Text of the submission by Dr Chris Stals, Governor of the South African Reserve Bank, to the Section 417 Commission of Enquiry Into the Affairs of Tollgate Holdings Limited, 26 February 1996

PART ONE: GENERAL PHILOSOPHY BEHIND CENTRAL BANK ASSISTANCE TO BANKING INSTITUTIONS

1. The nature of central banking

Central banks are very special institutions . They are empowered by sovereign governments to create money where money does not exist. Central banks are therefore not dependent on outside sources such as governments, business organisations or private individuals for their funding. This very potent power places a great responsibility on central banks, namely to manage the monetary system of the country in the interest of the total community .

Private banking institutions are licensed bycentral banks (or governments) to share in this responsibility of the central bank . They also create money, using central bank money as a basis for their money creation activities. This makes banking institutions different from all other types of financial institutions.

In addition, private banks also serve as custodian for the money holdings of the community, and provide the public with savings and money payments, transmission and settlement facilities.

The central bank has a vested interest in establishing and maintaining a sound banking system, with healthy and well-managed banking institutions. It is therefore normal in most countries to find special relationships between central bank.a and private banking institutions, established for example through bank regulation and supervision, discount window facilities, national payment and settlement arrangements, and lender of last resort assistance. It is this latter function that is of great importance for this investigation.

The origin of the function of lender of last resort was described by Dr M.H. De Kock in his authoritative hook Central Banking, first published in 1939:

11 It was only after the publication of Bagehot's Lombard Street, in 1873, that the responsibilities of the Bank of England as the lender of last resort were 'unequivocally recognize'd', and it was Bagehot himself who coined the expression 'lender of last resort'. After its final recognition by the Bank of ' England, this function was also assumed by similar banks of issue in other countries, and it came to be regarded as a sine qua non of central banking. It was thus automatically accepted by the many new central banks which were created in the twentieth century. There was, for example, no argument about it when the Federal Reserve Banks were established in the United States. Moreover, within its first two years (1921-23) the South African Reserve Bank was called upon to face the responsibilities of lender of last resort when one of the biggest banks became involved in serious difficulties, and it did so unflinchingly and successfully". (pp. 32 /93).

2. The functions of central banks

Universally, central banks are tasked with the function of promoting, supporting and maintaining overall financial stability. Financial stability may be interpreted differently in different countries - it may, for example, be regarded as low inflation or, alternatively, a stable exchange rate of the currency, or a more general connotation of overall stability attained simultaneously in a number of financial aggregates such as money supply, bank credit extension, interest rates, inflation, exchange rates and the level of the foreign reserves. Financial stability is regarded as essential for economic growth and as a minimum prerequisite for sustainable economic development in the long term - the ultimate objective of macroeconomic policies in most countries.

In order to achieve their objectives, central banks will often target intermediate goals, for example the growth in the money supply, or in the amount of domestic bank credit extension, or a predetermined level of interest rates. Central banks may also use different operational instruments to pursue these intermediate goals, for example open-market operations, variable cash reserve requirements, intervention in the money and foreign exchange markets, etc.

Be that as it may, in most countries in the world, including South Africa, monetary policy cannot be implemented successfully without the presence of sound and well-managed banking institutions, operating in most cases in and through efficient and effective financial markets, and trusted at all times by the public.The effectiveness of the central bank's monetary policy is therefore to an important extent dependent on the existence of sound individual banking institutions.

3. The relationship between central banks and private banking institutions

In all countries, there exists an intimate relationship between the central bank as the creator of base money, and other recognised banking institutions as the conduit through which the money creation process is extended . This "relationship is in the first instance substantiated by almost daily contact through discount window operations, clearing and settlement arrangements and central bank intervention and operations in the financial markets.

The relationship, however, goes further than the normal operational aspects of banking. In many countries. , as in South Africa, the central bank has also been tasked with the function of bank regulation and supervision, and with providing at its discretion in the unavoidable periodic need for special assistance to banks in distress - the "lender of last resort" function of the central bank . Banking is a risk business and, however extensively, dedicated and effectively bank regulation and supervision may be applied by the authorities, the odd banking institution may still find itself from time to time in the situation where its total liabilities or commitments to the public, exceeds the value of its total assets .

