A significant problem with the “twin peaks” regulatory model lies in the necessity for the “peaks” – the prudential “peak” and the market conduct “peak” – to co-ordinate their efforts, given the inherent conflict of interest that arises out of their different objectives.
Prudential regulation speaks to financial stability concerns, irrespective of market conduct considerations. Market conduct regulation aims to remove or reduce abusive practices, irrespective of prudential considerations. The two goals are often at odds, as market conduct action can, in extreme cases, impact financial stability. A good example of how this conflict could manifest itself in practice is when the National Credit Regulator (NCR) has to recommend a fine that is substantial. In a recent case, the NCR’s proposed fine of R300 million was reduced to R20 million following settlement negotiations with African Bank.
A current example of the negative consequences of the big brother approach taken by the South African Reserve Bank (SARB) is its decision to buy the “bad” book of African Bank. The consequences of this decision have yet to be felt, but the facts speak for themselves. The SARB has used R7 billion to buy R17 billion in junk debt. Instead of reducing the burden on consumers by having this debt legally written off, consumers will, for many years to come, have to pay back capital, interest, and vast collection costs, on loans that should never have been granted. It is a disaster for consumers and it has been justified on prudential grounds.
While some argue that the decision by the SARB to intervene and save African Bank was justified, in reality it sets a bad example and runs contrary to good banking practice throughout the developed world. We should let African Bank’s share and bond holders take responsibility for their poor investment decisions.
The NCR should not be let off the hook. Yes, the SARB has bought the “bad” book, but that should not stop the NCR from auditing the whole book, good and bad, to determine, first, whether African Bank checked consumers’ credit records before granting the loans and, second, whether African Bank granted loans to consumers who were already in default of their existing credit obligations. If that audit, which could be outsourced to one or more credit bureaus to perform, determines that African Bank failed to conduct a credit check prior to issuing a loan, or granted a loan to a consumer who was in default of his or her credit obligations, this would, prima facie, amount to reckless lending under the National Credit Act.
However, unless a court determines, following such an audit, that such loans were reckless, and therefore illegal, consumers will have to pay back the loans and/or taxpayers will be left to foot the bill.
Buying the bad book without checking whether or not these loans were reckless and without considering the consequences for the affected consumers, powerfully illustrates the impact of allowing prudential considerations to trump the need to rectify abusive conduct.
Before rushing to condemn the NCR for the African Bank debacle, policy makers should face the facts and acknowledge that the SARB was responsible from a regulatory perspective for the failure of African Bank. African Bank’s balance sheet and inadequate provisions should have resulted in more than fireside chats. Balance sheets are core to prudential regulation; the holes in African Bank’s balance sheet point at a failure in prudential oversight. The SARB should not have acted retrospectively. They knew what was happening well in advance and they should have insisted that African Bank take action ahead of time to avoid a lack of capital adequacy. Claiming now that they did their job in advising the bank’s executive to seek further funds from shareholders was, with respect, a cop-out.
The NCR is not to blame, and the failure of African Bank should not be allowed to justify the NCR’s inclusion in a problematic twin peaks structure. On the contrary, the NCR should be commended for raising the alarm and taking African Bank to the National Consumer Tribunal. In summary, the NCR’s regulatory independence and integrity should be supported.
Despite this overwhelming and recent evidence of why prudential regulation should not be allowed to undermine market conduct regulation, there are those such as Herbert Kawadza, a lecturer in banking and finance at the University of the Witwatersrand’s School of Law, who argue that the twin peaks model should nevertheless include the NCR, as this would improve regulatory oversight. The examples provided show that they are wrong.
In the idealistic regulatory world of Kawadza and other supporters of the twin peaks model, we have a picture of peaceful and perfect co-existence between prudential and market-conduct regulation. The reality is clearly very different. Our experience is not an isolated one. As may be seen in the United States, the Dodd-Franks Act has resulted in the creation of an independent Bureau of Financial Protection which sits outside the Federal Reserve.
Senator Dodd voiced his opinion that “I really want the Federal Reserve to get back to its core enterprises ... We saw, over the last number of years when they took on consumer protection responsibilities and the regulation of bank holding companies, it was an abysmal failure.”
Let’s not make the same mistake. Let’s ensure that the market conduct regulators have the freedom to do their work without interference from prudential regulators.
There is every reason to believe that the incorporation of the NCR into a super regulator under the twin peaks model would result in a similar captive regulatory scenario that Senator Dodd describes as an abysmal failure.
In the current proposals, government is right to exclude lending from the ambit of the twin peaks regime. It should go further and establish a stronger market conduct regulator. Consumer credit is par excellence a matter of market conduct. In the UK, the new Financial Conduct Authority is focused on market conduct. So important is the regulation of market conduct in the UK that banks have been forced to repay more than £5 billion in mis-sold credit life insurance. That is the right way to go. We need to stop holding banks to a lower level of market conduct. By reforming and punishing abusive conduct we create stronger financial markets and support prudential objectives.
Unless we maintain a strong separation between these regulatory bodies, South Africa faces a grave risk of undermining the excellent progress we have made in forging effective consumer credit regulation and enforcement.
* Stephen Logan is an attorney who specialises in consumer law. He is the founder of Fair Credit, a non-profit company that exists to protect consumers from abusive credit practices.