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At last, consensus on the much-anticipated Basel 3 capital requirements for banks

At last, consensus on the much-anticipated Basel 3 capital requirements for banks

By Howard Davies, Chairman of the Royal Bank of Scotland.

LONDON – After long and sometimes painful negotiations, which stress-tested the personal relationships between many countries’ central bankers and regulators to the limit, the Basel Committee laid a long-expected egg in December. Described as a package that finalizes the post-2008 reforms to the global regime for bank capital, it brings to an end the process known as Basel 3.

Bankers have dubbed the result “Basel 4,” arguing that the final package contains many new and more burdensome requirements. But the Committee is adamant that the new rules should be regarded as part and parcel of the reform program begun in 2009, in the wake of the global financial crisis. Basel 4 may come one day, but this is not it, they insist.

What problem does the new package seek to resolve? In the preamble, the regulators refer to “a worrying degree of variability in banks’ calculations of [risk-weighted assets].” They have found that applying the major banks’ different internal models to the same portfolio of loans can produce very different numbers, meaning that some banks would be carrying significantly less capital than others for the same quantum of assumed risk.

The logical answer to that problem, one might think, is to interrogate the models closely, to see what is driving the differences, and demand calibration changes where the resultant asset reductions are deemed excessive. But the regulators clearly doubt their capacity to penetrate the dark recesses of banks’ internal models; so, instead, they have imposed a so-called “output floor.” In other words, however much your model reduces risk-weighted assets, you cannot take credit for more than a 27.5% cut.

The output floor is expressed as a net figure, of 72.5%, below which you cannot go. Why the unusually precise figure of 72.5%? The answer is obvious. It is half way between 75%, which was the final US bid, and 70%, which was the French offer. They agreed to split the difference.

Although this may make no sense, even affected banks had come to the view that some kind of agreement was better than none. Continuing uncertainty made capital planning very difficult. So bankers favoured a deal, and will live with the outcome, if it is genuinely the end of the program.

Unfortunately, this new agreement is unlikely to draw a line under the capital debate. Even though senior central bankers like Mark Carney, the Governor of the Bank of England and Chair of the Financial Stability Board, think there is now enough capital in the banking system, many do not share his view.

Anat Admati of Stanford would like capital ratios well above 20%. Martin Wolf of the Financial Times makes a similar case. He thinks banks are still dangerously unstable. Andy Haldane of the Bank of England points out that, given the low pricing of bank equity, on a market-adjusted basis banks are not as strong as they seem.

Bankers, by contrast, point to the high cost of equity and argue that forcing banks to raise even more will increase the cost and decrease the availability of credit. In Europe, around half of the improvement in capital ratios has come from reducing lending rather than raising new equity. There is little meeting of minds between the two camps.

So it was a relief to encounter William Cline’s book The Right Balance for Banks, which attempts to produce a rationale for the appropriate level of bank capital. Drawing on a wide range of research and market analysis, Cline argues that requiring banks to hold more capital does indeed increase the cost of credit to some extent. Although there is some evidence that bank debt is cheaper if equity backing is high, which one would expect, the reduction is not one for one. And an increase in the cost of credit is likely to depress growth and generate welfare losses.

On the other hand, higher equity for banks will reduce the incidence of bank failures, which impose high costs on the economy and on individuals. Reducing the number and severity of crises is evidently desirable. So Cline attempts to calculate where the optimal balance might lie, recognizing that to reduce the risk of bank failure to zero might carry irrationally high costs. Cline’s conclusion is that “the optimal capital ratio is 7% to 8% of total assets, corresponding to 12% to 14% of risk-weighted assets (using the ratio of risk-weighted assets to total assets in euro area and US banks).”

These figures are, in fact, quite close to the numbers underlying the new Basel requirements as implemented by national regulators. Most British banks, for example, are now targeting a requirement of 13%, and typically carry a bit more “for luck.”

