South African bank guilty of committing a serious offence by Bianke Neethling

[Nat Quinn]

South African bank guilty of committing a serious offence by Bianke Neethling

Finbond Mutual Bank was recently dealt a significant blow in its case against the Prudential Authority after the bank was found to have committed a “serious offence” by misrepresenting its financial position.

This case dates back to 2012 when Finbond Mutual Bank (FMB) loaned R155 million to its parent company, Finbond Group (FGL).

This loan was reported in FMB’s financial statements as an unsecured, interest-free loan payable on demand. The loan persisted from 2013 to 2019.

However, by 2018, the Prudential Authority raised concerns about this loan because FGL held 100% of the shares in FMB.

The regulator was concerned about how this loan would affect the bank’s capital adequacy ratio, which is regarded as a key indicator to assess a bank’s financial safety and soundness.

In short, a capital adequacy ratio is calculated by dividing a bank’s net qualifying capital by risk-weighted assets. The higher the risk-weighted assets, the lower the capital adequacy ratio.

Where a bank has exposure to a single counterparty which exceeds 25% of its net qualifying capital, the Prudential Authority may require the bank to increase the risk weighting of its assets.

Due to these concerns, the Prudential Authority approached KPMG, FMB’s auditors at the time, to review the loan.

KPMG reported that FGL intends to repay the loan in full. It found that FGL can raise additional cash quickly and could, if needed, consider selling one of its subsidiaries, Supreme Finance, to FMB.

Notably, KPMG also found that there was no formal loan agreement in place between FGL and the applicant.

Following KPMG’s findings, the Prudential Authority raised its concerns with the loan with FMB.

The bank reassured the regulator that it planned to reduce its exposure significantly by the end of 2018.

However, in December 2018, the loan still stood at R111 million, and the Prudential Authority again raised its concerns with FMB.

The regulator said that this issue was required “to be settled as a matter of urgency”.

A few months later, in March 2019, the company said in a meeting with the Prudential Authority that it had complied with KPMG’s recommendation to sell Supreme Finance’s debtors’ book to FMB to settle the loan.

It said this “resulted in the balance of the FGL being reduced to zero at the end of March 2019”.

However, a different auditor reviewed the debtors’ sale agreement and confirmed that the repayment was not concluded after the March 2019 meeting.

Therefore, the Prudential Authority again asked the company to settle the loan urgently.

A month later, FMB told the regulator that “the loan between FMB and FGL has been settled in full as of the end of March 2019”.

In July 2019, the Prudential Authority asked FMB for more details regarding how the loan was settled.

FGL provided more details, but the regulator was dissatisfied with the bank’s explanation and mandated an independent auditor’s review of the issue.

The independent auditor found that “Supreme did not transfer substantially all of the risk and rewards and had retained control of the debtors’ book”.

“As a result, FMB should not have recognised Supreme’s debtors as an asset. Consequently, this transfer should not be used as a mechanism to settle the FGL loan.”

“The fact that the correct accounting was not applied has further implications from the regulatory perspective.”

Based on these findings, the independent auditor concluded that despite what FMB reported, the loan had not been settled as of 31 March 2019.

The loan was ultimately settled in cash only in 2020, contradicting FMB’s earlier claims.

After reviewing the independent auditor’s report, the Prudential Authority imposed an administrative penalty of R10 million on FMB in February 2024.

R5 million of the R10 million penalty was suspended for three years, subject to FMB not committing a similar contravention during this period.

The Prudential Authority explained that this penalty was imposed because the bank misrepresented its accounting records by reducing the intercompany loan account from Finbond to FGL.

Consequently, the bank also misrepresented the monthly DI returns it submitted to the Prudential Authority from 2014 to 2020 to achieve a favourable regulatory outcome.

FMB applied to the Financial Services Tribunal to reconsider the Prudential Authority’s penalty.

The bank asked the tribunal to consider whether it genuinely contravened any financial sector law and whether the Prudential Authority’s penalty was appropriate.

After reviewing all the evidence, the tribunal concluded that FMB did contravene the Mutual Banks Act.

“The long period in which the applicant relied on a simulated set of transactions to bolster its capital adequacy ratio is cause for concern in that this conduct represented a sustained attempt to misrepresent the substance of its financial position,” the tribunal said.

“In this case, the applicant has been found to have committed a serious offence which requires an adequate response from the Regulator to deter such activities by financial institutions.”

Therefore, the tribunal found that FMB’s long-term misrepresentation of its financial position justified the penalty as a deterrent against such practices in the financial sector.

 

source:South African bank guilty of committing a serious offence – Daily Investor

 

 

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