Banking policy and oversight – Analysis by Lucian Croitoru
Oversight and prudence are crucial for the proper operation of the banking system or capital markets. If financial intermediaries, banks or capital market players are not functioning properly, available capital can end up in relatively inefficient investments.
Prudential norms are designed to prevent such routes, and oversight must ensure that these norms are observed.
An effective prudence and oversight system identifies in time the financial institutions headed for failure, and forces them to take corrective action or shut down, thus protecting deponents’ investments or savings.
Oversight and prudence are relevant even in cases of financial crises at the level of the financial system.
Exchange rate crises have emerged even when the classical foundations – budget deficit, domestic credit, current account and inflation – were relatively healthy (for instance, the exchange rate crisis in the European Union in 1992-93, or in Mexico in 1994-95), therefore the list of fundamentals was extended (neo-fundamentals) to include financial oversight and prudence as well.
Although they cannot be used to predict the moment of a financial crisis, the fundamentals, analysed together, can indicate whether a financial crisis is likely.
As a conclusion, these days, when capital is very mobile, without adequate prudence and oversight, the banking system or capital markets can undergo serious earthquakes.
What can be said about prudence and oversight in Romania? First of all, these systems have developed to different degrees on the capital market and on the banking market.
The system is very frail and it needs serious improvements on the capital markets. The FNI bankruptcy has confirmed this. In the banking system, the set of prudential and oversight rules have been very precarious in previous years, but they have undergone substantial improvements lately, both with the creation of an early warning system and with the extension of oversight at bank level.
Second, leaving aside the degree of refinement of the set of prudential and oversight rules, its effectiveness in the banking system has been seriously diminished, not to say annulled, by the fact that some loans have been granted under political pressure or political criteria.
By definition, oversight and prudence make sense as long as decisions within banks are made on economic criteria. But some state banks (a few years ago state banks accounted for almost 80% of credits granted in the banking system) were forced to use other criteria than economic ones when extending loans.
It is the case of loans extended to political clientele, loans to some sectors (such as oil or agriculture) or loans to socially significant large companies or autonomous regies.
Today, the failure of some banks is vehemently interpreted, especially by politicians, as a result of the defective oversight effected over time by the NBR.
This is convenient because the blame is cast whence it mostly comes from, the political area, onto an institution and an oversight system.
But this is forgetting that NBR’s independence was clearly stated by law only in 1998, so the Central Bank lacked the effective capacity to oppose the use of state banks on political criteria.
Bank oversight – a necessary evil – Analysis by Lucian-Liviu Albu
A brief analysis of the operators that exist today in the Romanian banking system reveals two basic characteristics: state or mostly state-held banks still make up the bulk, and a poor presence of foreign banking capital.
A background analysis exposes a major flaw of the system: its poor involvement in the real economy. All these characteristics are inherent to an under-developed banking system. Under these circumstances, anyone can wonder why oversight is needed.
Oversight, after all, can preserve and strengthen the present system. Shouldn’t its restructuring be promoted instead? The NBR, the authority in the sector, has no solutions at hand.
Privatisation in the banking system is even more difficult than in the industry, for instance. With domestic banks poorly anchored into the real economy, the only solution for some improvement remains the oversight performed by the central bank.
And the modernisation of the oversight system, initiated already by the NBR, principally by introducing the so-called CAMPL rating, could prove effective in the future.
But there remains the risk of a vicious circle, already experienced in the first part of the year by the banking system, which can have a negative impact on the overall development of the economy.
Thus, a more strict bank oversight has first of all caused exaggerated prudence on the part of the banks in extending loans to the real economy. This has happened due to banks’ fear of increasing their “portfolio” of bad loans.
At the same time, banks slipped into a “stasis” as their lending function was pruned off, which leads, in time, of course, to low performance. But the very criterion of bank performance should be another basic element of the rating system.
On the other hand, poor banking activity on the lending side brings with it lower passive rates (as it has happened recently).
