Mutual banks to deduct FLAC holdings from regulatory capital
Mutual banks in South Africa must deduct First-Loss Absorbing Capacity instruments from regulatory capital under a draft directive published by the Prudential Authority. The consultation on the proposed rules runs until September 23, 2026.
Deductions start at secondary capital
Under the draft directive issued in terms of the Mutual Banks Act, 1993, mutual banks investing in First-Loss Absorbing Capacity (FLAC) or similar instruments must deduct the full exposure from secondary capital.
If secondary capital is insufficient to absorb the deduction, institutions must deduct the remaining balance from primary capital.
For indirect exposures via index holding securities, banks must apply a look-through approach to calculate underlying FLAC instruments of the relevant entity.
If calculating exact exposures proves operationally burdensome, banks may apply for written approval from the Prudential Authority to use a conservative estimate.
Preventing contagion across resolution tiers
The directive supports the South African Reserve Bank's open bank resolution framework, which created unsecured subordinated FLAC debt to ensure systemically important financial institutions maintain loss-absorbing and recapitalisation capacity in resolution.
Regulators aim to prevent contagion across the banking sector by stopping non-systemic mutual banks from absorbing losses meant for designated institutions.
The framework builds upon Prudential Standard RA03 and Guidance Notice 1 of 2025.
Prudential prudence over portfolio yield
The capital deduction correctly closes a regulatory loophole that could have imported systemic distress into smaller mutual institutions.
Permitting estimated index exposures offers welcome operational relief without diluting prudential rigor.
This draft delivers sound structural safeguards for the resolution regime.