Although central banks (and/or governments) therefore do their best to prevent default in banking institutions, the safety of a bank can never be fully guaranteed. When any individual banking institution finds itself in distress, the central bank, taking account of its assignment as lender of last resort1 of its responsibility for maintaining financial stability, and of its function as the main creator of money, is often faced with difficult options.

The first course of action open to the central bank in such a situation could be one of benign neglect - leave the institution to be liquidated and let its shareholders and depositors suffer the consequences of the liquidation. This in many cases presents the best course to follow, provided it will not contaminate the rest of the banking sector and undermine public confidence in the banking system as a whole which could then lead to the collapse of the whole system.

A second course of action could be one of damage limitation - that is, the provision of special support to the particular banking institution to enable it to recover from its affliction. This is the option often preferred where the collapse of a large banking institution could lead to a dispersion of mistrust in other banks, and to the contagion of the total system.

A third course could be one of mitigation of consequences let the institution be liquidated, but provide some special assistance to its depositors to alleviate the burden of liquidation. This alternative may be preferred when the main concern of the authorities is the protection of depositors, and where the affected bank is too small to taint the entire system.

The appropriate course of action is no easy decision for a central bank to take, and any decision will usually be a no-win decision - the central bank will be criticised for the course it takes whatever its decision might be .There are, however, some general guidelines that are universally applied by central banks, and which guidelines are normally not based on the nature of any particular institutional problem, but rather on relevant circumstances surrounding the event.

The nature of the assistance giyen by central banks may also vary from country to country, and also from case to case. As the interest in this investigation is primarily focused on outright financial assistance to a banking institution, a few recent examples of such assistance provided to banking institutions in distress in some other countries are provided in the next section.

4. Recent experiences in some other countries

A number of cases occurred recently where a major banking crisis developed and where the overall banking system of the country concerned fell into distress. Remedial action in such cases will normally not only involve central banks, but also governments. To the extent that government funds are utilized for the assistance of banking institutions - - a very common practice as will be illustrated below -- taxpayers' money is directly applied for the .purpose.

There are also numerous examples where central banks provided financial assistance from their own resources, that is through the creation of money. It is more difficult to assess and to understand the implications of this type of assistance for taxpayers. The question can be raised whether new money created by the central bank for this purpose, without any recourse to the government’s budget, can also be regarded as taxpayers' money, particularly in a country where the central bank is privately owned and in cases where no losses are incurred, and the newly created money is eventually returned to the central bank for cancellation. If the answer is yes, should new money created by private banking institutions under licence from government then also be regarded as taxpayers' money? This is a debatable issue which will rather be left aside.

There are, undoubtedly social and macroeconomic costs involved in a bank rescue operation that involves money creation by the central bank. These costs should rather be assessed by considering possible effects of the operation on monetary policy in general, the control of money supply in particular, and the level of interest rates and inflation in the economy .

A fair amount of specialised economic analyses will be required to argue this point. It should, in all circumstances for example, be taken into account that the alternative, that is not to provide assistance to a banking institution in distress, will also have adverse consequences for taxpayers, particularly if it happens to be a large banking institution serving thousands of individuals and businesses in the community . The unenviable task of the central bank confronted by such a situation is, in each case, to decide on the basis of overall social cost benefit considerations, what alternative option will in the end bear the least cost for the total community.

Central banks often provide assistance to an individual banking institution in an effort to avoid the danger of systemic risk that could lead to a collapse of the whole banking system. The action of the central bank is therefore intended to protect taxpayers from massive losses they are confronted with, either through the liquidation of a number of large banking institutions, or through forced fiscal assistance to the total banking system provided directly from the budget of the central government.

A good example of this strategy recently occurred in Finland which experienced a major banking crisis. In September 1991, a major Finish commercial bank (Skopbank} ran into problems and was heavily supported by special loans from the Bank of Finland. The total injection of funds by the central bank amounted to FIM 15,6 billion (equal to R10,6 billion}. In 1992, Skopbank was transferred government funded agency for FIM 6 billion (R3,8 billion) , and the Bank of Finland, suffered losses of more than FIM 9 billion (R5,7 billion) in the exercise.

This initial support by the Bank of Finland did not succeed in avoiding a major banking crisis, 'and the Government of Finland had to step in, and in 1992 established a Government Guarantee Fund, capitalised with taxpayers' money for more than FIM 80 billion (R50,5 billion), equal to more than 10 per cent of the total gross domestic product of the country, to provide assistance to banking institutions in distress .

