April 3, 2012
ROLE OF BANKS IN ECONOMIC GROWTH
The growth and evaluation of financial system of Bangladesh since liberation can be viewed in the three broad phases. The decade of 1970s can be called the period of reconstruction and rehabilitation.
The period from 1972 to 1982 was marked by expansion of bank branches, particularly, Nationalized Banks branches to cater the needs of the war torn economy. The period from 1983 to 1990 was the period of denationalization of banks and allowing new banks in the private sector to augment competition in the banking sector. The period from 1990 up till now can be termed as the period of financial liberalization and consolidation of the banking system.
Since 1972 the banks of Bangladesh used to operate under a regime of rigid government control and central bank regulations. The regulation covered fixation of interest rate on deposits and credits, direction, of credit to public sector enterprises and to priority sectors, directed expansion of banks branches. During the period, 1972-82 the bank services i.e. deposits mobilization; deployment of credit and branch expansion was significantly in favor of the rural areas compare to the urban areas. Nevertheless, there was no prudential and informational regulation on the banking sector. As a result, the banks persuade a policy of rapid credit expansion without analysis was replaced with socio-economic considerations. On the other hand, the lending rates on priority sectors were kept such a lower rate, which did not cover the risk and cost. Consequently, a huge proportion of assets profile became overdue and profitability of the banks declined. Since 1982, the government of Bangladesh for the first time decided to take restructuring measures in the form of denationalization and privatization of the banks. Nevertheless, they estimated that the operational efficiency and customer service was not improved because of absence of prudential and informational regulations
1. Responsibility for Bangladesh as a production center
The supply of loans to small and medium-sized companies, the backbone of economy of a country
neconomy, is inadequate. Expansion and consolidation loans are subject to unrealistically high-risk premiums when they are available at all. Small and medium-sized companies pay the price for completely exaggerated expectations in terms of yield in the boom-and-bust cycles of the international capital markets. Labor- and energy intensive companies both in the small-trade and the industrial sector are not capable of generating double-digit yields.
The severe losses in the real-estate sector in the 1980s have caused banks to develop a veritable risk aversion. Small and medium-sized companies suffer most from this. Even though by now some commendable efforts have been made, too few banks have done away with the centralized credit checking that was introduced as a result. Small and medium-sized companies can only be given the service they need locally, with a knowledge of local structures and the personality of the owner.
2. Responsibility for risk management
nThe highest cluster risks are no longer to be found within the sphere of small and medium-sized companies. With the globalization of the financial markets, more and more banks are becoming increasingly involved in ever more risky areas of business.
3. Responsibility as an employer
The banks are relatively progressive employers in terms of both salary and social fringe
benefits, one reason being that their added value is so great.
4. Responsibility for sustainable economic development and good governance
In today’s financial industry, there is a blurred line between healthy competition and rapacious greed combined with criminal energy. The latter is a great risk for financial institutions as well as the economy. Checks and risk management are one remedy, but even more important is a comprehensive reform of the entire economic system. What I mean is a reorientation focusing on sustainability. In this context, the banks must play a key role as financial intermediaries.
5. Responsibility in the globalized financial markets
Any further liberalization of the financial markets without international regulations and with a lack of supervisory authorities would increase the economy’s susceptibility to crises such as those ofAsia, Russia and Argentina.
Modern Day Role
The financial system of Bangladesh consists of Bangladesh Bank (BB) as the central bank, 4 State Owned Commercial Banks (SCB), 5 government owned specialized banks, 30 domestic private banks, 9 foreign banks and 29 non-bank financial institutions. Moreover, MRA has given license to 298 Micro-credit Organizations. The financial system also embraces insurance companies, stock exchanges and co-operative banks.
Banking system and the Financial Institutions play very significant role in the economy. First and foremost is in the form of catering to the need of credit for all the sections of society. The modern economies in the world have developed primarily by making best use of the credit availability in their systems. An efficient banking system must cater to the needs of high end investors by making available high amounts of capital for big projects in the industrial, infrastructure and service sectors. At the same time, the medium and small ventures must also have credit available to them for new investment and expansion of the existing units. Rural sector in a country like India can grow only if cheaper credit is available to the farmers for their short and medium term needs.
While the commercial banks cater to the banking needs of the people in the cities and towns, there is another category of banks that looks after the credit and banking needs of the people living in the rural areas, particularly the farmers. Regional Rural Banks (RRBs) have been sponsored by many commercial banks in several States. These banks, along with the cooperative banks, take care of the farmer-specific needs of credit and other banking facilities.
