The New Financial Architecture: South African Supervisors, Banks and the New Basel Accord

The new international financial architecture has its roots in the financial crises that shook emerging-market economies in the l990s Mexico in 1994-5, and East Asia in 1997-8. The problems there, as well as in Russia in 1998, in Brazil in 1998-9, and more recently in Turkey and Argentina, underscored the importance of strengthening the international financial architecture.

These crises generated a broad consensus that fundamental reforms were required in the international financial system.

The international community has launched a series of initiatives referred to collectively as the new international financial architecture to strengthen the operation of the global financial system. A focal point of this architecture is the prevention of crises.

Work on strengthening the international financial architecture is being undertaken on several fronts simultaneously. The major building blocks of this undertaking are transparency and accountability, international standards and codes, the strengthening of financial systems, capital account issues, sustainable exchange rate regimes, the detection and monitoring of external vulnerability, private sector involvement in forestalling and resolving crises, and IMF facilities.

This paper focuses on one of these building blocks: the strengthening of financial systems. In the search for increased international financial stability and possible measures to prevent future periods of systemic risk, concerns have grown that international financial markets themselves may be increasingly important sources of financial instability.

The implementation of the proposed Basel Accord on capital adequacy is another important initiative of the new financial architecture. By more closely aligning regulatory capital charges and banks' risk profiles, the adoption of the proposed Accord could substantially strengthen banking systems, thereby increasing the overall stability of the financial system. In the current environment of globalisation and increasing competition in the financial services industry, risks are larger in scope and scale than ever before. Keeping pace with the changes in the risk environment, as well as with the newest developments in risk-management practices, poses significant challenges to regulators and banks alike. For supervisors, the most important challenge involves developing an approach to capital regulation that works in a world of diversity and near-constant change. Financial institutions face the challenge of implementing advances in risk modelling in a coherent and systematic fashion, and of coping with conceptual difficulties regarding model specification and data limitations The new capital adequacy framework proposed by the Basel Committee is an attempt to address these challenges. However, implementing the proposed Accord creates additional challenges, especially in an emerging-market context.

This paper gives a perspective on the new financial architecture from the viewpoint of banks, and concentrates on the effect of the implementation of the Basel Accord on the South African banking system. A secondary aim of the paper is to identify the challenges posed by the implementation of the proposed capital adequacy framework to South African banks and bank supervisors and to see how prepared they are for these challenges.

Although a review of annual reports of South African banks suggests a relatively sophisticated approach to credit risk management and the use of internal credit risk ratings, it is likely that the rating systems of South African banks do not meet all the requirements set out by the Basel Committee for the internal ratings-based approach to setting regulatory capital requirements. Recent problems at Saambou and Unifer also point to potential shortcomings in the credit risk management processes of certain South African banks.

Against the background of South Africa's sophisticated and efficient financial markets and yet its vulnerability as an emerging market∩┐╜ï∩┐╜¿∩┐╜½∩┐╜Ã∩┐╜┬é∩┐╜ï∩┐╜¿∩┐╜½∩┐╜Â∩┐╜  an overview is given of the structure of the South African banking sector. This includes quantitative indicators of financial system soundness, like various indicators of credit risk and capital adequacy. An overview is given of the risk management practices of South African banks, as well as of the supervisory approach of the South African Reserve Bank. All of this is compared to international best practice policy guidelines.