Cline’s approach is intuitively appealing. He recognizes that the ratio might reasonably be shaded up for systemically important banks, those famously dubbed “too big to fail.” In the regulatory school where I was trained – the Bank of England – we were told never to use that fatal phrase, for fear of generating precisely the moral hazard we wished to avoid. But there is no getting away from it in the post-crisis world.

Will Cline’s hard work end the debate? I doubt it. Even now, I hear axes being ground, and statistical models being recalculated. And there are still no votes in taking the pressure off big banks. The central bankers will need to hold their nerve, and the bankers themselves to behave, or a genuine Basel 4 may hove into view on the banks of the Rhine.

Copyright: Project Syndicate, 2017.



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Sanlam 2018 Annual Results

7 March 2019


Sanlam’s 2018 annual results provides testimony to its resilience amid challenging operating conditions and negative investment markets

Sanlam today announced its operational results for the 12 months ended 31 December 2018. The Group made significant progress in strategic execution during 2018. This included the acquisition of the remaining 53% stake in SAHAM Finances, the largest transaction concluded in the Group’s 100-year history, and the approval by Sanlam shareholders of a package of Broad-based Black Economic Empowerment (B-BBEE) transactions that will position the Group well for accelerated growth in its South African home market.

Operational results for 2018 included 14% growth in the value of new life insurance business (VNB) on a consistent economic basis and more than R2 billion in positive experience variances, testimony to Sanlam’s resilience in difficult times.

The Group relies on its federal operating model and diversified profile in dealing with the challenging operating environment, negative investment markets and volatile currencies. Management continues to focus on growing existing operations and extracting value from recent corporate transactions to drive enhanced future growth.

The negative investment market returns and higher interest rates in a number of markets where the Group operates had a negative impact on growth in operating earnings and some other key performance indicators. This was aggravated by weak economic growth in South Africa and Namibia and internal currency devaluations in Angola, Nigeria and Zimbabwe.

Substantial growth in Santam’s operating earnings (net result from financial services) and satisfactory growth by Sanlam Emerging Markets (SEM) and Sanlam Corporate offset softer contributions from Sanlam Personal Finance (SPF) and Sanlam Investment Group (SIG).

Key features of the 2018 annual results include:

Net result from financial services increased by 4% compared to the same period in 2017;

Net value of new covered business up 8% to R2 billion (up 14% on a consistent economic basis);

Net fund inflows of R42 billion compared to R37 billion in 2017;

Adjusted Return on Group Equity Value per share of 19.4% exceeded the target of 13.0%; and

Dividend per share of 312 cents, up 8%.

Sanlam Group Chief Executive Officer, Mr Ian Kirk said: “We are satisfied with our performance in a challenging operating environment. We will continue to focus on managing operations prudently and diligently executing on our strategy to deliver sustainable value to all our stakeholders. The integration of SAHAM Finances is progressing well. In addition, Sanlam shareholders approved the package of B-BBEE transactions, including an equity raising, at the extraordinary general meeting held on 12 December 2018. Our plan to implement these transactions this year remains on track.”

Sanlam Personal Finance (SPF) net result from financial services declined by 5%, largely due to the impact of new growth initiatives and dampened market conditions. Excluding the new initiatives, SPF’s contribution was 1% down on 2017 due to the major impact that the weak equity market performance in South Africa had on fund-based fee income.

SPF’s new business sales increased by 4%, an overall satisfactory result under challenging conditions. Sanlam Sky’s new business increased by an exceptional 71%. Strong growth of 13% in the traditional individual life channel was augmented by the Capitec Bank credit life new business recognised in the first half of 2018, and strong demand for the new Capitec Bank funeral product. The Recurring premium and Strategic Business Development business units also achieved strong growth of 20%, supported by the acquisition of BrightRock in 2017. Glacier new business grew marginally by 1%. Primary sales onto the Linked Investment Service Provider (LISP) platform improved by 5%, an acceptable result given the pressure on investor confidence in the mass affluent market. This was however, offset by lower sales of wrap funds and traditional life products.

