South Africa was too some degree insulated from the international financial crisis in late 2007. Many economists believe that the international crisis was largely a consequence of liquidity and credit problems experienced by many businesses. This paper highlights the importance of credit as well as the types of credit offered at different stages in the economy. The theories reviewed included the Hyman Minsky’s theory and the 2/28 adjustable rate subprime mortgages theory. The analysis confirmed risks associated with credit within the economy.

In the South African context, it is quite evident that the following contributed effectively to lessen the negative impacts of this financial crisis:

Prevention of access credit: The National Credit Act, FICA, Company’s Act of 2008 will discussed with relation to its role in the economy.

Monitoring measures: Basel I and II: South Africa implements these policies and procedures for all financial institutions to achieve best practice.

Sound governance mechanisms: The importance of King Reporting and Code of Ethics for various associations will demonstrate the importance of transparent reporting and procedures that should be followed for best business practice.

It is concluded that sound monitory policies including monitoring and corporate governance improves sustainable financial management.

1. Introduction

The global financial crisis was triggered in 2007 by the liquidity crisis in the United States of America (USA) banking system primarily as a consequence caused by the overvaluation of x assets (Demyank and Hasan, 2009). It is considered by many economists to be the worst financial crisis since the Great Depression (Ryan, 2008). Economies worldwide have since slowed as credit tightened and international trade declined.

The South African economy was not impacted to as large an extent as the USA. This report illustrates how the regulatory framework in South Africa buffered the impacts to the South African economy. South Africa as part of the post-apartheid era and its social and economic transformation towards democracy adopted, inter alia, various regulatory mechanisms to manage credit lending’s in the country. The banking system adopted is thus well regulated without compromising the country’s competiveness. The report will provide some details illustrating the impact of the banking system during the global financial crisis.

Studies have shown that the different forms of borrowing and lending (also known as Credit) have become one of the biggest and most important roles in consumer spending (Cynamon and Fazzari, 2008). Consumer spending, in turn is one of the largest drivers of the economy. Hence, it can be said that credit plays one of the most significant roles in recent times within the economy.

Furthermore, it has been established by many economists that when an economy is stable, investors tend to extrapolate the current stability out into the future. This caused increased risk taking and was one of the major catalyst for the global economic recession which began during the late 2007(Demyank and Hasan, 2009). South Africa, during the global period in fact proved to be an important stable emerging market resulting in additional benefits in terms of investments.

The paper will address the following questions:

• How important is credit in the economy?
• What type of credit is offered in the different stages of the economy?
• What monitoring and legal requirements does South Africa have in place?
• What are the various prevention measures that South Africa have in place?

The method adopted includes:

• A literature review of the cause and effects of the economic crisis in the United States of America (USA)
• A literature review of the South African banking regulatory framework in South Africa
• Identifying the factors in South Africa that offered the protection
• Conclusions to address the research question

The conclusion will identify whether the monitoring and prevention measures that are in place are effective and helped South Africa buffer the global economic crisis.

The remainder of the paper is sequenced as: Section 2 discusses the importance of credit in the economy, Section 3 investigates economic theory and credit, Sections 4 and 5 investigate monitoring and prevention measures implemented in South Africa. Finally, Section 6 discusses the findings and concludes the paper.

2: Importance of credit in the economy

Consumer spending and financial preferences has evolved with the transformation of social and economic norms. According to Barry Cynamon and Steven Fazzari (2008), consumers base their consumption norms on what others should or should not purchase. Their research shows that in current times, households use financial markets to heavily finance their expenditure. As most households make use of credit, actual consumption growth will exceed income growth.

Research done by Guiso, Sapienza and Zingales (2003; 2006) shows that religion is correlated with the attitude towards savings. Their findings indicated that variables reflecting culture are highly sensitive to cross country saving and expenditure ratios.

The high spending patterns of households that have developed in society has caused many consumers to over-debt themselves. The recent research conducted by Yuliya Demyank and Iftekhar Hasan (2009) shows that financial institutions in the USA were offering consumers mortgage loans for houses at levels far higher than the actual sale value. The main reason for this was that securitisation increased lending between 2001and 2006, which in turn lead to lower incentives for banks to screen the potential borrowers. The consequence of not screening borrowers before approving loans was high default rates.

The recent credit crisis in the United States of America USA was largely due consumers being over-indebted. Factors such as securitizsation (Mian and Sufi, 2008) and weakened monetary policy (Taylor, 2008) resulted in high consumer debt.

Some of the fixed income products offered to consumers include (CFA Institute-VOL 5, 2010):

• Asset backed securities (ABS)
• Mortgage backed securities (MBS) and
• Collateraliszed debt obligations (CDO’s)

Asset backed securities is a security created from a specific pool of collateraliszed assets. The pool of assets is a group of small illiquid assets that are unable to be sold separately (an example include credit sales). The mechanism of how this type of security is created is:

Initially, the seller of the goods issues the loan to the customer for the purchase of the goods. The loan is sold to a special purpose entity (SPE) created by the seller. The SPE will in turn repackage the loans into various tranches and issue these as notes into the market. In other words, the notes purchased by the investors are funding the loans issued by the seller through a conduit. The collateral which is given over the notes is the loan.

A mortgage backed security is a security created from a pool of one or more mortgage loans. The institution repackages the pool of securities and issues bond notes into the market and the collateral given over the bond is the pool of mortgages. The interest and principal received by the bond holder come directly from the repayment of the mortgage loan. The institution again, is merely a conduit through which the notes are issued to lenders and loans given to borrowers. The institute issues the loans at a high rate and the notes at a lower rate, thereby profiting through a spread.