Chart 4. The Hirschman‐Herfindahl Index of Funding Model Concentration; the market concentration of loan to deposit ratios, UK
We combine our funding gap spread index and our L/D diversification index to form a measure of financial resilience
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2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015
Chart 5. UK Resilience Index – Mortgages and Savings Markets
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
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2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015
Chart 6. UK Geographic Concentration of Head Offices and Strategic Decision Making
Deposits
Mortgages
The Diversity Index Michie and Oughton D‐Index
• We combine our 4 aspects of diversity into a single D‐Index
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2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015
Chart 9. UK Diversity Index for Financial Services (D‐Index):Ownership, Competitiveness, Resilience & Geographic Spread
Deposits
Mortgages
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
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2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014
Chart 1 C3 Concentration Ratio Bank Assets %
Canada
France
Germany
Italy
Japan
South Africa
UK
US
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.
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2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015
Chart 2 Corporate Diversity: % of Retail Deposits Held by Non‐PLC Banks
Canada
France
Germany
Italy
Japan
South Africa
UK
US
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
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2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014
Chart 3 Lending to Other Financial Corporations, Excluding Banks, as % of GDP
Canada
France
Germany
Italy
Japan
South Africa
UK
US
• Moreover, South African banks are not significantly exposed to more ‘foot loose’ non‐resident deposits
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2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015
Chart 4 Banks' Foreign Claims as % of GDP
Canada
France
Germany
Italy
Japan
South Africa
UK
US
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
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2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015
Chart 5 Total Bank Assets to GDP %
Canada
France
Germany
Italy
Japan
South Africa
UK
US
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2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015
Chart 6 Household Debt to Gross Disposable Income %
Canada
France
Germany
Italy
Japan
South Africa
UK
US
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%
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2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014
% of b
ank loans to no
n‐fin
ancial firm
s and
for con
sumption
Chart 7 Real Economy Credit Ratio
Canada
France
Germany
Italy
Japan
South Africa
UK
US
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
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2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013
Chart 8 Broad Non‐Core Liabilities Ratio %
France
Germany
Italy
Japan
South Africa
UK
US
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
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2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014
Chart 9 Securitisation Outstanding as % of GDP
Canada
France
Germany
Italy
Japan
South Africa
UK
US
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2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015
No. of T
imes
Chart 11 Ratio of Bank Assets to Equity
Canada
France
Germany
Italy
Japan
South Africa
UK
US
Leverage
• Banks capital (equity) to assets ratio
• Indicator for South Africa has changed little over time and is around the G7 average
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2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014
Chart 12 Financial System Resilience Index
Canada
France
Germany
Italy
Japan
South Africa
UK
US
Financial System Resilience Index
• After standardisation the indicators were combined to form a single index with equal weights
• South Africa is ranked 6th 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.