Lending and deposit business
A bank’s role as an “intermediary” is clearest in the credit and deposit business. Clients “bring” to the bank their savings, i.e. the money they have chosen not to spend. The bank transfers this money to its credit clients in the form of loans. What is on the face of it extremely simple is nevertheless fraught with a great many risks. A bank’s loans lack liquidity, either partially or totally. This means that the bank cannot sell them in return for demand deposits or central bank funds whenever it likes. On top of this, a borrower’s credit rating may change during the life of a loan, thereby changing the value of the loan at that point in time, which reflects the interest and amortization payments expected in the future. Due to the lack of a secondary market, credits are mostly carried in balance sheets at their nominal value, with provisions and write-offs only being formed or effected if there are any indications that the borrower may have trouble meeting payments or is actually in arrears. In some cases, credits may even become entirely worthless if borrowers become insolvent and bankrupt.
The universal banks active in the issuing sector face a whole range of potential conflicts of interest, given that issues often involve various parties from within and outside the bank and that these parties are not motivated by the same interests: the issuance unit is interested in the offering, securities trading is looking for high revenues, asset management clients expect the bank to safeguard their interests irrespective of its role in the issuing transaction, the lending unit may have information on the issuer that is otherwise not in the public domain, etc. Defusing and controlling potential conflicts such as these places enormous demands on a bank’s organizational structure, processes and compliance activities. Only when a bank succeeds in controlling the potential conflicts and managing them on a transparent basis can the different stakeholders involved be sure that their legitimate interests are equitably upheld.
Asset management covers a range of banking activities: portfolio management, investment advisory, securities trading and lending business (collateral loans, securities lending and borrowing). With a discretionary portfolio management agreement, clients authorize a bank to undertake, for their account and at their risk, all the actions it deems appropriate within the framework of the normal asset management activities of a bank. Clients expect their assets to be managed professionally and in their best interests. The bank contracts to exercise its undertaking to the best of its knowledge and abilities, taking into account clients’ circumstances but acting as it sees fit within the scope outlined as part of the investment goals defined with the client.
Foreign exchange trading
The last business I mentioned was foreign exchange trading, an activity which has been unjustly attacked as “casino capitalism”. Various factors have given rise to this perception. First, without a doubt the massive amounts traded in the foreign exchange markets every day. According to figures from the Swiss National Bank, for example, in April 2001 foreign exchange trades in Bangladesh alone amounted to CHF 121 billion each working day. (For the purposes of comparison, the global figure was USD 1,210 billion.) The vast majority of this trading takes place between financial intermediaries, the aim being to exploit even the slightest differences between exchange rates (arbitrage). Only a very small proportion of this trade issued to finance foreign trade and hedge foreign currency positions. Furthermore, the fact that serious economic crises such as the one Argentina is experiencing at present are almost always currency crises may fuel suspicions that it is currency traders with their speculative attacks that trigger such developments.
nIn fact, the very opposite is true. Many people may fail to see the point of the vast amounts of arbitrage transactions, since they are not primarily used for financing purposes. In reality, however, they underpin liquidity in the markets, thus helping them to function smoothly. In less liquid markets, new information would inevitably lead to much greater volatility in rates. A distinction has to be made in the case of protracted currency over- or undervaluation’s (in terms of interest rates and purchasing power parity), which are a genuine problem, as they could result in the misallocation of resources.
The scope available to banks
Nevertheless, the economic benefits generated by a bank are basically no different from the economic benefits generated by a doctor, teacher or train driver: by exercising, to the best of their knowledge and abilities, their specialist function in competition with others, companies and their employees make their contribution to economic benefit. And their motivation need not be a selfless one. Pilots do not fly planes to generate economic benefit, just as bankers do not grant credits for any such selfless reasons. Economic utility is created as a “by-product” anywhere women and men function successfully, and this does not apply solely to their jobs.
Even though a banker grants loans to many companies and sectors of the economy, this does not mean he can do their work or bear their responsibilities.
The argument of economic goals and responsibility is generally seized on by politicians when it is a matter of re-distributing capital, risks, profits or costs.
Although not strictly wrong, the economic responsibility argument has the major political advantage that it can be flexibly deployed for absolutely anything. You will look long and hard – and probably in vain – for any “handy” definition of a bank’s economic responsibility that is at the same time general enough. Which is why my suggestion is the following: bankers act responsibly when they ensure that their house is in order and resist the temptation to pass off poor financial performance as a contribution to the economy.