(Quoted from Bank of Finland Bulletin, August 1995, Vol 69, No. 8.)

Other Nordic countries such as Denmark and Norway, went through similar experiences and provide further interesting case studies of central bank and government support operations for banking institutions.

Further examples of public support for banking institutions in cases of sectoral crises can be found in the Savings and Loan Associations debacle in the United States in 1989; in the major banking crisis that developed in Mexico after the financial breakdown of December 1994; and in Japan at present times. In Mexico, the central bank created and partly financed a saving Protection Fund (FOBAPROA) to provide additional capital for banking institutions in the form of subordinated debt (FOBAPROA) was partly funded by the Bank of Mexico, partly by the Government of Mexico, and partly by aid funds made available to the country by foreign governments {mainly the United States and Canada}.

In Japan, the Bank of Japan was heavily involved in a number of bank rescue operations and, for example, provided a loan of ¥100 billion (R3,9 billion) at a low interest rate to the Tokyo Kyodou Bank, and "special" loans of Y50 billion (R2,0 billion) to·Cosmo Bank and 600 billion (R23,4 billion) to the Kizu and Hyogo Banks. The Bank of Japan also provided fresh capital for some of the banks in distress.

Examples of more isolated support to individual banking institutions are also numerous, but details of the support facilities are not always available because of the equally common practice of central banks not to disclose such information. The reason for such secrecy was recently very aptly described by Mr Eddie George, Governor of the Bank of England, in a speech in Tokyo on 26 October 1995. Mr George said, in explaining the Bank of England's policy in this regard:

“… we may try to keep the fact that we are providing systemic support secret at the time. In principle, I am against secrecy for the sake of it. And in this field there are often circumstances where the markets will be reassured by knowing that we are involved. Sometimes, however, the opposite is true. If people know that we are so concerned about systemic fragility that we have judged it necessary to provide support... that could lead to a wider loss of confidence. They would wonder how far that support would be extended, and we could rapidly find ourselves in the position where we were in practice under-writing all the liabilities of the banking system".

(Speech given to the Japanese Federation of Bankers' Associations.)

Mr George could have added that premature disclosure of such assistance could easily lead to a loss of confidence in the particular banking institution, to a 0run on the bank", and to the forced liquidation of the institution that needs salvation.

In such a situation, and particularly in a country such as South Africa where the ethical code of most people is self-protection rather than national interest, the central bank will be blamed for the downfall of the bank. Disclosure would indeed defeat the object of the exercise and would impose the social cost of the liquidation of the bank on the general public, without any chance of escape.

In a recent authoritative book on central banking entitled The Central Banks {Hamish Hamilton, London, 1994), Marjorie Deane and Robert Pringle had the following to say about the need for or secrecy of lender of last resort assistance:

"it (the central bank) tries to keep the fact that it is providing support secret at: the time, in order to minimize the risk of a wider loss of confidence. Even when the danger is past, it will often be difficult to disclose publicly the details of the support as disclosure could weaken even banks that had succeeded in dispensing with support". (p. 196)

In his Tokyo speech of October 1995 Mr George also said:

“When we [i.e. the Bank of England] do consider extending last resort support - on our own balance sheet, or, if the amounts are too large, with the support of government - there are a number of other principles that we seek to apply."

The Bank of England therefore does from time to time provide lender of last resort financial assistance to banks in the United Kingdom, if in the assessment of the Bank it is regarded as being in the interest of the protection of the stability of the financial system. In addition the Bank of England often does keep such assistance secret.”

This was confirmed to me in discussions with Governor Eddie George and other senior Bank of England officials in London on . February 1996.

