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September 25, 2017

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South African bank rescue rekindles bailout fears

JOHANNESBURG--South Africa's decision to rescue a small lender seen as neither "too big" nor "too interconnected" to fail shows that taxpayers worldwide may have to accept that bank bailouts are here to stay.

When South Africa's central bank recently announced a US$700 million (520 million euro) rescue of faltering African Bank Investments Limited, it scarcely made a splash outside the country.

The bottom line, at least for the rest of the world, was that African Bank is not very big and not very important.

The bank's managers made far too many bad loans to too many South Africans who could not afford to pay them back.

Because it had not asked borrowers to put up their car or any other asset as collateral, it was left with a massive hole in its balance sheet when they failed to pay.

African Bank is not one of South Africa's "big-four" — Standard Bank, FNB, Nedbank or ABSA (Barclays Africa) — which are deeply enmeshed in the global financial system.

While many South African banks had made similar "non-secured" loans, most notably Capitec, they have profitable lines of business that should cover any losses.

And because deposits accounted for only one percent of African Bank's creditors there would be little risk of a "It's a Wonderful Life" style bank run, with South Africans clambering to withdraw cash.

The South African financial sector — which makes up about a quarter of the country's gross domestic product (GDP), and which is vital to investments across the African continent — seemed safe.

Why the Bail-out?

Announcing the rescue, the South African Reserve Bank, which is well respected globally, pointed to a very local reason for the rescue: to support lenders who serve the poor.

African Bank had mainly provided small loans to low-earning black South Africans, helping them start businesses or get into the housing market.

Two decades after the end of white minority rule and with South Africa still one of the most unequal countries on earth, which is something the government is desperate to encourage.

But the Reserve Bank was also motivated by something more globally relevant: the need to prevent a panic.

"The rescue," according to Jac Laubscher, an economist with Sanlam, "once again demonstrates the difficulty of allowing a financial institution to fail and to let all the messy consequences play out unhindered."

"This is of course not a problem peculiar to South Africa."

Since the 2008 global financial crisis regulators have tried to reduce the risk that taxpayers' cash will be needed to save banks that have made dodgy bets.

"Too-big-to-fail" banks have been told to improve the quality and quantity of their capital and to put in place plans for their possible demise.

But at the same time authorities, including those in South Africa, are acutely aware of what happened to the U.S. financial system and the global economy when Lehman Brothers was not given a bail out.

Its collapse sent shock waves across the financial sector, making major banks unwilling to lend to anyone in case the recipient would be next to go.

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