By Jac Laubscher, 14 August 2014
It has been suggested in the media that the real reason why the SARB rescued African Bank is the exposure of money-market funds to African Bank debt instruments. The perceived risk was that losses on African Bank paper held by money-market funds could cause them to “break the buck” (viz. unit prices declining to below R1.00 per unit or par) and that a resultant loss of confidence could then have caused a run on these funds. This could then develop into a systemic event creating difficulties for borrowers issuing commercial paper to finance their operations, in turn affecting real economic activity negatively.
The question is whether this is a plausible argument.
Fears in this regard probably originate from the 2008 financial crisis when subsequent to the bankruptcy of Lehman Brothers the world’s oldest money-market fund, the Reserve Primary Fund with total assets of $62 billion, “broke the buck.” The eventual losses to investors amounted to less than 1,5% in spite of the severity of the subprime crisis and its consequences.
The losses at the Reserve Primary Fund coincided with a switch in the amount of $500 billion (14% of total money-market assets) out of primary funds, with the bulk of the funds reallocated to government money-market funds because of their lesser risk. However, it is important to note that this was not a “run” on primary funds but a rational response by investors to a change in risk perceptions and that the money did not disappear into thin air but remained within the financial system. However, to avoid disruption in the market for commercial paper, the US government stepped in to temporarily extend deposit insurance to money-market funds while the Federal Reserve established a special liquidity facility to support the market for commercial paper.
According to the Financial Services Board (FSB), which regulates the collective investments industry, money-market funds as a whole had an exposure of 1,3% of total assets to African Bank debt. Leon Campher, chief executive officer of ASISA (the Association for Savings and Investment SA, which counts collective investment schemes among its members, has expressed the view that fund managers’ exposure to African Bank was not so high as to cause “meaningful losses”.
The exposure of individual money-market funds to African Bank debt would of course have varied around the average of 1,3% mentioned by the FSB. Funds will differ in the way they account for any losses, with many of them preserving the price of R1 per unit by cancelling an appropriate number of units.
Money-market funds also differ in the degree to which they have warned investors about the possibility of capital losses, as remote as it may have been. Many funds were quite clear in spelling out the risks to investors, warning them of the possibility of capital losses that in the event would be borne by investors*. To the extent that investors took these warnings to heart the losses imposed by the failure of African Bank should not come as a shock, thus dampening any systemic risk.
Fears regarding the money market did not necessitate the rescue of African Bank. If fears of money-market funds “breaking the buck” were really that severe, direct measures to safeguard the commercial-paper market as in the US would have achieved the desired effect. However, industrial companies in South Africa are not dependent on the commercial paper market for their short-term financial needs as in the US, which to a large extent weakens the argument for intervention.
The attraction of money-market funds has always been their ability to earn higher returns than those offered by bank deposits. However, the basic investment principle that higher returns come with higher risk still applies and should not be distorted.
An interesting twist to this argument is how it relates to banks’ compliance with the new Net Stable Funding Ratio that forms part of Basel III. The implication of this requirement for South African banks is that they should reduce their dependence on wholesale funding (which includes money-market funds) and switch to greater use of retail funding (viz. individual deposits) on the assumption that the latter is a more stable source of funding that is less likely to cause liquidity problems for banks.
A greater awareness of the risk in money-market funds compared with bank deposits should favour investment in the latter and therefore help banks to comply with the Net Stable Funding Ratio. So paradoxically the SARB should in fact not try to dampen increased perceptions of risk in money-market funds because of the failure of African Bank!
Alan S Blinder: After the Music Stopped. Penguin Press. New York. 2013.
* The fact sheet for the Sanlam Glacier Money Market Fund, for example, contains the following warning: “The price of each unit is aimed at a constant value. The total return to the investor is primarily made up of interest received but may also include any gains or loss made on any particular instrument. In most cases this will merely have the effect of increasing or decreasing the daily yield, but in an extreme case it can have the effect of reducing the capital value of the fund.