Reserve Bank warns sanctions could threaten financial stability

The South African Reserve Bank warns that sanctions due to its relationship with Russia could threaten South Africa’s financial stability and coupled with the recent FATF greylisting, the potential implications for the economy are severe.

“Even in the absence of formal secondary sanctions, counterparts of South African financial institutions could put institutions under intensified scrutiny and decide to reduce their exposure to South Africa as part of their own risk management processes,” the South African Reserve Bank (Sarb) says in its latest Financial Stability Review.

The Sarb is responsible for protecting and enhancing financial stability in terms of section 11 of the Financial Sector Regulation Act and is legally obliged to take steps to avoid the materialisation of risks such as sanctions and manage systemic events.

A systemic event that is reasonably be expected to have a substantial adverse effect on the financial system and economic activity in South Africa.

When US Secretary of the Treasury, Janet Yellen, visited South Africa in January, she warned: “My main message is that we take very seriously these sanctions that we’ve placed on Russia in response to its brutal invasion of Ukraine.”

“Violation of those sanctions by local businesses or by governments – we would respond to quickly and harshly and we certainly urge that there be compliance with those sanctions. That’s the discussion I’ve had here.”

The Sarb says numerous media articles highlighted the growing challenges South Africa’s efforts to maintain its neutral stance on Russia.

“The events reported in the media and recent remarks by the US Ambassador to South Africa could change perceptions about South Africa’s neutrality, which could build up to a point where it triggers secondary sanctions being imposed on South Africa,” the Sarb warns.

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Key risks of sanctions

The Sarb identifies the greylisting, the impact on cross-border payments and correspondent banking relationships, the risk of damaging relations with South Africa’s largest trading partners and the impact on the management of South Africa’s foreign reserves as key risks for domestic financial stability that would result from the imposition of potential secondary sanctions on South Africa.

Therefore, the Sarb warns that the double impact of secondary sanctions and the recent FATF greylisting may cause severe and long-lasting damage to South Africa’s reputation in the global financial system, with a range of adverse consequences.

If secondary sanctions are imposed on South Africa, the most immediate impact would be the tightening or termination of correspondent banking relationships and increasing costs of cross- border payments.

In addition, there will also be a regional impact as many countries in the Southern African Development Community (SADC) region depend on South African banks for correspondent relationships and cross-border transactions.

Secondary sanctions could also cause possible pressure on the continuous linked settlement (CLS) system to remove the Rand from the system, which would expose local banks to principal risk.

The Rand is one of 18 currencies that participate in the CLS system and the only African and BRICS currency that participates in CLS.

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Risk of losing access to markets

There is also a risk that South Africa’s favourable access to the US market in terms of the US African Growth and Opportunity Act (AGOA) may not be renewed when it expires in 2025.

The Sarb says this will have severe consequences for corporates and industries who benefitted from this agreement since its inception in 2000.

The Sarb also points out that the South African banking sector’s claims on the UK amounted to R324 billion at the end of 2022 (close to 38% of the total banking sector’s claims on the rest of the world), and R70 billion on the US, while claims on Russia were immaterial.

On 31 December, 82.5% of foreign direct investment originated from the US, EU and UK, with only 0.003% from Russia.

“Foreign markets and in particular European markets are a stable source of term funding for South African banks. Any secondary sanctions would constrain or even completely close off access to international capital markets for South African banks, other financial institutions and corporates. This will also spill over into the cost and availability of funding for the rest of the financial sector and the real economy.”

International market participants providing USD clearing, settlement and payment services to local banks would either fundamentally reduce or completely halt such transactions and services, based on the aspects related to the imposition of secondary sanction.

The Sarb warns that many of these factors would significantly increase regulatory capital requirements for banks and constrain revenues due to a loss of business, counterparties and clients.

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Impact on SA’s foreign reserves

The impact on South Africa’s foreign reserves will also be severe.

The Sarb’s foreign reserves are denominated mainly in gold and hard currencies such as USD, euro and British pound and the management of these foreign reserves may be impacted in the case of secondary sanctions.

Secondary sanctions could result in a systemic event where it will be impossible to finance any trade or investment flows, or to make or receive any payments from correspondent banks in US dollar.

There is also the risk that sanctions could be expanded to include payments in EUR or GBP.

“This will be catastrophic for the South African economy and has the undeniable potential to trigger a financial crisis. The South African financial system will not be able to function if it is unable to make international payments in US dollar. “

The Sarb says the impact on the economy and financial markets will be far-reaching. More than 90% of South Africa’s international payments are currently processed through the Society for Worldwide Interbank Financial Telecommunication (SWIFT) international payment system.

“Should South Africa be banned from SWIFT as a result of secondary sanctions, these payments will not be possible. As a country with low domestic savings and a current account deficit, South Africa is highly dependent on foreign investment inflows to fund this deficit. 

“South Africa is already plagued by foreign investment outflows as a result of its weak economic conditions and the recent FATF greylisting. Jeopardising remaining investment inflows, which come predominantly from the US, EU and UK, could therefore lead to financial instability,” the Sarb says.