As the VBS mess slowly catches up with the perpetrators, few have asked what we can learn from how the bank was regulated.

VBS was a mutual bank, a somewhat odd type of bank which works under its own regulatory regime. Created in the wake of the great rationalisation of building societies in the 1990s, the key feature of mutual banks is that their depositors are also their owners.

Having a deposit in the bank means you effectively have shares in it, but in practice the banks create a unique class of deposits which have such ownership rights attached to them. In effect, they are not that different from ordinary banks and their shareholders.

Mutual banks are, however, under a different kind of regulatory regime. For starters, they do not need to hold nearly as much capital, and can get a licence with R10m as opposed to R250m required for an ordinary bank. They also get a lighter touch in terms of their compliance with Basel capital requirements, adhering to a regime based on Basel 1 rather than the more complex Basel 3. They don’t, for instance, need to concern themselves with liquidity risk the way larger banks do, and they have a much simpler approach to determining how much capital they must hold.

Bank regulation faces a constant tension between systemic soundness and competitive innovation. The system is less risky when there are a few strong banks that are well capitalised and profitable. But that has downsides, including making the system uncompetitive.

So, you also want to have a way for feistier smaller banks to enter the system and shake things up through new technology or other compelling customer propositions. The balance between risk and competitiveness tends to follow a cycle — after a systemic shock, regulators become risk averse and small banks find it difficult to enter or stay in the market. But the pendulum swings back as consumer pressure rises and demand for more competition grows.

The cycle has been swinging towards fewer banks in SA after the sudden arrival of entrants such as Discovery, Bank Zero, TymeBank and the resurrected African Bank. Now we are seeing consolidation, with Grindrod, Mercantile and Ubank all recently acquired by competitors. They cite the burden of the regulatory regime as a reason to exit the market.

The problem is that worldwide, since the financial crisis, banking regulation has become far more onerous. This is felt in capital levels, various ratios that test the riskiness of a bank’s balance sheet, and the overall burden of compliance. Regulators globally also have lost much of their discretion. Previously, they could set their own rules for various tiers in the banking system. But they have come to standardise regulation as if every bank was a large systemically risky one.

Our existing Banks Act was written as if regulators would have a level of discretion in how they regulate the banks. Until the financial crisis, they did. Now, the Prudential Authority (PA) in practice treats all banks registered under the Banks Act the same. The burden is high, irrespective of how big or small it is.

Faced with this, new entrants have been eyeing the Mutual Banks Act as an alternative, lighter touch regime. Banks such as Bank Zero and Finbond Bank have gone this route, joining the handful of remaining mutual banks, of which VBS was one (the acronym derives from its old name of Venda Building Society).

Naturally, after VBS’s collapse, we should ask questions on whether this regime is effective. A key question is whether it was the mutual nature of VBS that allowed the brazen fraud to evolve to the point where R2.2bn could be thieved from it without detection by the regulator.

Auditor

A key failing at VBS was the auditor of the bank. The lead partner who oversaw the audit, Sipho Malaba, was a senior and well-respected head of financial services audit at KPMG. He is also alleged to have been on the take from VBS. Regulators rely on auditors to do their jobs honestly.

VBS was making up numbers to hide the huge holes that were growing in its balance sheet as money was being siphoned out. There are various legal requirements on auditors to report material issues to bank supervisors. Often it is the auditors who first sound the alarm about a bank in distress — as was the case in previous failures such as Saambou and African Bank.

The SA Reserve Bank was able to detect things really going off the rails only when VBS began failing to meet obligations to the National Payments System (NPS). In terms of the NPS rules, a bank must have on deposit with the Bank sufficient cash to cover its liabilities.

I doubt the mutual bank requirements itself played a role in VBS’s collapse. It was not that the bank was able to do what it did because it didn’t have to comply with a liquidity capital ratio, for example. It collapsed because of fraud.

We should, however, think about the future banking system we want. One that balances systemic stability with competition. There does need to be a lighter touch regulatory regime for less risky banks, though it would be better purpose built, rather than the aberration of the Mutual Banks Act that now serves the function.

And then we need to think hard about how to manage the risk of auditors being corrupted. That is a risk that must be managed for all banks.