BASEL III – Another liquidity test?

While it has been well documented that South Africa’s major banks were able to avoid the worst of the global economic downturn due to strong liquidity, a regulatory challenge looms in the form of the Basel III global banking regulations.

There is a prevailing concern that these same banks will be unable to meet the planned liquidity coverage ratios (LCR).To this end, reports have surfaced that South Africa’s banking regulator has approved a facility to help banks meet the LCR, after a series of quantitative impact studies of seven lenders revealed “shortfalls among some of the participant banking groups”.

BASEL III is a global regulatory standard on bank capital adequacy, stress testing and market liquidity risk agreed upon by the members of the Basel Committee on Banking Supervision in 2010-11.This, the third of the Basel Accords (see Basel I, Basel II) was developed in response to the deficiencies in financial regulation revealed by the late-2000s financial crisis. Basel III strengthens bank capital requirements and introduces new regulatory requirements on bank liquidity and bank leverage.
The LCR is designed to ensure that a bank has sufficient high quality unencumbered liquid assets to enable it to survive (i.e. to allow it to meet its cash commitments arising over) a short term (30 calendar day) period of significantly severe stress. It therefore requires a bank to consider the cash outflows and cash inflows it can expect to be subject to over the 30 calendar day period of stress, recognising that it is likely to have increased commitments and less available resources as a result of the significantly severe stress, and then maintain a buffer of high quality liquid assets equal to or greater than its expected total net cash outflow. Banks will be required to meet the LCR at all times.

Interestingly enough, similar regulation has found its way into other South African legislation promulgated subsequent to the late-2000s financial crisis. Section 4 of the Companies Act 71 of 2008, has introduced a corporate solvency and liquidity test. The Solvency test requires that the assets of the company, fairly valued, must equal or exceed the liabilities of the company. The liquidity test requires a company to be able to pay its debt as they become due in the ordinary course of business for a period of 12 months. The Act also describes the circumstances in which the tests are to be applied.

Chapter 6 of the Companies Act 71 of 2008 coupled with the King Report on Corporate Governance 2009 goes on to describe the obligations of the board in the form of ‘Business Rescue’ with respect to a company that is “financially distressed”. “Financially distressed” means that-

  1. It appears reasonably unlikely that the company will be able to pay all of its debts as they fall due and payable within the immediately ensuing 6 (six) months; OR
  2. It appears to be reasonably likely that the company will become insolvent within the immediate ensuing 6 (six) months.

In conclusion, it is reasonably safe to assume that these and other short term stress guards will continue to pervade our legislation for some time to come in the wake of one of the most crippling global economic crises the world has experienced. These time related stress guards serve additionally as an indictment against corporations who pre-2008 were guilty of the pursuit of financial gain at the expense of the short term health of the same entities.

For assistance in training and advice relating to Governance, Strategy and Leadership please go to www.sinkorswim.co.za or contact us on roger@sinkorswim.co.za.

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