The well-publicised collapse of Silicon Valley Bank (SVB) in the US, followed in short order by New York’s Signature Bank, highlighted the important role deposit insurance plays, says Michael Jordaan, chairperson of Bank Zero
It successfully prevented widespread panic over the solvency of the many regional banks operating in the US, some of which, like SVB and Signature, are surprisingly large.
The South African Reserve Bank introduced a new deposit insurance scheme, which came into effect on 24 March 2023. This means South Africa is also one of the G20 nations to adopt statutory insurance to protect depositors in the event of a bank failure.
The Reserve Bank has established a subsidiary, the Corporation for Deposit Insurance (CoDI), to levy premiums on banks and manage a fund to be used to repay the depositors of failed banks up to R100 000 per account.
Banking failures in South Africa are fairly rare, thanks to generally sound management and good banking regulation. In 2002, three banks went under: Regal Treasury Bank, New Republic Bank and Saambou Bank.
Only two more bank failures have occurred since then, namely African Bank in 2014 and VBS Mutual Bank in 2018. Four of these five failures were caused by bad management and liquidity problems, while the fifth, Regal, was the only case where depositors lost money.
Looking back further, there were 10 bank failures in South Africa in the 1990s, three in the 2000s, two in the 2010s, and none, so far, in the 2020s. South Africa is becoming an ever-safer place to bank.
The fear that deposits might be at risk is a common driver of runs on banks that are perceived as smaller or weaker than the industry giants. Even banks that are perfectly sound can get caught up in such panic. No bank can withstand a run on deposits, so trying to prevent panic withdrawals is a core function of effective banking regulation.
In a pure free market, one would say ‘buyer beware’ and let depositors pay the price if they place their money in a bank that is inadequately capitalised or badly managed.
In reality, however, most smaller depositors cannot be expected to conduct thorough risk assessments on banks. Even seasoned pros can find it hard to evaluate the adequacy of a bank’s holdings.
It is widely acknowledged, therefore, that smaller depositors ought to be protected and not held liable for banking failures over which they have no control and which they cannot predict.
A consequence of this inability to assess risk is that many depositors use a crude heuristic to evaluate their banks, and that heuristic is usually size.
Even though new start-up banks offer a highly compelling alternative to the lumbering giants, with innovative products, responsive interfaces and customer service, and even zero fees, many people stick to the rule of thumb that it is unwise to bank with smaller banks since larger banks are safer.
This makes it very hard for new banks to compete in the banking sector. Many have tried in South Africa, with mixed success, but they often remain on the fringes of the market because a large number of potential customers just don’t feel that small banks are safe enough.
Deposit insurance, even if limited to only R100 000 per account, will make it easier for innovative small banks to challenge the large incumbents in the market.
An important reason for deposit insurance is to stem systemic risk. SVB, for example, wasn’t just any bank. Many of its customers were Silicon Valley companies, which routinely held more than the insured amount of $250 000 in order to meet payroll obligations.
If those business customers lost their deposits and couldn’t pay staff, this would force the unpaid workers to withdraw savings from other banks, which could spark runs on other banks, only for the vicious cycle to repeat and spread like a contagion.
This is why the US Federal Deposit Insurance Corporation, which like South Africa’s CoDI, is a subsidiary of the central bank, took the unprecedented step to waive its $250 000 limit on deposit insurance and make customers whole for the entirety of their deposits.
If South Africa’s banking regulators want to level the banking playing field not only for consumer banking but also for business banking, they will have to consider raising the R100 000 limit considerably or even permit unlimited deposit insurance at the discretion of the Reserve Bank to limit the destructive effect of a bank’s failure on the businesses that depend upon it.
Still, the establishment of the CoDI and protection of bank deposits up to R100 000 is a very welcome development. It will protect small and unsophisticated depositors, improve systemic stability, and level the playing field between small banks and large incumbents.