Reference to such support facilities, which incurred a loss of £115 million for the Bank of England in 1991/93, can be found in the Bank's Report and Accounts for 1993. The names of the banks assisted, the amounts involved, and the nature of the assistance provided to each bank were never disclosed - only a vague reference to the reason for the assistance:

... "The support was designed to avert the possibility of more widespread difficulties in the banking system and in the wider economy, and was successful in containing the potential problem". (p .10)

Two other recent examples of assistance provided by central banks and governments to particular banking institutions can be quoted. The one is the crisis that engulfed Banco Espanol de Credito (Banesto), Spain's fourth largest bank, in 1993/94.The central bank at the time decided that Banesto was "too-big-to-fail" and the authorities offered open- ended liquidity support to enable the bank to recover from its affliction. The stated objectives of the Spanish central bank's action were:

"(i) to protect the assets;

(ii) to protect the interests of depositors; (iii) to assure the correct functioning of the banking system;

(iv)  to maintain public confidence in the banking sector;

(v) to restore the financial stability of the bank through the incorporation of executives of recognised stature and banking experience; and

(vi} to establish the exact financial position of the bank and subsequently to restructure and refloat the baank. There are no limits placed on the plans to be adopted and, specifically, these plans may call upon the Deposit Guarantee Fund to purchase assets and to provide finance.

(Financial Regulation Report, Financial Times Business Information, January l9S4.)

Another recent case which attracted much publicity was the support provided by the Bank of France and the French Government to Credit Lyonnais in 1994/95. Credit Lyonnais made a net loss of FFr 6,9 billion (RS,O billion) in 1993/94, and suffered large losses on loans and investments made in the preceding five years. The French Government, working with the Bank of France, agreed to back a FFr 44,9 billion (R32,7 billion) rescue operation which involved a FFr 4,9 billion (R3 ,6 billion) cash injection and the creation of a new Government funded company to take on FFr 40 billion (R29,1 billion) of non-performing property loans.

General rules for central bank lender of last resort assistance to banking institutions

There are no fixed rules for central bank assistance to private banking institutions. Monetary policy cannot be governed exclusively by rules subjective discretion is unavoidable. Governor Eddie George, in the speech quoted above, expressed himself as follows .on this issue:

"There are no hard and fast rules - no objective criteria - that can be applied in such situations. The considerations vary from time to time and place to place”.

and

"The judgement is invariably a difficult one. The potential commitment of public funds to support failing financial institutions can be daunting. But failure to extend support, which then turns out to have been needed, may ultimately turn out to be even more costly.”

From the foregoing examples of central bank/government support to failing banks, it is interesting to note that special guarantee or support funds have been set up in a number of countries for this purpose, for example FOBAPROA in Mexico and the Government Guaranty Fund in Finland. These special organisations are all being funded by governments and central banks - that is with taxpayers' funds and with newly- created money provided by the central bank. In many countries there are also various public schemes for depositor protection in respect of funds placed by the general public with banking institutions. No such organisations or deposit insurance schemes exist in South Africa, which places the responsibility for handling bank crises squarely on the Reserve Bank (working closely with the Minister of Finance).

Some general rules can nevertheless be derived from the practices followed universally by central banks:

Firstly, financial assistance is applied very sparingly, and as a general rule only when a particular case provides a threat of contagion of the whole banking system .

Secondly, protection of depositors is a major consideration that must be taken into account, especially by central banks that have to opera e in a vacuum where there is no public system of depositor protection.

Thirdly, confidence in the banking system must be preserved, without providing open-ended support for mismanagement, fraud or internal inefficiencies in banking institutions.

Fourthly, arising f ram the foregoing, financial assistance emanating from the central bank/government must, as far as possible, serve to protect depositors and not shareholders of banking institutions.

Fifthly, in order to assist the banking institution to overcome its problem, the central bank may provide a loan at. a nominal rate of interest, or perhaps provide guarantees for raising low interest rate loans from other institutions.

Sixthly, the assistance must be conditional upon remedial action that will lead to recovery and may often require a change of ownership, of senior management, and even of the structure of the affected institution.

Seventhly, there must be possible exit for the central bank from the assistance programme, perhaps only after the credibility, credit­ worthiness and public trust in the institution have been re-established.

Eighthly, it may in certain circumstances be necessary to keep the assistance package secret, particularly if disclosure could be counter-productive and defeat the objective of the exercise .

These are generally the considerations that the Reserve Bank applied in providing ·assistance to South African banking institutions in recent years. The Bank is of the opinion that, if tested against those criteria, the assistance it provided to the Bankorp Group and later Absa was justified in terms of such common practices applied in this regard by central banks in the rest of the world.