The strong growth in new business volumes at Sanlam Sky had a major positive effect on SPF’s VNB growth, which increased by 7% (14% on a comparable basis).

Sanlam Emerging Markets (SEM) grew its net result from financial services by 14%. Excluding the impact of corporate activity, earnings were marginally up on 2017 (up 8% excluding the increased new business strain).

New business volumes at SEM increased by 20%. Namibia performed well, increasing new business volumes by 22% despite weak economic conditions. Both life and investment new business grew strongly. Botswana underperformed with the main detractor from new business growth being the investment line of business, which declined by 24%. This line of business is historically more volatile in nature.

The new business growth in the Rest of Africa portfolio was 68% largely due to corporate activity relating to SAHAM Finances, with the East Africa portfolio underperforming.

The Indian insurance businesses continued to perform well, achieving double-digit growth in both life and general insurance in local currency. The Malaysian businesses are finding some traction after a period of underperformance, increasing their overall new business contribution by 3%. New business production is not yet meeting expectations, but the mix of business improved at both businesses.

SEM’s VNB declined by 3% (up 6% on a consistent economic basis and excluding corporate activity). The relatively low growth on a comparable basis is largely attributable to the new business underperformance in East Africa.

Sanlam Investment Group’s (SIG) overall net result from financial services declined by 6%, attributable to lower performance fees at the third party asset manager in South Africa, administration costs incurred for system upgrades in the wealth management business and lower earnings from equity-backed financing transactions at Sanlam Specialised Finance. The other businesses did well to grow earnings, despite the pressure on funds under management due to lower investment markets.

New business volumes declined by 13% mainly due to market volatility and low investor confidence in South Africa. Institutional new inflows remained weak for the full year, while retail inflows also slowed down significantly after a more positive start to the year. The international businesses, UK, attracted strong new inflows (up 57%).

Sanlam Corporate’s net result from financial services increased by 4%, with the muted growth caused by a continuation of high group risk claims experience. Mortality and disability claims experience weakened further in the second half of the year, which is likely to require more rerating of premiums in 2019. The administration units turned profitable in 2018, a major achievement. The healthcare businesses reported satisfactory double-digit growth in earnings, while the Absa Consultants and Actuaries business made a pleasing contribution of R39 million.

New business volumes in life insurance more than doubled, reflecting an exceptional performance. Single premiums grew by 109%, while recurring premiums increased by a particularly satisfactory 56%.

The good growth in recurring and single premium business, combined with modelling improvements, supported a 64% (71% on a comparable economic basis) increase in the cluster’s VNB contribution.

Following a year of major catastrophe events in 2017, Santam experienced a relatively benign claims environment in 2018. Combined with acceptable growth in net earned premiums, it contributed to a 37% increase in gross result from financial services (41% after tax and non-controlling interest). The conventional insurance book achieved an underwriting margin of 9% in 2018 (6% in 2017).

As at 31 December 2018, discretionary capital amounted to a negative R3.7 billion before allowance for the planned B-BBEE share issuance. A number of capital management actions during 2018 affected the balance of available discretionary capital, including the US$1 billion (R13 billion) SAHAM Finances transaction. Cash proceeds from the B-BBEE share issuance will restore the discretionary capital portfolio to between R1 billion and R1.5 billion depending on the final issue price within the R74 to R86 price range approved by shareholders.

Looking forward, the Group said economic growth in South Africa would likely remain weak in the short to medium term future, and would continue to impact efforts to accelerate organic growth. The outlook for economic growth in other regions where the Group operates is more promising. Recent acquisitions such as the SAHAM transaction should also support operational performance going forward.

“We remain focused on executing our strategy. We are confident that we have the calibre of management and staff to prudently navigate the anticipated challenges going forward,” Mr Kirk concluded.

Details of the results for the 12 months ended 31 December 2018 are available at