Following the 2007 – 2009 financial crisis, it became evident globally that there were weaknesses in the financial regulation of commercial banks, specifically in relation to the liquidity and capital requirements of those banks. In response to this global realisation, the Basel Committee on Banking Supervision, which sets the global standard for prudential regulation of banks and is a forum which caters for regular cooperation on banking supervisory matters, comprising of central banks and bank supervisors from 28 different jurisdictions, issued the Basel III framework (“the Basel Framework”) to address measures on bank capital adequacy and liquidity. As a member of the G20, South Africa committed to the implementation of the Basel Framework, which was adopted in 2013 and resulted in amendments to the regulations under the Banks Act, 1990 (“the Regulations”).
The Regulations require that all banks, bank controlling companies and branches of foreign banks hold regulatory capital. Regulatory capital is the minimum amount of capital a bank is required to hold to absorb losses. The idea is to avoid an outcome where a bank which is considered ‘too big to fail’, does fail, and the resulting outcome is one which results in a “severe detrimental impact on the rest of the financial system, consumers and the real economy”. However, given South African banks' conservative lending practices and stringent oversight by the South African Reserve Bank (Reserve Bank), the traditional market would likely meet with these requirements. Nonetheless, the Regulations set out the requirements for the different forms of regulatory capital.
In 2015, the Financial Stability Board, which is an international body that monitors and makes recommendations about the global financial system, issued the standard titled ‘Principles on Loss-absorbing and Recapitalization Capacity of Global Systemically Important Banks (G-SIBs) in Resolution’, which set out the principles for total loss-absorbing capacity. As a G20 member, and in efforts to keep abreast of the latest developments relating to regulation and supervision in the financial sector, South Africa and the Reserve Bank participate in and contribute to the work of the Financial Stability Board. This standard requires that globally systemic important banks have sufficient loss-absorbing and recapitalisation capacity to allow them to continue operating while the resolution process, which is a process in which a failing bank is restructured by a designated resolution authority in order to protect the public interest and ensure financial stability, is underway. Although there are no global systemically important banks in South Africa, the need for sufficient loss-absorbing and recapitalisation capacity is still relevant and Flac is aimed at addressing these requirements.
What is FLAC, Why is it Needed, and Who is Required to Issue it?
In December 2023, the Prudential Authority published the Draft Prudential Standard RA03 titled "Flac Instrument Requirements for Designated Institutions" (“the Draft Standard”) requiring designated institutions which to date are only banks but may also be non-bank entities, and their holding companies to issue an additional form of capital, namely financial loss absorbing capital – Flac. According to the ‘Statement* explaining the need for, expected impact and intended operation of the draft Prudential Standard RA03: Flac Instrument Requirements for Designated Institutions’ published by the Prudential Authority, the issuance of Flac instruments would further ensure a “reduced reliance on public funds when banks fail and empower the resolution authority to assign losses to shareholders and creditors in resolution”.
Following the publication of the Draft Standard, there was uncertainty and ambiguity around some of the requirements and application thereof. The final Prudential Standard RA03 was published on 11 December 2024 (“the Standard”) together with a consultation report in which the Prudential Authority addresses some of these uncertainties. In addition, the publication of Guidance Note 1 of 2025 titled “Guidance on the Minimum Flac Requirements” (“Guidance Note”) also addresses, among other things, the ranking of the Flac instruments.
Flac instruments are unsecured, subordinated debt instruments which were introduced in the Financial Sector Regulation Act, 2017 (as amended by the Financial Sector Laws Amendment Act, 2021 (Act No. 23 of 2021)) (“the FSRA”) as an additional form of capital to be readily available for bail-in by the Reserve Bank (in its capacity as Resolution Authority), in resolution. The Standard sets out the principles and requirements for Flac instruments.
The Standard makes provision for the issuance of both ‘external flac’ and ‘internal flac’. External flac instruments must be issued by the holding company of a designated institution, provided that the holding company is the ultimate holding company and not an intermediate holding company. Internal flac instruments must be issued by the designated institution to its holding company, which allows the funds obtained from external persons through the issuance of the external flac issues to be pushed down to the designated institution.
Only those designated institutions designated as ‘systemically important financial institutions’ (“SIFI”) by the Governor of the Reserve Bank in terms of section 29 of the FSRA, and their holding companies, are required to issue Flac instruments. Currently, the following institutions have been designated as SIFI’s: Absa Bank Limited, Capitec Bank Limited, FirstRand Bank Limited, Investec Bank Limited, Nedbank Limited, and The Standard Bank of South Africa Limited.
Requirements for FLAC
Paragraph 8 of the Standard sets out the qualifying criteria for Flac instruments.
Following the publication of the Draft Standard, it was not clear if Flac instruments would only be capable of bail-in by the Resolution Authority during resolution or if contractual bail-in, i.e. bail-in in accordance with the terms of the instrument, would also be possible. This is because the Draft Standard required that Flac instruments contain contractual terms that promote the ability of the Reserve Bank to conduct a resolution and for these instruments to be subject to bail-in under South African law. By including this requirement, it seemed to imply that the intention was to cater for contractual bail-in of Flac, as there would be no need for this requirement where bail-in is only possible in resolution. This is especially true in relation to Flac instruments governed by South African law, as the provisions of the FSRA would apply automatically.
If contractual bail-in in respect of Flac instruments was indeed possible, this would result in difficulties when considering the bail-in of Flac instruments together with the bail-in of regulatory capital, as regulatory capital and Flac instruments fall under two separate frameworks and under the purview of different authorities. In addition, it would create uncertainty around the ranking of Flac instruments if the contractual trigger for the bail-in of Flac instruments was not simultaneously triggered with the contractual trigger for the bail-in of regulatory capital.
Although the Standard has retained this requirement, the Reserve Bank has confirmed, in the Flac Consultation Report, that Flac instruments can only be bailed in, in resolution and not before the designated institution is placed into resolution. In addition, the Reserve Bank has advised that the contractual terms to be included in the Flac instrument are not prescriptive. Therefore, all Flac instruments issued must include this contractual recognition to ensure compliance with paragraphs 8.5 and 8.6 of the Standard.
Related to the above, following the publication of the Draft Standard, it was also not entirely clear where the Flac instruments would rank. The Draft Standard requires that the contractual terms and conditions specify the ranking of the instrument in line with the creditor hierarchy in the Insolvency Act, 1936 (“the Insolvency Act”). However, the ranking of Flac is not addressed in the Insolvency Act but rather in the resolution provisions of the FSRA, in section 166W of the FSRA. The Guidance Note has confirmed that Flac instruments rank junior to other unsecured liabilities and senior to regulatory capital, which aligns with the position set out in section 166W of the FSRA.
The Standard is set to come into effect on 1 January 2026.
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Read the original publication at ENS
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