PART TWO: SOUTH AFRICAN RESERVE BANK ASSISTANCE TO THE BANKORP GROUP

6. Background to the Bankorp aqreement:

The assistance to Bankorp had its origin in 1985/86 when the bank first approached the Reserve Bank with a request for special assistance to enable it to cope with bad invetments and other non-performing assets inherited with the takeover of Trust Bank in 19?7 and Mercabank in 1984. Moreover, 1985 was an extremely difficult year for South Africa when international sanctions were extended, and trade boycotts, disinvestment campaigns and international loan withdrawals put severe pressure on the balance of payments. In the process, a domestic liquidity squeeze adversely affected the banking sector in particular, and weak elements in the system were cruelly exposed.

Against the background of the emerging international debt standstill and the declining credit- worthiness of South Africa in the international capital markets, a crisis in the domestic banking system had to be averted at all cost. In the judgement of the monetary authorities, the situation of Bankorp, one of the major banks in the country, created a serious threat of contagion of the rest of the banking system. At the same time, failure of a major South African banking group with extensive international relations at that juncture would have aggravated the country's international debt crisis.

In April 1985, Bankorp approached the Reserve Bank with a request to provide financial assistance of R300 million to it. Initially a low interest-rate loan of R200 million was extended, but after further representations the amount was increased to R300 million in April 1986. The loan was to be repaid, in consultation with the Reserve Bank, from 1 June 1988 and full repayment had to be achieved by 31 May 1990. In 1987 the Bankorp Group introduced a major reconstruction and rationalisation programme and to lend support to that programme, the Reserve Bank agreed to a rescheduling of the repayment of the loan. Accordingly, the loan was to be repaid in five equal instalments of R60 million each, beginning on 1 April 1990 and ending on l April 1994.

I was appointed Governor of the Reserve Bank in August 1989. Early in 1990 I was approached for the first time by the Chief Executive Officer of Bankorp who informed me that Bankorp would not be able to meet its obligation on 1 April 1990 for a first repayment of R60 million in terms of the loan arrangement .

I immediately demanded a thorough investigation into the Bankorp situation by the Registrar of Banks and the management of Bankorp, and requested proposals for a final and comprehensive restructuring programme that would re-establish the bank as a viable proposition. Alternatively, the bank would have to be liquidated. The time for the repayment of the instalment of R60 million was extended until 1 August 1990.

Extensive investigations were made during the period April to July 1990, and .senior Reserve Bank officials {mainly from the Office of the Registrar of Baoks) and senior management of Bankorp were involved in these investigations. The external auditors of Bankorp were also drawn into the investigation and I, as Governor of the Reserve Bank, was kept informed of the findings as progress was made.

7. The assistance package of August 1990

Based on the findings referred to above, I convened a meeting to be attended by senior representatives of Bankorp, Sankorp and the Reserve ank.This meeting, which was held on 1 August 1990 in my office in Pretoria, was attended by:

South African Reserve Bank

Dr C.L. Stals - Governor

Dr J.A Lombard - Senior Deputy Governor

Dr B.P . Groenewald - Deputy Governor

Dr J.H. van Greuning - Registrar of Banks

Mr S.S. Walters - Secretary

Bankorp and Sankorp

Mr M .H. Daling - Chairman, Sankorp

Mr P.J. Liebenberg - Executive Chairman, Bankorp

Mr H.J. van der Merwe - Bankorp

Mr P. Strydom - Bankorp

Mr A. du Plessis - Sankorp

Summary notes of the discussion at this meeting were incorporated in the official documents submitted by the Reserve Bank to the Commission.

The picture that emerged from this discussion was rather desperate. Bankorp made no profit during the 1989/90 financial year, and only about 52 per cent of the bank's total assets at that stage were profitable. The management of the bank did not succeed in absorbing the bad debts inherited from the past, and the situation was aggravated by the takeovers and the expansion programme of the preceding five years. The Reserve Bank was confronted with the option of either closing the institution, or providing further assistance.

The South African economy was then in recession and the liquidation of Bankorp at that stage would not only have adversely affected other banking institutions and the many depositors of the bank, but would also have forced the liquidation of many of the debtor clients of the bank.

