It is fair to say that government-owned banks — the state institutions that are legally permitted to accept deposits — are not meeting even basic standards of prudence.

Ithala, the KwaZulu-Natal development finance institution that was permitted to operate as a bank, is in a messy liquidation process. The Postbank has been getting disclaimed audit opinions and has two major fraud investigations under way into thefts and tender irregularities. The third is Land Bank, which is now the only one trending in the right direction, after getting back on its feet after it defaulted to bond holders four years ago.

Ithala has been capturing headlines because the Prudential Authority (PA) has been pursuing its liquidation. That has been strongly resisted by the KwaZulu-Natal government, which is Ithala’s ultimate shareholder. Ithala has always operated under exemption from the Banks Act, which allowed it to take deposits without being fully regulated in line with other commercial banks.

The heart of the Ithala matter is R2.5bn in deposits (though this number might be higher as it continued accepting deposits after being told not to). There have long been concerns that Ithala has not been managed prudently, with default rates on loan books at alarming levels and the bank operating for years without top officers in place such as a CFO. Rumours have long circulated of loans to politically connected individuals that were not performing, conjuring nightmares of another VBS Mutual Bank-style fraud. Because Ithala is not a bank, its depositors are not covered by deposit insurance.

In late 2023, the PA notified Ithala that its exemption from the Banks Act had lapsed and it could no longer take deposits and therefore must pay them back. That happened after it had been given notice to apply for a normal banking licence, rather than rely on the exemption. It failed to do that.

The PA has been trying to get Ithala to pay back the deposits it holds ever since. It appears from all accounts that Ithala simply doesn’t have the money to pay. It is insolvent by between R500m and R1.6bn, according to differing accounts (the larger number being the PA’s view). When a bank is insolvent, it is generally liquidated, with the objective to maximise the amount of money that can be paid to settle depositors.

There is a thorny and politically explosive question over what to do if depositors cannot be settled. The PA is aiming to have Ithala liquidated in full to maximise the recoverability of assets. It had a setback last week, when the high court in Pietermaritzburg ordered that Ithala may resume operations in all respects except deposit taking.

The PA is appealing against that decision. It is, however, a sideshow. The chances of being able to cover deposits is materially prejudiced if Ithala as a whole cannot be liquidated. But for depositors that might not matter — because R2bn of deposits have been guaranteed. Though there is a dispute about who is responsible for that guarantee.

The finance minister wants the KwaZulu-Natal government to make good on the guarantee. In the last extension of Ithala’s exemption from the Banks Act in 2022, the PA required an unconditional guarantee from the government of 75c in every 100c of depositor funds. The province challenged those requirements in court at the time but failed to get them overturned.

So, debatably, the KwaZulu-Natal government must cover up to three quarters of the deposit book, though how it might do this within existing legislation is rather unclear. It is not inconceivable that the National Treasury might end up on the hook for the money, if depositors are going to receive theirs.

The PA has appointed Johan Kruger as an administrator to take over the running of Ithala to realise the deposits. He is a partner at law firm Bowmans who specialises in corporate investigations and banking. He has his work cut out for him.

Underneath the sorry saga, however, is the long-running effort to tidy up the mess of state-owned banking activities. The Postbank is the next major concern.

While much effort has been made to ring-fence depositor funds there and ensure appropriate management, it has consistently failed to obtain a proper commercial banking licence. While it has spent years on applications, it has not been able to satisfy the concerns of the PA that it has the appropriate risk management systems in place to safely operate a bank.

You can see why — there have been several major losses to the bank as a result of employees conspiring with other criminals to steal cash. The Postbank limps on without any clear resolution in sight, but at some point its failure to secure a banking licence must put an end to it.

These problems of course bear on the often-raised idea of establishing a new state bank, that regularly crops up as a political solution to anyone who feels aggrieved that they are unable to get funding through existing commercial banks. There has been much special pleading over Ithala in the court proceedings, about its role in extending banking services to those who cannot get them elsewhere.

I am sceptical that is indeed the case. There has been frequent political noise that Ithala’s liquidation is an attack on a “black bank” to try stoking support from those concerned to diversify the banking industry, even though Ithala is owned by the province.

In all the political noise there must be two non-negotiables. Banks must be solvent, and they must be regulated appropriately, which means being registered under the Banks Act, with the capital and other requirements that comes with it.

Ithala by all accounts is insolvent — the only dispute is by how much. Those calling for it to be “revitalised” must answer the question “by whom?” Any insolvent bank can be rescued if someone contributes the capital to do it. Those calling for its rescue should put their money where their mouths are, recapitalise the bank and apply for a banking licence.

They won’t, however, because the intention has never been to run a bank prudently. Instead, it has all the signs of a business run for the sake of insiders, especially those who have been beneficiaries of its loans. The PA and the minister of finance are entirely right to want to put an end to it.

• Stuart Theobald is chair of research-led consultancy Krutham.This article first appeared in Business Day.