Thus, the vicious circle is already closing in on the banking side, especially if we consider that banks went to “sleep” waiting for the state to keep issuing significant supplies of government bonds at convenient rates (and risk-free).
But there is the threat that the vicious circle, generated in the banking system, should extend in the long term over the real economy as well. The mechanism is easy to open and there are even signs that it might begin to work in the Romanian economy today.
Passive rates are falling, even below inflation, savings in lei are discouraged, and the flight to dollars becomes imminent. On the other hand, as fewer government bonds are issued and banks cease loaning, they are ending up with a substantial “surplus” of money they cannot place anywhere.
Hence the pressure on the state to issue new bonds with attractive rates. Although initially the state was not tempted to respond to these pressures, still, so as not to encourage speculations on the exchange rate, the state might eventually be forced to give in (thus placing more burden on the populace).
From what was said, essentially banks are not willing to risk loaning to a sector of the real economy which could be willing to take the risks of new investments.
In other words, the present banking system, disconnected from the real economy, wants the utmost safety amidst an inevitably risky environment in this period of transition.
Therefore, we believe bank oversight is a transitory solution, only valid until the end of the restructuring process, carried out strictly according to market economy laws.
After this transition stage, bank oversight will lose its importance, and become a routine, as it is today in developed countries. The “health” of the banking system stems from its real solidity, proven on the market, not on stiff bank oversight.
The limits of oversight – Analysis by Claudiu Doltu
The mere externalisation of the bank oversight function from the central bank does not guarantee more safety for the banking system. If, eventually, the NBR will end up giving away its banking oversight prerogatives to another institution, this would probably be a strictly organisational decision or perhaps a political one.
The fact that in recent years there have been several bankruptcies is not a sufficient argument to support either option (oversight exerted by the central bank or another institution). Increased safety in the banking system is not conditioned merely by the shape of the organisation effecting the oversight. The independence of the oversight authority from interest groups, effective legal system, the public’s degree of economic culture, influences perhaps to a greater extent the safety of the banking system than the “umbrella” under which oversight is being unfolded.
The regular perception of the oversight function amidst the public at large is that when those in charge of it are doing their job, singular situations such as bankruptcy do not occur. If this reasoning were true, then it should be used in other institutions, such as the Police – whose purpose is also to prevent singular situations. But no one blames the traffic police for accidents on the highway. Therefore, one cannot accuse the oversight authority of a bankruptcy. Ultimately, the purpose of the oversight authority is to initiate the bankruptcy procedure when it is certain the bank is insolvent.
Given the existing relationships between institutions in Romania, it is quite likely that the externalisation of the oversight function from the NBR should generate communication problems between those who conduct monetary policy (NBR) and the new oversight authority. This prospect can serve as an argument against the externalisation, along with the fact that a new institution would cost a lot to set up.
On the other hand, however, externalisation could contribute to the central bank’s actual degree of independence. The NBR would no longer need to consciously compromise the accomplishment of its fundamental goal – price stability – to help banks in difficulty.
Regardless of what authorities will decide as to externalising the oversight function out of the NBR (if such an analysis is ever made), certainty in the banking system must grow. This requires a set of clear rules and more transparency in the early warning system as to bank’s “health.” But, perhaps even more important is that the public (companies and individuals) should be more demanding with the banks they work with.
The importance of “fine tuning” – Analysis by Florin Pogonaru
The development of oversight in financial markets is illustrative for the difficulties of institutional construction in a transition economy.
In bank oversight, past mistakes seem to have led to maturity and institutional stability. The painful experience of bankruptcies has highlighted the social costs of political pressure or group interests over the banking system. Bancorex and Banca Agricola are eloquent instances of lending on non-economic criteria to state enterprises by state banks.
The current issue is that of “fine tuning,” that of the professional manner in which rigour should not inhibit creativity in launching new products. Future issues will be to ensure the independence of bank surveillance in relationship with the political. Pursuing the privatisation of banks is the first guarantee to that end.
Things are different with oversight on the capital market.
Created to provide the financial resources needed for the privatisation process, the capital market has been permanently affected by negative elements or the slow pace of the transfer of state property to the private sector.
