Handle banks with care

Banks are not fragile like glass but they need to be handled with care. In the first place, this is the responsibility of the bank management and the board of directors. The central bank that oversees their activities and guides them with a regulatory framework has no less important a role. The healthy state of the banking system depends on a symbiotic relationship that is mutually advantageous. But just as banks are not totally free to decide on this, the central bank lacking complete independence cannot determine this mutual relation wholly on its own. The limitation on bank's freedom is for the sake of monetary discipline. Theoretically, this should also be the sole objective of the central bank. But the exigency of the political economy in a democracy sometimes leads the government to use the central bank to further its political goal, thereby curbing the central bank's authority. This is acceptable as long as the political considerations do not completely or even overwhelmingly outweigh the merit of decisions based on economic criteria. The establishment of commercial banks and their guidanceregulation is a case study of political economy at work that may not be of academic interest to us at this point of time. After Bangladesh became independent there were five commercial banks, four of which were nationalised soon after independence. In the mid-eighties permissions were given to start five more commercial banks in the private sector following the policy of privatisation and opening up of the free market, largely at the instance of donors and multilateral financial institutions. The imperative of the new economic policy of liberalisation rather than economic considerations was behind this decision. From 1992 until 2000, a total of 19 commercial banks were given permission both under Awami League (AL) and Bangladesh Nationalist Party (BNP) governments. The background of the sponsors show their direct or indirect links with the political party in power. From newspaper reports it appears that ten more commercial banks are waiting for permission and almost all the sponsors of these banks have political background. There is nothing wrong in having politicians or politically-linked persons as sponsors of banks. The question is whether the banks that were given permission since the early nineties and those awaiting permission now are justified on the basis of economic criteria. The only criterion that has so far been fixed for the sponsors of new banks is their ability to mobilise a certain amount of taka as paid-up capital. In the beginning, this amount was Tk 100 million (10 crore) which was raised to Tk 200 million (20 crore) and finally to Tk 2.0 billion (200 crore). According to unconfirmed information, the requirement fixed for paid-up capital for the new banks has been fixed at Tk 4.0 billion (400 crore). The ability to mobilise paid-up capital cannot be the sole or even main criterion for starting a new commercial bank. A bank does not operate with the help of paid-up capital alone. It needs additional resources as loan-able fund for which it attracts deposits. Deposits may come from domestic savers, wage-earners who make remittances through banks and counterpart taka of foreign aid and loan channeled through the banks. Of these, deposits made from domestic savings constitute the lion's share of the total. As the income of people rise their capacity to save also increases. It is elementary to point out that income can increase when there is growth in the economy. The faster and higher the rate of economic growth is, the greater is the capacity for saving, provided inflation is kept at a moderate level. These macro-economic indicators are interlinked and have a relationship among them that can be both positive and negative, depending on the directions they are moving. A decision to allow a commercial bank to operate cannot simply be based on the mobilisation of a required amount of paid-up capital. Growth of the economy leading to increase in income and savings made by income earners are important indicators that give an important objective basis for opening of new banks. A brief look at these figures will show whether their trend justified in past and will justify at present the opening of new commercial banks. According to the Bangladesh Bureau of Statistics (BBS), annual growth rates of the economy (gross domestic product or GDP) at market prices were on average 3.0 per cent during the seventies, 4.0 per cent during the eighties and 5.0 per cent during the nineties. From 2004 to 2010 it has ranged between 6.0 to 6.5 per cent. From the same source it is seen that gross domestic savings as percentage of GDP remained almost constant at around 20 per cent. If it is accepted that domestic savings is the main criterion for setting up commercial banks, as is being argued here, then on the basis of growth of gross domestic savings there is no reason now for allowing new commercial banks, at least not the number that has been in the news. However, some allowances should be made to the other sources of deposits of commercial banks to consider the justification for new banks. As mentioned earlier, there are two of these -- the remittances made by wage-earners and net foreign assets. Here it is seen that though remittance from abroad trebled from 2004-2005 to 2009-2010, the amount has not been more than domestic savings. On the other hand, funds from foreign aid and loan have been declining as the country moves towards self-reliance. So, loan-able funds available for commercial banks are not increasing at such a rate as to justify the opening of new banks, at least not by the number that has been mentioned in newspapers. Already the country has 43 commercial banks (including foreign banks) and the question that should be asked is whether the growth of the economy, domestic savings and trends in remittance, foreign aid and loan provide adequate economic justification for opening of new banks at this stage. In giving permission to new banks their number has to be determined on the basis of objective economic criteria. When economic and political considerations converge, decision can be taken regarding the number of new banks. The calculation of such convergence may be complex and never completely satisfactory but no analytical efforts should be spared to arrive at even an approximation of the ideal. So far, decisions about opening of new banks have been mostly taken arbitrarily without examining the economic criteria. This sort of trial and error procedure cannot be continued as it is fraught with risks. The over-riding consideration should be whether the economy can sustain additional banks and whether it is necessary to have so many banks in the country to help the economy to grow. Unless decisions are taken satisfying economic criteria some of the new banks may be seen struggling ab initio. On the other hand, competition for limited resources may put the whole banking system under strain which will not augur well for the economy. Commercial banks are given advice and sometimes instructions to invest in selected sectors by the government through the Bangladesh Bank. In doing this, the principle of prudent banking should not be lost sight of. Of course, commercial banks should invest in sectors like the stock market but whether the cap on this is fixed at 10 per cent by the government should be held in abeyance for as long a period as two years should be re-examined carefully keeping the possible risk of over exposure. Similarly, whether recent policy decisions like excluding bank loans to their subsidiaries from being treated as stock exposure and exempting long-term equity investment of commercial banks from the exposure limit will nullify the cap on 10 per cent also need to be further examined. Both the profitability of banks and the safety of their liabilities should continue to be given preference. In America, the Glass-Steagall Act separated the commercial banks from the merchant banks to prevent their over-investment in stocks and shares. According to many financial experts, when the Fed's former chairman Allen Greenspan did away with the firewall provided by the Act, most of the commercial banks went on an investment binge, as a result of which most of their loan has become toxic. This happened recently and its lesson has been lost on financial regulatory authorities all over the world. Banks are effective institutions for implementing macro-economic policies. However, for all policy decisions in this regard there are consequences. All of them may not be conducive to the long-term growth of the economy. Policymakers cannot afford to ignore this fact. Email: hasnat.hye5@gmail.com