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OP-ED: Can we salvage our banking?

  • Published at 05:30 pm November 8th, 2020
money
Technology will play a major part BIGSTOCK

An effective banking sector would surely help accelerate recovery from the Covid-19 fallout

I am sure that to all my readers, it’s not just a million-dollar question but, in every possibility, a billion-dollar question. If we trust our media reports or even civil society discussions, the picture portrayed regarding our banking sector is quite dismal and there are a thousand reasons why people are quite pessimistic about the future of our banking sector. 

On the other hand if we look at the banking sector reforms carried out in neighbouring India, China, Indonesia, or a few European countries, we have reasons to believe that with the right kind of structuring and more so with seriousness from the political seniors and development partners, the situation could be enhanced to an acceptable manner.

This issue becomes even more pertinent if we put it into the context of our battle against the economic shock from the Covid-19 pandemic. Majority of the experts agree that efficient financial resource allocation coupled with an effective banking sector would help accelerate recovery from the Covid-19 fallout and restore the country’s robust growth momentum. 

The IMF has taken this a bit further and singled out the need for a sound financial system as a prerequisite to speeding up the post-pandemic economic rebound. Against this backdrop, let us first consider some issues from the side of the bankers and regulators which need to be remedied in order to chart a path towards a strong and efficient banking or financial system. 

Improved risk management practices

The banking business by its own inherent nature is a risky business. The main focus of the risk management practices in the banking industry is to manage an institution’s exposure to losses or risk and to protect the value of its assets. 

The following questions may arise in the minds of all capable top-level bankers: What kinds of events/factors/issues can damage my business and how much damage can they cause (ie design and development of the risk management framework)? What actions can I take to mitigate and minimize such risks (ie actionable and executable policies and methods in place to defend against risks)? Did I make the right decisions to minimize such risks (ie continuous monitoring and improvement)? 

As long as banks have the wisdom and foresight to carefully design their risk management framework around these very broad questions and their more detailed but directly connected issues, they should generally be able to manage the risks within an acceptable level of certainty and uncertainty.  

In a Bangladesh context the answers to these questions will vary a lot compared to banks operating in a developed economy where firm regulatory and legal support exists to help and protect bankers. In Bangladesh, the struggle for bankers and therefore also a matter of grave concern for risk management, also pertains to surviving and sustaining from external nuisances such as: 

  • Undue and ruthless political pressure to forgive (or reschedule/restructure) bad and willful defaulters
  • Greedy and selfish motivations of the “not so independent” board of directors 
  • Weak regulations which provide very little protections 
  • Loss of employment (getting fired) if they do not comply with the wishes of influential people with highly questionable ambitions 
  • Lack of fully available and established financial instruments or choices to hedge against risks (ie derivative instruments, bonds, mutual funds, etc)

Therefore, in a developing environment like Bangladesh, the usual rules of risk management become much more complicated for a banker as compared to the general risks which bankers may face in a mature economy. 

Corporate governance and role of independent directors

Next, we will discuss the board of directors within the banks which ultimately dominate and control the executive branch of all the banks. Often in Bangladesh this is the root of many problems because major conflicts of interest exist here; it should be an “independent board of directors” but that’s seldom the case. 

The board of directors in the banking sector are often motivated by their own personal goals of wealth accumulation rather than placing the health of the institution above all else. Some members of the board may seem “independent” from afar but upon more scrutiny, their conflicts of interests start to become more visible. 

It is often seen that these directors have direct or indirect relationships with willful defaulters and routinely use their influence over the executive branch of the banks to operate in highly risky and unhealthy ways. Therefore, fit and proper test criteria for board members should be strictly enforced and updated, including the requirement of identifying the beneficial owners of a significant or controlling interest of a financial institution. 

Besides, the boards of commercial banks should include a majority of independent directors like in most of the developed and developing world. Legal systems should be enhanced to support banks to recover non-performing loans (NPLs), particularly those by willful defaulters.

Role of automation and alternative banking

It can be safe to say that almost all the problems in Bangladesh’s banking sector are mostly due to errors in judgment of people, undue influence from people, conflict of interest of people, and lack of proper regulatory protections (also implemented and executed by people). 

It appears that whenever people are involved within the banking framework and processes, there are systemic failures and bad decisions being made. So, what if we tried to remove the human factor out of the process as much as possible? What if we automated the entire banking system to the highest degree possible, whereby we shift the burden of major decisions to computers and sophisticated algorithms? 

This is already the case in most developed nations where human judgment and influence has been all but completely removed. Bangladesh would also greatly benefit if the same level of technology and MIS were to be implemented and utilized. If a machine makes the evaluation and the judgment call, then there can be no further argument or influence. 

An effective and sophisticated MIS should be able to collect vast amounts of intelligent and useful data based on past behaviours and actions of millions of transactions and consequences and then be able to analyze and make decisions regarding what actions need to be taken on a case by case basis. This kind of support will provide bankers the necessary tools and capability to mitigate the risks of loans going bad, well in advance. 

