A legal expert with deep knowledge of regulation of financial institutions has warned that the United States’ legislation against the closure of bank accounts due to reputational risk could see South African banks sanctioned if they close accounts of businesses in which US companies or individuals are invested.

This comes as the US Banking Committee announced this week that the Federal Deposit Insurance Corporation (FDIC) will eliminate reputational risk as a factor in bank supervision, following the passage of Senator Tim Scott’s Financial Integrity and Regulation Management (FIRM) Act.

The FIRM Act aims to remove reputational risk as a component of federal financial regulation, potentially addressing issues like "debanking", which refers to financial institutions terminating relationships with businesses or individuals due to concerns about reputational risk.

The legislation aims to scrap this concept across all federal banking regulators.

In an interview with Business Report on Thursday, the legal expert who preferred to keep his anonymity, said banks were a law unto themselves for in the way they were arbitrarily using reputational risk.

“Reputational risk has got no parameters, and has got no level of calibration. Like everything else that is legal, you've got to do something which must trigger something to get to the conclusion that something has happened,” explained the legal expert.

“That's how our law functions. Anything legal has to have parameters. Parameters which have got graduations. Graduation which then leads to the commission of an offence, or the conclusion of something that is statutorily improper, or whatever any fraction of the law, to that extent. The graduation point here is the sufficiency of proof. It is one thing even if you have evidence or proof. But that proof must meet a certain standard, what we call the evidentiary burden of proof.

“The banks are buying themselves out of the legal process by alleging and concluding without going through all the necessary steps of converting the allegation into fact, and factually proving it by an independent corroboration. They are the accuser, the judge, and the hangman, all at once.”

In South Africa, the Supreme Court of Appeal in Bredenkamp v Standard Bank set the standard for the unilateral termination of the bank-customer relationship on the grounds of reputational risks.

John Bredenkamp was a Zimbabwean-based business tycoon suspected of being involved in illicit business activities including tobacco trading, arms trafficking, oil distribution, and diamond extraction.

The judgement sets out several principles South African banks have relied on when terminating relationships with their customers.

Over the years these principles have been challenged in courts, where customers have instituted legal proceedings to prohibit banks from closing their accounts, requiring banks to keep accounts open against the banks' wishes.

The South African Reserve Bank, which oversees the industry, offered no comment on potential regulatory changes.

The Banking Association South Africa also dodged the issue on Wednesday, stating, “The closure of bank accounts is a matter between individual banks and their customers. Any queries should be directed to the individual banks concerned.”

However, the legal expert said that South African financial institutions must prepare for an escalating regulatory environment.

He said South Africa should brace itself in the accentuation of the role of the Financial Intelligence Centre as the FIRM Act will one way or another extend its tentacles to domestic shores.

“So the implication we believe is going to happen is that as soon as South Africa agrees that there shall be no reputational risk, otherwise we stand a chance of offending against United States banking legislation and being fined,” he said.

“And South African banks are not in a position to take the pressure of being fined by the Attorney General of New York. And this time around, they have to be so proactive, otherwise they would sink the many banks that they protect all the time when the Attorney General of New York starts imposing $1 billion and more fines again.”

BUSINESS REPORT

#debanked

US banking rules may affect South African banks over reputational risk closures