bank crashes be prevented?
Sri Lanka has had a proud record of not experiencing any bank
crashes since independence. Prior to independence several efforts
to establish local private banks failed. In fact it was these failures
that prompted the government to initiate the establishment of the
Bank of Ceylon in 1939. There can be no doubt that the record of not
having bank crashes is a good one.
Of course several
foreign bank branches that were opened in Colombo after 1977 closed
down. Even when the Bank of Credit and Commerce (BCCI) was collapsing
internationally, the Central Bank took measures to ensure that its
depositors of funds in Sri Lanka did not lose their deposits with
the Bank. All these are commendable in the country's banking history.
Currently there are rumblings that several banks, both private and
state, are facing financial difficulties and that if some remedial
measures and assistance are not forthcoming their liquidity and
financial sustainability would be threatened. Should the Central
Bank step in and rescue these banks? The maintenance of the country's
record of not having had bank collapses may not be a good enough
There are several
considerations that must be applied to determine an answer to this
question. First and foremost, what would be the consequences of
a crash of a particular bank to the financial system and the economy?
If these are serious and of proportions that would affect the economy
as a whole, then there are indeed justifications for the Central
Bank and the government to intervene. On the other hand, if the
banks are too small, of recent origin and the ripple effects on
the financial system would be limited, then there may be no justification
for public funds to be expended in the interests of a few in the
affluent class. The economy that is already in bad shape should
not be burdened by the results of mismanagement of directors and
management of a bank.
It is a different
story when it comes to the big state banks. In the first instance
these banks together control over half the banking assets in the
country. In fact in 2001 the two banks together accounted for about
58 percent of the country's total banking assets. This is not the
only reason though a very important one. The failure of these banks
could have ripple effects on many a business establishment and the
economy. Besides people have a right to expect that state owned
banks are financially secure. The mismanagement of these banks should
not result in a threat to the economy and to the financial system
as a whole.
for the possible insolvency of these banks should also be considered.
These reasons include the government's pressurising the state banks
to finance purchases for which there were no budgeted resources.
Such a course is of course in contravention of the principles of
accountability of public funds.
A second major
reason appears to be that these banks financed several large corporations
that are themselves in difficulties for various reasons. A third
problem is the bad debts incurred owing to politicians pressurising
bank officials to give credit to financially risky ventures and
individuals. In such cases bank officials have often by-passed the
usual lending criteria, not evaluated the financial risks and not
taken adequate collateral. The directors of these banks being appointees
of the government may have approved such loans. In each of these
cases there is a need to establish the principles of accountability
and those who have abused their authority should indeed be brought
issue is whether the regulatory framework for banking is weak and
whether there are needed reforms in banking regulations. What may
be even more pertinent is whether the Central Bank has the capability
to supervise the expanding and fast developing banking institutions.
Finance has grown in complexity in recent years and it may be that
the Central Bank's skilled personnel are inadequate to the modern
tasks. Banks and financial institutions have found innovative means
of circumventing the regulations imposed by the authorities. Creative
and innovative accounting methods can sometimes fool the supervisor
as it has happened in even the most advanced countries.
There is a
need to look into the causes of the financial difficulties faced
by banks. Where possible those responsible should be made to make
amends or be adequately punished. The principles of accountability
must be applied. Private banks that have become insolvent owing
to their own mismanagement should not be bailed out through public
funds. They must be allowed to crash.