South Africa’s big banking law gap

South Africa’s Finance Minister sees no need to amend banking laws regarding account closures for reputational risk.

However, critics argue the process lacks transparency, unfairly impacts politically exposed individuals, and highlights unresolved issues in the country’s banking system.

Finance Minister Enoch Godongwana recently stated that, for now, there’s no need to change banking laws regarding when banks can close the accounts of companies they consider a reputational risk.

Banks have, on several occasions, refused to do business with certain clients, closing their accounts. This leaves the companies unable to trade, make payments, or receive money. 

A notable example is the dispute between the Sekunjalo Group and its banks, particularly Nedbank, which closed Sekunjalo’s accounts following the findings of the Mpati Commission.

Chartered Accountant Khaya Sithole explained on The Money Show with Stephen Grootes that this “is a remarkably difficult issue”.

Banks can effectively shut down a business by denying it a bank account. However, it’s also difficult to argue that banks should be forced to do business with clients they don’t want to work with.

The core issue, Sithole said, is that banks operate under the same regulations, so they’re likely to reach the same conclusions about a client’s risk profile. If one bank deems a client too risky, others might follow suit.

“This is not an ordinary industry where if you don’t like me, I can find someone else who likes me,” he explained.

“If everybody’s been told to treat me the same way, then the answer is that Bank One will treat me the same way as every other bank. So, therefore, I’m being excluded from the system altogether.”

Adding to the complexity, banks aren’t required to disclose why they’ve decided to terminate a relationship. The concept of “reputational risk” is vague and subjective. 

For instance, institutions like Bain and McKinsey, implicated in state capture, haven’t faced the same account closures under the pretext of reputational risk. Yet, Sekunjalo has.

Sithole explained that Sekunjalo’s case is very important, even though they are unlikely to win, since it highlights unresolved issues in the banking system. 

“They’re going to enable us to explore some of the more difficult and unresolved issues relating to how the banking system works and how we define reputational risk.” 

Sithole pointed out that the minister’s statement that South Africa’s banking laws do not need to be changed is flawed because the current system has a critical gap.

Individuals and companies affected by reputational risk exclusions often don’t get the opportunity to explain their side. 

While some clients might be asked to clarify specific transactions, many argue they weren’t given a chance to defend themselves before their accounts were closed.

According to Sithole, if there’s one area of the law that requires attention, it is the requirement around transparency and disclosure.

Specifically, what kind of information banks should request from clients before making such decisions.

This issue was also raised during the Zondo Commission, where former Chief Justice Raymond Zondo noted that banks’ processes for terminating accounts seemed arbitrary. 

While his findings were based on a limited number of companies involved in state capture, Zondo observed that banks often cited “reputational risk” without explaining what it entailed or how clients might address these concerns to retain their accounts.

Notably, many high-profile cases involving reputational risk seem to have political links. 

For example, the Sekunjalo case stems from the Mpati Commission’s findings regarding money received from the Public Investment Corporation.

While personal or workplace conflicts wouldn’t typically factor into a bank’s risk assessment, politics is a different story, Sithole explained. 

Global rules have focused heavily on politically exposed individuals (PEPs) – those closely connected to decision-makers or potentially subject to inducements.

As a result, PEPs are often flagged as high-risk in a bank’s risk matrix. Transactions involving politicians facilitating deals or directly associating with companies significantly elevate the perceived risk. 

“Therefore, it is those political entanglements that seem to make it very difficult for people to explain their way through this whole reputational risk dimension,” Sithole said.

This issue is compounded by the relatively small number of banks in South Africa.

Some argue that being labelled as a PEP subjects them to significantly stricter scrutiny than others. They face more onerous disclosure requirements just to access basic banking services.

Sithole explained that there is a need to refine the definition of PEPs to distinguish between individuals who simply hold political office and those entangled in corruption or illicit activities. 

“I don’t think it’s a fair process and I do think it’s a process that is worth revising,” he said.

However, he added that the law doesn’t necessarily need to change, but simply how banks communicate with clients about the reasons behind their classification as undesirable.