New rules for better banks
The Central Bank's decision to make a hefty increase in minimum capital requirements of all licensed banks looks set to set off a series of changes in the industry that should transform the entire banking landscape in the country. For some time now it has been felt that the island has far too many banks, that urban areas especially, are over-banked and that rural areas are neglected by private commercial banks.

Furthermore, neither depositors nor the majority of borrowers are happy with the way they are treated by banks. Depositors complain that the interest paid by banks on their funds is far too low.

Many businessmen complain that the interest they have to pay for loans is far too high (except those big enough or with the right connections to get special rates), especially when compared with the rates paid by their overseas competitors. The government's stubborn maintenance of low policy interest rates despite skyrocketing inflation has meant that depositors are, in effect, getting negative returns - the value of their deposits is being eroded - and those borrowers lucky enough to be favoured customers of commercial banks are having it good.

Banks have also been accused of keeping too high spreads to cover up for their inefficiencies and making excessive profits, although the changed interest rate scenario has meant that the easy profits made by banks trading in government securities is no longer available, as reflected in the bottom line of some banks.

The fiasco over the collapse of Pramuka Bank has also left depositors feeling bitter. The effectiveness of the Central Bank's regulatory role and supervision was called into question. There are also dark rumours about the financial health of certain banks.

It is in this context that the Central Bank has introduced the new minimum capital requirements. The regulator has stated that one of the objectives is to promote a "robust and stable financial system" and that it is important to have strong banks that are resilient to internal and external shocks.

This is particularly relevant in the light of what happened at Pramuka and it is pertinent to note that the biggest increase in minimum capital requirements is for licensed specialized banks - a whopping 650 percent, from Rs.200 million to Rs.1500 million.

The Central Bank has also said that the enhanced minimum capital level for all licensed banks will "encourage the much-needed consolidation of existing banks". This should lead to many mergers among banks - a development the regulator has been known to favour for some time.

Predictably, the new rules have been welcomed by the bigger banks who are better placed to comply with them while the smaller ones are feeling threatened and fear they would be swallowed by the big banks or would have to close. It could trigger a wave of mergers among banks and a drive to raise fresh capital. This is certainly welcome in the face of the present fragmented nature of the industry. Bigger and stronger banks are needed because of increasing exposure to international market forces. Banks, by nature, are highly leveraged institutions with very little shareholder funds required in comparison with depositors' funds. While consolidation may have its benefits there is a need to ensure an adequate and healthy level of competition.

Despite the presence of so many banks in the country there is still a feeling that the competition has not brought about the desired benefits to customers - that banks did not bring down their lending rates to the extent desire by government and industrial borrowers. Ultimately, it is the bank customers - the depositors and borrowers - who must benefit.

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