It has been underscored in countless empirical studies and enquiry reports on the state of affairs in financial services that adequate and appropriate approach needs to be taken to rebuild the current low level of confidence in banks. The role of regulatory reform might be the first option for comprehensive review.
Of course, significant changes have already been made in the regulatory and supervisory framework. Reforms of capital and liquidity regulation, risk management, governance, anti-money laundering initiatives and resolution regimes have been introduced. Moreover, customer service as well as its protection has been enhanced. Though regulatory framework now seems to be on a better and broader base, it is still vulnerable. In the recent past, the Bangladesh Bank published a set of guidelines on supervisory interaction with banks on risk culture. The Banks and Financial Institutions Division of the Ministry of Finance has initiated more intensive monitoring mechanism to subject banking as well as non-banking financial institution sector to transparency, accountability and ensure better customer service orientation. The guidelines are aimed at assisting supervisors in their assessment of risk culture by listing a number of indicators or practices that can be indicative of an overall sound and well-balanced approach. These include key factors such as accountability, effective internal communication, existence of challenge mechanisms within the decision-making process and incentives for employees.
Supervisors themselves have also changed. They are now stricter, more proactive and assess banks in a much more holistic way. Topics such as governance, remuneration and risk appetite are among the key priorities on every supervisor's agenda. Findings indicate that a number of banks, while meeting national requirements, do not comply with best international practices with regard to governance. There is a concentration of power in individual board members (e.g. holding multiple offices or chairmanships within the same group), lack of separation between a bank's risk and audit functions, information asymmetries among board members, and there are instances where the board simply does not take enough time to discuss and reflect on individual issues. It is also apparent that some banks are still at the early stages of implementing their risk appetite framework and therefore still have a lot of work to do to ensure its consistent application throughout the entire organisation.
Rebuilding trust in the banking sector requires active engagement of bankers and their stakeholders. While regulatory reform and supervisory actions are certainly necessary to lay the foundation on which banks and financial institutions can restore trust, regulators and supervisors are not the key players in this process. The main effort to regain trust must come from bankers, in particular from banks' management and their boards. Without their active effort, the people will not start trusting them again. The necessary process will be laborious and time-consuming and it will not be one measure or action that does the job, but rather a complex mixture of governance, risk appetite, risk culture and behaviour from the top.
First, management of the financial sector should develop viable business models with a clear long-term perspective. Many of the recent crises have been the consequence of banks targeting high, but risky and short-term gains rather than pursuing lower, but more stable, long-term returns. Banks should refocus on their core functions of:
n Extending valuable investment opportunities to savers, while shielding them from liquidity risk, and
n Providing funds to those who need them, while assessing and monitoring their creditworthiness.
Financial intermediation is not simply a way to garner revenues; it also supports economic growth and thus, ultimately, provides an important service to the society. Significant changes in the economic environment in recent decades have diverted banks from these core functions. It seems that an increased range of investment opportunities and funding sources, a trend towards more liberal regulation and an increasingly competitive environment have led banks to reshuffle their priorities towards maximising short-term corporate and often also personal gains. The change in banks' business models can be seen as a prime example of losing sight of the goal of maximising long-term value.
Second, a bank's management and board must have a sense of responsibility for developing the bank's individual risk culture, thus enabling it to deal with risk in a way that supports this long-term business perspective and fosters transparency and accountability. Every bank needs a strong cultural base, which should embody its essence and aspirations and embrace its role as a profit-oriented organisation without neglecting its relevance for the well-being of the national economy and for the finances of both individuals and corporations.
The strong cultural base should serve as a shared value framework throughout the organisation. On top of these foundations, every bank needs clear risk-taking policies, allowing it to reach its business objectives, while ensuring that risk-taking activities beyond the institution's risk appetite can be identified and addressed in a timely manner. To complement this, there must be clear governance arrangements defining processes and responsibilities for decision-making, risk management, control and audit.
Lastly, a bank requires well-functioning communication mechanisms and IT systems to link the bank's decision-making, risk management and control organs together to convey information to where it is needed, and to help create awareness and transparency about the bank's objectives, policies and values throughout the organisation.
As stressed before, trust is essential for smooth functioning of the banking sector. Without trust, banks cannot function properly. A lack of trust negatively impacts on the relationship between regulators and banks. The interaction tends to become more adversarial. Regulators become less willing to listen to bankers and to take their views on how to do business into account. A lack of trust in some banks and bankers usually translates into a negative sentiment towards the entire industry. This, in turn, has negative implications for business. Customers may leave and it will be more difficult to recruit talents. But this negative sentiment not only has repercussions for banks' business prospects, it also affects the social standing of bankers, whose image is often tarnished in the society.
The writer, a former Secretary to the government and Chairman, NBR, is Chairman of the Chittagong Stock Exchange Limited.
mazid.muhammad@gmail.com