The classical example is the automatic listing on the RASDAQ capital market of all companies that have not undergone mass privatisation. Given the lack of transparency due to the automatic listing, it is very difficult to achieve an oversight function on the market. What’s more, all instruments or products created on this basis (including mutual funds) will be plagued by this “original sin.”
The stimulation at any cost of “players” on the market, who would “concentrate” shares resulted from the mass privatisation process, has been the second “sin” in the establishment of the capital market.
SOF and SIF, as “law-given” institutions, have amplified confusions in oversight through the casual nature of formulas, procedures and methodologies of evaluating portfolio assets.
Additionally, the control of their management (only by Parliament) has proved to be inefficient.
This background, based on approximation, and the lack of any connection in defining the operation of capital markets, has led to a lack of reaction from the CNVM (or, in any case, to a policy of “avoiding a present evil by transferring it into a future evil” – that of creating a time bomb, in other words).
Present issues of capital market oversight are, therefore, the identification and annihilation of these time bombs.
Future issues will be to ensure independence from various interest groups and fine-tune rigour and creativity and launching new products (the latter being the essence of the capital market).
Without this shift that exists between the banking system and the capital market, establishing unitary oversight is not advisable because it can become a source of crises in its own right.
Tossing the dead cat – Analysis by Dragos Negrescu
Unlike other ventures, bank institutions enjoy elaborate security systems: deposit safety, access to a last-resource lender (central bank) and, sometimes, guarantees for the proper functioning of the payments system.
This special treatment is justified in the protection of the deponent public and, especially, in the existence of a “system risk,” that is, in the likelihood that one bank’s difficulties should extend onto others, threatening their potential.
Bank regulation and oversight appear as the counterpart of this protection: it would be excessive for authorities to assume so big a responsibility for the stability of the financial-banking system without the instruments needed to minimise failure risks.
What’s more, the protection system itself can cause distortions, reducing risks associated to inadequate decisions (“moral hazard”). But oversight is not a miracle remedy.
It itself is affected by moral hazard and can assuage those in charge of monitoring banks’ activity (executive management and shareholders). Additionally, a deformed public perception, which tends to blame oversight bodies for banks’ problems, prevents them from taking decisive action since the first moments.
Also, as bank operations grow in complexity and come into effect faster, oversight bodies’ task becomes more difficult.
Too strict rules are not desirable because they negatively impact financial performance (in the USA, the cost of complying with prudential norms can run up to as much as 14% of a bank’s operating costs), but also because their mechanical application can trigger less-than-optimal adjustments within the sector (e.g., the exclusion of viable institutions from the market).
The alternatives are “pro-active” oversight, focused on the evaluation of protection systems against risks banks themselves pose (which assumes, however, a perfect fairness on the part of the overseen banks), or an increased role of other market players in uncovering faulty banks (for instance, in Argentina, banks are obliged to resort to private loans within a certain proportion of total liabilities).
The prospect of a “privatisation” of bank oversight, cited by the Fed chairman Alan Greenspan, is still remote, and anyway does not solve the other problems oversight authorities are encountering.
Recent criticism against NBR’s oversight role has a primary character, with a strong electoral flavour. They ignore the complexity of the above inter-conditioning, as well as the fact that, internationally, crises of magnitude such as the one that shook the Romanian banking system in 1999 are not rare.
They have always unfolded against the background of a tense and volatile macroeconomic climate, for which governments are mostly to blame.
An efficient oversight also requires other conditions, virtually absent in Romania: an adequate accounting system, easily convertible creditors’ rights, diligent bankruptcy procedures.
As to fraudulent practices, experience shows that even the most sophisticated oversight systems do not guarantee their discovery in time (e.g., the bankruptcies of British banks BCCI and Barings in the ’90s).
Spinning off the oversight function from the authority of the central bank is not a magical solution and does not reflect the proper international practice: crises have happened regardless of institutional arrangements, and the number of countries where oversight is separated from monetary policy is approximately equal to that of countries where the two functions are unified.