In terms of the Delegation of Powers of the Board of Directors of the Reserve Bank, read together with Section 10 of the South African Reserve Bank Act, 1989, (which authorises loans by the Reserve Bank against the provision of adequate security) I took full responsibility, together with the other Reserve Bank officials present at the meeting, for agreeing to a lender of last resort loan to Bankorp under the terms and conditions contained in a letter dated 3 August 1990, signed by me and accepted by Messrs Liebenberg and Daling on behalf of Bankorp.·

A copy of this letter has also been provided to the Commission as part of the official documentation, as Annexure A to the Bankorp agreement of 1 September 1991.

[Note: Although the Delegation of Powers Document vests the unqualified right to enter into agreements of this nature in the Governor or a Deputy Governor, the procedure in the Bank is, as far as possible, to involve the Governor and all three Deputy Governors in decisions - hence the presence of the Governor and two Deputy Governors at the meeting of 1 August , 1990. The third Deputy Governor, Dr C.J. de Swardt, could not attend the meeting but was also fully informed of the arrangements.]

The gist of the agreement of 1 August 1990, already in possession of the Commission, was the following:

* The existing loan facility of R300 million would be increased to R1 000 million;

* Certain strict conditions would be applied in the internal administration of the bank, including the following requirements:

- 70 branches of the bank will be closed by 31 December 1990;

- total staff will be reduced by approximately 3 000 before 31 December 1990; and

- total assets will be reduced by RS billion by 30 June 1991.

* Dividend payments would be restricted to minority shareholders for as long as the assistance facility continued. Sankorp had to reinvest its share of the dividends in the form of capital of Bankorp;

The external auditors of Bankorp had to report to the Reserve Bank from time to time on progress made within the Bank;

* The Managing Director of Bankorp was required to hold a quarterly review discussion with the Office of the Registrar of Banks; and

* The total loan of R1 000 million had to be collateralised at all times by. redepositing funds with the Reserve Bank or by ceding government stock to the Bank.

8. The 1991 agreement

In June 1991 the external auditors of Bankorp informed the bank that their investigations indicated a further deterioration in the position, and that the income of about R15O million per annum generated by the Reserve Bank support package would not be sufficient to salvage the situation. The external auditors indicated that it would not be possible for them to continue to certify the statements of Bankorp as the institution no longer complied with the capital adequacy requirement of the Banks Act. A final list of potential losses was then submitted to the Office of the Registrar of Banks to confirm accumulated doubtful debts of R1 930 million. (The list was attached as Annexure A to the agreement of September 1991 already in the possession of the Commission.)After further extensive negotiations, it was agreed that the shareholders of Bankorp would have 'to provide the means to cover approximately R800 million of the potential loss and the Reserve Bank's loan would be increased to R1 500 million to enable the bank, through the income earned on an investment in government stock, to generate approximately R1 125 million over a period of five years, which would be applied towards the write-off of the accumulated losses. The balance of about R800 million, representing the share capital of the bank at that time, had to be absorbed by the shareholders.

Before entering into a firm agreement with Bankorp, the ·further financial assistance was discussed with the then Minister of Finance, Mr B.J. du Plessis , at a meeting on 31 July 1991. The meeting was attended by myself, Dr C. J. de Swardt and Adv. M. J. van Rensburg as representatives of the Reserve Bank.

The Reserve Bank's lender of last resort facility therefore provided for the absorption of about 58 per cent of the potential and confirmed losses that had to be provided for at that time (30 June 1991). The list included a provision of R75 million against the name of Duros/Tollgate. The presence of the name of Duros/Tollgate as one of more than 100 identified “bad asset" items in this list was purely coincidental and had no special significance for Reserve Bank officials involved in the negotiations. Theoretically, 58 per cent of R75 million, that is R43,5 million, of realised losess on the Tollgate liquidation, could therefore have been recovered against the facility. It should be noted, however, that two overriding restrictions were placed on the use of the Reserve Bank facility. Firstly, the maximum amount of losses incurred by the owners of Bankorp on the disclosed portfolio of bad assets that could be written off against the income earned on the facility was restricted to R1 125 million .

