How Ithala’s banking ambitions crumbled: the rise and fall of a rural icon

The application by the Prudential Authority (PA) for Ithala SOC Limited’s provisional liquidation has triggered the closure of its 257 000 depositors’ accounts to prevent a run on the bank and ensure a fair distribution of funds. But how did the once-prominent institution find itself in this predicament?

Some background is needed to understand the origins of the bank-but-not-a-bank’s troubles.

The story begins with the establishment of the Ithala Development Finance Corporation Limited (IDFC) in 1958. Owned by the province of KwaZulu-Natal, the IDFC is a development finance agency, promoting economic growth in the province.

Ithala Ltd, a 100% subsidiary of the IDFC, was separated from the IDFC in 2001 following a South African Reserve Bank (SARB) recommendation.

The Banks Act does not allow provincially owned state-owned entities to be registered as banks. The Act requires a bank to be a public company incorporated or registered as a national state-owned company under the Companies Act.

So instead, Ithala operated under several exemption notices granted in terms of section 1(1)(cc) of the Banks Act.

Under the Banks Act, an exemption notice is a formal declaration issued by the PA with the approval of the Minister of Finance that grants certain entities relief from specific regulatory requirements outlined in the Act.

Prior to the PA’s establishment in 2018, exemption notices were granted by the Minister of Finance. Exemption notices are usually granted under specific conditions and have their own compliance requirements, to ensure the overall integrity and stability of the financial institution. Exemption notices are granted for a limited period as a temporary mechanism to enable the regulated institution to apply for and comply with the full regulations.

Operating a business of a bank without a banking licence or an exemption is an offence under the Banks Act.

The last of these exemption notices was issued to Ithala in July 2022.

Lapse of Final Exemption Notice

According to a frequently asked questions document published by the SARB, the Final Exemption Notice was granted to Ithala as a final opportunity to regularise its deposit-taking activities after a series of non-compliance issues flagged by the PA as supervisory concerns.

One key condition of the Final Exemption Notice required Ithala to obtain authorisation to establish a bank, which is a prerequisite for applying for a banking licence, by 30 June 2023. Ithala failed to meet this condition, along with other linked requirements in the notice.

The PA noted that Ithala’s application for authorisation to establish a bank did not adequately address the supervisory concerns raised, leaving the institution non-compliant.

Additionally, despite multiple representations Ithala made to the PA over an extended period – on which the PA relied in granting exemptions, including the Final Exemption Notice – Ithala failed to restructure its operations to meet the requirements of the Banks Act for authorisation to establish a bank or a mutual bank under the Mutual Banks Act.

Ithala initiated several court proceedings to challenge and overturn the conditions imposed in the Final Exemption Notice, but all of these attempts were unsuccessful.

As a result, the Final Exemption Notice lapsed on 15 December 2023, which meant that Ithala was holding deposits unlawfully.

According to the founding affidavit that accompanied the PA’s notice of motion seeking Ithala’s liquidation, that amount is R2.47 billion (as reflected in its 31 March 2024 financial statements).

Litigation and more litigation

In preparation for the Final Exemption Notice’s deadline, the PA appointed Johan Kruger as the repayment administrator (RA) on 12 December 2023.

Ithala, together with the RA, was tasked with devising a plan to safeguard or repay deposits in the interest of depositors by 15 December 2023. The PA requested an undertaking from Ithala to co-operate with the RA, but Ithala failed to provide one.

As a result, the PA approached the High Court in Pretoria, obtaining an order confirming that the Final Exemption Notice had lapsed and requiring Ithala to co-operate with the RA.

Kruger was again appointed on 18 December 2023, but the scope of the RA’s powers soon became the subject of litigation.

A court ruling that limited the RA’s powers is currently under appeal.

In February 2024, Ithala initiated proceedings in the High Court, seeking, among other things, permission to continue accepting deposits under the supervision of the RA, despite the lapse of the Final Exemption Notice.

The High Court dismissed Ithala’s application, as well as its subsequent request for leave to appeal. The Supreme Court of Appeal (SCA) also dismissed Ithala’s application for leave to appeal. However, Ithala petitioned the Judge President of the SCA to reconsider the decision and was granted an opportunity to argue its case.

On 18 July 2024, Ithala filed another application in the High Court, requesting that the PA issue a notice allowing it to continue taking deposits for a further 12 months. This matter remains pending.

The PA and RA have opposed Ithala’s latest application, arguing that the High Court has already decided the issue and cannot be revisited.

Meanwhile, the PA filed a notice of motion, dated 16 January, indicating its intention to submit a liquidation application with the High Court in Pietermaritzburg on 30 January. If Ithala intends to oppose the application, it must submit its notice of opposition and an answering affidavit by 20 January, paving the way for yet more litigation.

Concerns flagged

According to the founding affidavit accompanying the notice of motion, the PA’s primary reason for seeking Ithala’s liquidation is insolvency under the Banks Act. The PA asserts that Ithala is deemed insolvent under section 83(3)(b) of the Act for failing to comply with directives and instructions to repay deposits.

In response, Ithala issued a scathing media statement, claiming it is solvent and that its assets significantly exceed its liabilities. The entity further argued that, during the 13 months since Kruger’s appointment as RA, no evidence of wrongdoing or irregularities in its deposit-taking activities has been found.

“Due to the integrity of its deposit-taking activities, soundness of its business and the loyalty of its depositors, there was no panic withdrawal of deposits. Deposits have been secure throughout the 13 months of the RA’s tenure,” Ithala stated.

So, if that’s the case, what exactly is it that irks the PA so?

The SARB’s frequently asked questions document provides several reasons, starting with Ithala’s failure to comply with all the conditions of the Final Exemption Notice.

“Including submitting its annual financial statements on time and being audited in accordance with the provisions of the Financial Sector Regulation Act 9 of 2017,” the PA stated.

The Authority adds that it has raised numerous supervisory concerns regarding Ithala’s corporate governance, prudential compliance, and risk management, “which have persisted since its early years”.

The PA also expressed concerns regarding the effectiveness of Ithala’s boards, particularly with respect to:

• compliance with the exemption notice and applicable legislation, as well as adherence to banking practices;
• prolonged vacancies;
• challenges in attracting experienced and skilled banking executives; and
• difficulties in establishing a succession planning framework, all of which have contributed to Ithala’s complexities.

The Authority further highlighted instability at the executive management level due to high attrition rates.

“Moreover, there have been several instances of non-compliance associated with anti-money laundering and combating the financing of terrorism. These could not be resolved without significant investment into a new information technology system.”

Ithala was also the subject of a PA investigation into alleged mismanagement related to its initiative to modernise its core banking system.

According to the PA, the project, contracted to Tech Mahindra, was unsuccessful and marred by maladministration, resulting in R34.97 million in wasteful expenditure in 2020. The investigation found that Ithala did not act to recover the lost funds beyond reporting a criminal case to the police.

“The PA communicated all matters of non-compliance to Ithala through various correspondence and provided the entity with several opportunities to make representations. While Ithala has used such opportunities, the entity’s comments and representations remained largely unchanged,” the PA stated.