Enhancement and increased digital and alternative banking options will also highly benefit the customers by largely reducing the need for physically having to go to the bank for various transactions. Again, the goal would be to limit human to human interactions to the lowest degree possible. Examples are: 

  • Checks may be deposited via smartphone apps and pictures instead of physical deposits 
  • Loan decisions can be adjudicated within seconds by complex algorithms based on an individual’s credit score and other financial and legal indicators 
  • Wider and easier availability of customized credit cards could be implemented 
  • Greater migration towards a cashless society could be achieved 
  • Instant blocks on accounts and credit lines could be executed in the event of any kind of illegal or criminal activity detected by the bank’s artificial intelligence. Such illegal or unacceptable activities would be immediately and automatically reported to law enforcement without any kind of impediment or delay from the human factor

Leveraging fintech for asset-liability management

Increased use of MIS, AI, and customized banking technology may even improve a bank’s asset versus liability management ratios and make the process much more efficient. Again, removing the possibility of human error and biased judgment becomes of key importance. The primary objective of asset/liability management computation and exercise is to find the correct balance of risk versus return ratio and trade-off. 

This is much more difficult than it may appear because it involves highly complicated tactical and planned actions to manage many different variables, ratios, mixes, volumes, short-term v long-term considerations, rates, etc in a highly balanced manner such that the desired level of profit is realized without too much risk, which could put the entire institution in jeopardy.

Therefore, increased usage of MIS to carry out such computations would be a much more prudent approach than leaving it subject to human judgment. 

Human resource development and upskilling

Due to increased automation and computerization, the services to be provided to the customers will become faster. However, it will never be possible to completely remove the human factor out of the banking system, especially in the case of large transactions and specifically when particular customers demand it. 

Therefore, it is critical that a bank’s workforce is adequately trained, and their expertise is upgraded to match the level of technology in place such that an optimization between the use of technology and the human factor may be achieved. 

Transparency of policies and regulatory enforcement

The banking sector policies and regulations by the central bank need to be fully transparent so that there is no ambiguity or lack of understanding among the banks/FIs, thereby, facilitating appropriate implementation. Easy and fast access to all relevant regulatory and policy documents needs to be ensured and utilization of fin-tech can certainly help in this regard. 

Another important issue that needs to be addressed is the sub-optimal enforcement of certain existing regulations. Hence, the financial health of the countries’ banking sector is suffering due to regulatory forbearance by banks. A regulatory forbearance initiated by a central bank is a policy that permits banks and other financial institutions to run their operations by way of relaxing the standard banking norms. 

Under a regulatory forbearance, Bangladesh Bank allowed local lenders to reschedule defaulted loans to the tune of Tk 52,770 crore last year, the highest in a single year. This inaction reflects the unwillingness or inability of the regulator to enforce their own regulations and has resulted in continuous piling up of non-performing loans (NPLs) well beyond acceptable levels. 

Such forbearance needs to be avoided and banks, where it is practiced, should face strict and prompt remedial actions. Especially in case of NPLs, banks where it is practiced should face strict and prompt remedial actions rather than relaxing the standards. Also, the legal systems should be enhanced to support banks to recover NPLs, particularly those by willful defaulters.

Reassessing the role of state-owned commercial banks

A 2019 research on 19 commercial banks in Bangladesh shows that the state-owned commercial banks (SOCB) have been consistently outperformed by the private ones in terms of efficiency. The role of SOCBs , therefore, should be reassessed, transforming some into developmental institutions with a clear public mandate and necessary budget support. Other SOCBs should be converted into banks operating on commercial principles or closed. 

On top of that, the reputation of the SOCBs have taken some damage due to some past issues like the Hallmark or Bismillah scandals. Hence, the central bank needs to strengthen its regulation and supervision of the SOCBs. However, the central bank’s ability to do so depends crucially upon its own independence and autonomy as discussed later. 

Independence and autonomy of Bangladesh Bank

None of the above discussed matters can be implemented and executed without the full support and direction from the primary banking regulator of the country, which is Bangladesh Bank. It is the regulator which has to have the country’s strategic vision in mind and then bring together all the pieces such as asset/liability management policies, interest rates, the level of automation permissible, the amount of protections given to bankers to fight undue influence, punishment against willful defaulters, and rules governing the board of directors. 

In this regard, the full sovereignty and independence of the central bank is critical, including choosing the right persons for the central bank board if the above-mentioned issues are to be mitigated and tackled and the worries of bankers are to be eased. If the primary regulator is not perceived to be above all undue influence and pressure, then the system it governs will never be either. 

Right wisdom and independence of Bangladesh Bank will give it the power and “teeth” it needs to fight the undue political and “Godfather” type influential pressures placed on the bankers. The central bank must become a source of direct and reliable protection and guidance from such unfair influences and powers.

Mamun Rashid is a partner at PwC Bangladesh. Views expressed in this article are his own.

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