Secondly, only losses that already existed or were anticipated on 30 June 1990 and that were reported in the list, could be written off against the income generated specifically for this purpose. Total confirmed and projected losses included in the list amounted to R1 930 million, and Bankorp was allowed the flexibility to use its own discretion in deciding what losses from the accepted list would be charged against the Reserve Bank facility, and what write-offs would be debited to shareholders' funds. There was also an overriding constraint (section 9.3 of the 1991 Agreement) that if the realised losses on the bad investment portfolio turned out to be less than the total amount of financial assistance provided .by the Reserve Bank and Sankorp, namely R1 635 million, up to 20 per cent of the interest earned on the facility would be recoverable by the Reserve Bank. At the end of the day, evidence was provided to confirm that the total losses on the bad, book portfolio indeed by far exceeded R1 635 million. In terms of a report submitted to the Reserve Bank on 8 November 1995 by the independent auditors, Ernst & Young and KPMG, the cumulative write-off up to 31 March 1995 exceeded R1 900 million so that the recovery provision would not have been triggered.

The loan of R1 500 million carried interest at a rate of 1per cent per annum and was partly invested in government stock (R1 100 million), and partly placed on deposit with the Reserve Bank (at an interest rate of 16 per cent). Both the investment in government stock and the deposit with the Reserve Bank were ceded to the Reserve Bank as security for the loan. In this way it was assured that the Reserve Bank would not incur any loss on the transaction. The requirement that R400 million of the loan proceeds had to be redeposited with the Reserve Bank, prevented this part of the newly created money from flowing into the money market. The balance of the cash proceeds amounting to R1 100 million had to be invested in government bonds and therefore accrued to the Treasury, and contributed to the normal funding of the Budget deficit for that year. The amount was deposited in the Exchequer Account with the Reserve Bank and, until it was spent by Government, had no impact on the money supply.

In the books of the Reserve Bank, a simple book entry was passed to credit an account for Bankorp, and debit Loans and Advances (to Bankorp) with R1 500 million. With the acquisition of the government stock, the Bankorp account was debited with R1 100 million and the Exchequer Account (the Government's account with the Reserve Bank) credited with the same amount. The balance of R400 million, remaining in the Bankorp account, earned interest at 16 per cent per annum for Bankorp, and the amount of R1 500 million on the Loan account (to Bankorp), earned interest at 1 per cent per annum for the Reserve Bank. The two balances remained in the books of the Reserve Bank until 1995. Normal entries were passed through the profit and loss account every year for the interest payment and receipt and these were absorbed in the profit and loss allocations as decided on by the Board of the Bank from time to time.

The assistance to Bankorp was represented by the income generated through the transaction, which consisted of interest earned on the Reserve Bank deposit plus interest on the government stock, and would in total amount to approximately R225 million per annum . This amount had to be applied to the gradual absorption of part of the confirmed and projected losses of R1 930 million that existed at that time, (and that were verified in the list of identified losses attached to the agreement). Bankorp was thus given more time to wind down the book of bad debts accumulated during the consolidation period of the nineteen eighties, and to salvage what it could from this portfolio of non-performing assets.

The contents of the final arrangement were 'incorporated in the text of a formal ·extensive loan agreement, drafted by the Reserve Bank's legal advisors, and signed by the Governor of the Reserve Bank on 5 September 1991, acting in tenns of the general mandate from the Board of the Bank referred to above. The agreement was executed by the advance of a loan of R1 500 million to Bankorp, which the bank partly invested in South African Government' stock that were ceded to the Reserve Bank to se. rve as collateral for the loan amount, and partly placed on deposit with the Reserve Bank. The interest earned on the investments accrued to Bankorp and provided Bankorp with additional income against which the amount of the agreed potential losses that existed at the time and that were verified in the schedule attached to the loan agreement, could be written off, as and when they materialised. The loan amount would become repayable to the Reserve Bank once an amount of R1 125 million had been earned by Bankorp, or as soon as its total capital and reserves had been replenished to a level of R3 000 million.

The agreement remained in force until 23 October 1995, when a total amount of R1 125 million was earned by Bankorp/Absa . This amount was fully utilised to absorb part of the losses carried forward from 30 June 1990. Only minor amendments were introduced to the agreement during its tenure, firstly, in April 1994 (with effect from April 1992), to provide for the transfer of the agreement to Absa Bank as new owners of Bankorp, and in June 1995 to provide for the purchase by the Reserve Bank of the government bonds (some of which were due to mature), and for the depositing of the proceeds by Absa with the Reserve Bank for the remaining tenure of the agreement.

