South Africa’s decision to rescue a small lender seen as neither “too big” nor “too interconnected” to fail shows that taxpayers worldwide may have to accept that bank bailouts are here to stay.
When South Africa’s central bank recently announced a $700 million (520 million euro) rescue of faltering African Bank Investments Limited, it scarcely made a splash outside the country.
The bottom line, at least for the rest of the world, was that African Bank is not very big and not very important.
The bank’s managers made far too many bad loans to too many South Africans who could not afford to pay them back.
Because it had not asked borrowers to put up their car or any other asset as collateral, it was left with a massive hole in its balance sheet when they failed to pay.
African Bank is not one of South Africa’s “big-four” — Standard Bank, FNB, Nedbank or ABSA (Barclays Africa) — which are deeply enmeshed in the global financial system.
While many South African banks had made similar “non-secured” loans, most notably Capitec, they have profitable lines of business that should cover any losses.
And because deposits accounted for only one percent of African Bank’s creditors there would be little risk of a “It’s a Wonderful Life” style bank run, with South Africans clambering to withdraw cash.
The South African financial sector — which makes up about a quarter of the country’s gross domestic product (GDP), and which is vital to investments across the African continent — seemed safe.
Announcing the rescue, the South African Reserve Bank, which is well respected globally, pointed to a very local reason for the rescue: to support lenders who serve the poor.
African Bank had mainly provided small loans to low-earning black South Africans, helping them start businesses or get into the housing market.
Two decades after the end of white minority rule and with South Africa still one of the most unequal countries on earth, that is something the government is desperate to encourage.
But the Reserve Bank was also motivated by something more globally relevant: the need to prevent a panic.
“The rescue,” according to Jac Laubscher, an economist with Sanlam, “once again demonstrates the difficulty of allowing a financial institution to fail and to let all the messy consequences play out unhindered”.
“This is of course not a problem peculiar to South Africa.”
Since the 2008 global financial crisis regulators have tried to reduce the risk that taxpayers’ cash will be needed to save banks that have made dodgy bets.
“Too-big-to-fail” banks have been told to improve the quality and quantity of their capital and to put in place plans for their possible demise.
But at the same time authorities, including those in South Africa, are acutely aware of what happened to the US financial system and the global economy when Lehman Brothers was not given a bail out.
Its collapse sent shock waves across the financial sector, making major banks unwilling to lend to anyone in case the recipient would be next to go.
Credit markets were frozen, hitting consumers and fuelling the Great Recession.
For the South African authorities the risk of a similar panic or a similar freeze — however slight — was too great, particularly with the economy already on the verge of recession.
According to Andrew Canter, chief investment officer for Futuregrowth, which has around $13 billion of assets under management, there was legitimate concern that uncertainty over African Bank could have caused tumult for well run banks.
“A bank failure with uncertainty in the press and uncertainty at street level could have caused people to say: ‘All banks are bad and this unsecured lending is out of control and I think I’m going to charge down to my local Capitec branch and take my money out as fast as I can’.
“If ABIL (African Bank) had of been left to rot there would have been so much uncertainty it could have created systemic uncertainty,” he said.
Some investors baulk at calling African Bank’s rescue a bailout at all, citing steep losses for shareholders and imposed losses for some debt holders.
“Serious pain has been felt by equity holders, all debt holders, money market funds and the wider banking system,” said Nomura economist Peter Attard Montalto.
But ultimately taxpayers are still on the hook for $700 million of African Bank’s “bad book.”
Which just goes to show, after years of crisis, bank bailouts are still far from a thing of the past.