A bank failure occurs when a bank is unable to meet its obligations to its depositors or other creditors because it has become insolvent or too illiquid to meet its liabilities. More specifically, a bank usually fails economically when the market value of its assets declines to a value that is less than the market value of its liabilities. (“bank failure.” Definitions.net. STANDS4 LLC, 2018)
1.1 Major factors that led to the failure of VBS Bank
– A bank severally mismanaged
– And fraud mental
• VBS Bank faced a challenge which was an assets-liability mismatch: the bank was accepting short term deposits from municipalities which is regarded as unlawful in terms of the Municipal Finance Management Act.
• Financial institutions like Absa, Fnb, Nedbank or Standard Bank if it happens all their customers decide to withdraw banks will find it hard to continue operating but all these institutions have a million of individuals and a variety of funding lines. Which limits the risk. However VBS’s deposits came from just 21 municipalities with the average amount between R50 million and R100 million. As these deposits matured or were terminated VBS faced a cash flow crisis.
• Trouble seems to be have caused by unpleasant growth in the bank’s balance sheet, which doubled in size over a year to March 2017. The bank’s assets jumped from 537% between 2014 and 2017 from R330 million to R2 billion, driven by 416% increase in the loan book from R210 million to R1 billion. (live, 2018)
• The amount VBS bank owned it customers between 2016 and 2017 was a large number nearly to r1.6 billion on exponential growth and fixed deposits from municipalities. The growth in loans led to an increase in bad debts, with expected losses on nonperforming loans increasing from R1.9 million in 2016 to R6.3 billion in 2017.
• There was reckless granted mortgages and other short term loans to the bank’s own executive directors which moved from R82 089 to R4.1 million in just one year, more than the bank’s after-tax profit of R3.2 million. It’s now revealed the bank was processing a loan application from the former president Zuma for R7.8 million he needs to pay for the Nkandla Security upgrades. It’s now faces a possible probe from the Financial Services Board relating to an R136 million loan.
• It’s said VBS bank tried repeatedly to engage the bank and treasury’s instructions to municipalities to withdraw funds from mutual banks to resolve the matter of the regulations caused a “run on the bank”. This effectively sabotaged VBS. (live, 2018)
1.2 Basel II risk management and implementation
• The Basel II implementation was created to make sure financial institutions have enough cash on reserve to match any potential risk the bank might come across (operational, legal or otherwise).
• Management is a particularly important part for Basel II requirements, which simply means security and technical controls play a huge role when it comes to compliance.
• Operational risk is defined as the “risk of loss resulting from inadequate or failed internal processes, people and systems or from external events.”
Objectives of Basel II
• Safety and soundness- ensure consistency with fundamentals banking principles yet recognize innovation
• Balance- attempt to incorporate a reasonable trade-off between enhanced risk-sensitivity and implementation burden
• Aggregate Capital Level- roughly maintain the current amount of capital in the banking system (Emre Balta, 2009)
The Basel II framework uses three pillars.
• Pillar I: Minimum Capital Requirements provides detailed methods for calculating minimum regulatory capital. Organizations have the option to choose estimating credit risk exposures with a (IRB) approach or the the (AIRB) approach, to calculate capital requirement per the pillar 1 directives, organization must collect different types of market risks, credit risks ; operational risk information such as loan information from sources. Trust worthiness of the calculated requirements depends on the quality of the underlying information.
• Pillar II refers to supervisory review standards that provide regulations with oversight, discipline and action over Basel II including the implementation of ERM which referred to as Effective enterprise Risk Management. A large percentage of the operational risks comes from information quality issues. To effectively mitigate information risks, financial organization need to use appropriate controls to detect and avoid information quality issues in their transactional system.
• Pillar III refers to a market disclosure and aim at promoting financial stability through increased transparency and disclosure requirements. This is a final pillar requires financial institutions to publicity offer details of their risk management activities, risk-rating processes also risk distributions the reconciliation of financial reporting standard (IFRS) Generally Accepted Accounting Principal (GAAP) will be a challenge to reduce information risk exposure through appropriate risk mitigation processes, financial organizations need to put a stronger focus on information.
– Market discipline by allowing market participants to assess key pieces of information on the capital adequacy of the institution
– scope of application
– capital risk exposures
– risk assessment processes
• Poor information quality in risk information repositories increases the uncertainties about the information used for risk calculating possibly resulting in an inaccurate risk capital. To achieve favorable ratings, organization should be able to demonstrate sound practices in dealing with risk including information risk.
• Basel II uses VaR to measure risks, and operational risks requires capital. Operational losses are an important source of risk for banks. It may be as high as the capital charge for market risk. However Basel II does not really specifically an approach or distributional assumptions. But should meet some regulatory requirements such as appropriately weight each of the 4 elements: BEICFs, external data, internal data scenarios and capture potentially severe tail events, consider dependence quantify at the 99.9th condense level over a one year horizon granularity of the model commensurate with the risk parole of the bank minimum 5 years of data.
Basel II implementation makes a good opportunity for a bank to elevate risk management and ultimately economic capital management. (Emre Balta, 2009)