9. The 1994 agreement

The substance of the 1991 agreement, in terms of which financial assistance of up to a maximum amount of R1 125 million was made available by .the Reserve Bank to Bankorp over a period of approximately 5 years, was not affected by the 1994 amendments. The main reason for the amendments was the take-over of Bankorp by Absa, with effect from 1 April 1992, which required the transfer of all rights and obligations under the 1991 agreement from Bankorp to Absa.

As a result of the take-over some of the stipulations in the 1991 agreement either became irrelevant or could no longer be enforced and, therefore1 had to be deleted. In particular, most of the requirements that had to be complied with in the internal administration of Bankorp, were either fulfilled or became irrelevant. In addition, for example, the requirement in terms of which Sankorp had to invest all dividends, received from Bankorp during the tenure of the 19 91 agreement, in Bankorp shares, could no longer be enforced. Another example of a stipulation which had become irrelevant was that of empowering the Reserve Ban1t to take certain actions if it was deemed that Bankorp had become unable to continue its business as a bank.

Other important amendments that were introduced by means of the 1994 agreement were the following:

(a) Bankorp was allowed to substitute a new statement of bad and doubtful debts as at 31 March 1992, the details of which had been audited, for t!>b.e unaudited list of bad and doubtful debts as at 30 June 1991, which was incorporated as an appendix in the. 1991 agreement.

(b) The debts of debtors who had been classified as bad or doubtful as at the beginning of the 1991 financial year, i.e. as at 30 June 1990, could, depending on the financial position of the debtors, be increased or decreased in the actual write-off of bad debts against the amount of financial assistance provided by the Reserve Bank, with the proviso that in the case of any debtor, the debt written off might not exceed the amount of his total indebtedness to Bankorp on 31 March 1992. The total amount of assessed bad and doubtful debts as at 31 March 1992 totaled R5 400 million and far exceeded the total amount of financial assistance of R1 635 million provided by the Reserve Bank and Sankorp.

(c) Absa's external auditors were required, in respect of every financial year during the tenure of the 1991 agreement (as amended), to audit amounts written off, in order to ensure that such write-offs conformed to the stipulated conditions.

The long period between the 1991 agreement and the subsequent 1994 amendment reflected the time required for the Bankorp/Absa external auditors to audit in detail Bankorp's financial position as at 31 March 1992, i.e. immediately before the take-over on 1 April 1992. This comprehensive audit was also necessary to produce the new statement of bad and doubtful debts. Such a statement was received by the Reserve Bank from the auditors under cover of a letter dated 1 December 1993 and was incorporated in the 1994 agreement .

10. The 1995 agreement

The 1995 agreement supplemented and amended the 1991 and 1994 agreements. The main reason for the 1995 agreement was that part of the government stock which served as security for the Reserve Bank's loan to Bankorp/Absa would mature before the termination of the agreement. During the tenure of the 1991 agreement, as amended, the Government converted some of the stock into new stock which would mature in three tranches. The first tranche would mature before the termination of the agreement and Absa would have received the redemption amount prematurely.

To resolve this problem, the Reserve Bank purchased all of the government stock from Absa and required Absa to deposit the proceeds of R1 100 million with it and to cede the deposit to he Reserve Bank as security for the loan extended to Absa. Absa would earn interest on the deposit exactly equal to the interest that it would have received on the government stock investment.

The 1995 agreement terminated on 23 October 1995 when the accumulated total of financial assistance generated in terms of the 1991 agreement, as amended, reached the specified amount of R1 125 million. On that date the Reserve Bank's loan of R1 500 million to Bankorp/Absa was fully repaid.

11. Final remarks

It should be noted that the loans made available to Bankorp and to Absa over the period from 19 85 to 1995 were at all times recorded in the books of the Reserve Bank, were regularly audited by the Bank's internal and external auditors (who also had to verify the existence of the required collateral), and were included in the published financial statements of the Bank and in the financial statements that served before Board Meetings and meetings of the Committee of Governors.

The Bank's Directors and its staff were, however, at all times bound by the restrictions of Section 33 of the South Af rican Reserve Bank Act from disclosing any information on the loans to outside parties.

The Resrve Bank appreciates the opportunity af f orded by the Commission to make this inf ormation public knowledge at this stage, particularly now that the assistance programme has been successfully concluded and Absa, the present owner of the Trust Bank, Bankorp and

Mercabank assets, is in a position to continue to function as a sound and well-managed banking institution.

Source: Businesslive.