Financial ExpertSpeak: Banks must no longer display ‘exuberance’ in lending
In an exclusive interview with AfricaMoney, the Bank of Mauritius Governor Rundheersing Bheenick spoke about turbulent times such as the Ponzi scheme which broke in March 2013 and forced a re-look at the powers of the central bank.
AfricaMoney spoke to Rundheersing Bheenick, Governor, Bank of Mauritius (BOM) on how the island economy’s banking sector has emerged largely unscathed from the global financial crisis. With characteristic dry humour, our financial expert took us though the journey of the banking sector amid turbulent times such as the Ponzi scheme which broke in March 2013 and forced a re-look at the powers of the central bank. Insisting that effective intermediation is key to managing interest rates, the down-to-earth Governor explained how to strike an optimum balance between savings and investment.
Edited excerpts from an interview:
The Market Intelligence Cell recently started by BOM seeks to prevent frauds by collecting suspicious information in advance and alerting the public. Your views on how the Cell can additionally protect the public from Ponzi schemes.
The Market Intelligence Cell came into existence as we realized that the central bank had started taking a narrow view of its larger responsibilities to the economy, and was in danger of focusing exclusively on the banking sector that was under its immediate purview. In fact, there was no focal point for information related to financial crimes. Can you imagine that at one point, financial crimes were directly referred to the Police because the central bank had no information collection and enforcement capabilities!
First, we tried to discharge our responsibilities to the public by collaborating with the Police over financial crimes but that turned out to be simply not enough. Even before Ponzi schemes broke on the horizon, the central bank discovered that the number of points for buying and selling of gold had gone up exponentially. While that was not an issue immediately concerning us, we realized its long-term implications and alerted the Police. However, the Police responded too slowly to the threat, and, in the meantime, it turned from a civil issue to a criminal matter as speeding bikers started snatching gold chains off women’s necks. For an economy which does not mine gold, it may seem unbelievable, but Mauritius was exporting gold for some time!
After that, the Ponzi scheme broke and there was complete chaos. The judicial administration was unable to cope with basic issues such as whistleblowing and this is where the central bank decided to step in to plug the glaring gap in reporting and tackling financial crimes. The Reserve Bank of India (RBI) assisted with the setting up of the Cell, which has been designed to cover not only Ponzi schemes but any form of fraud across the financial sector.
To conclude, you may be surprised to learn that there was no formal channel through which the Ponzi scheme came to the surface but a chance conversation with a retired ambassador that brought this fraudulent scheme to my attention. Today, with the Market Intelligence Cell, we are no longer leaving such critical issues to chance, but are proactively following up with members of the public for any suspicious information which may indicate a possible scam on the horizon.
How many people currently comprise the Market Intelligence Cell?
There are four people currently in the Market Intelligence Cell. We are planning to merge it with the Enforcement and Compliance Cell which additionally looks after internal compliance issues in the central bank. Besides, the central bank firmly believes that market intelligence begins at home. The MI Cell is only as effective as the information communicated to it and the internal staff of the central bank can be a crucial source of on-the-ground information about the financial services sector and can bring any suspicious information doing the rounds to the attention of the Cell.
Given a choice between a low interest rate to spur lending and foster corporate growth or a higher interest rate to encourage savings and check inflation, which one would you prefer and why?
Well, this is a tough call to take as both saving and investment must be balanced. At the essence, effective intermediation is the key to managing interest rates. To explain, if there is deficiency of savings, there is an argument for increasing the interest rate to stimulate households to save more and get more interest in return. However, if there is a deficiency of borrowers, reducing the interest rate is the only way out. But, reducing the interest rate on on-lending also carries the danger of spurring bad loans as weak projects can get approved since the rate of return, however less, would be sufficient to repay the lowered interest on capital.
So, you would argue in favour of higher interest rates?
No, as I said, it is important to maintain a balance between savings and investment. However, it cannot be denied that higher interest rates help to weed out bad projects as, in order to earn a high enough rate of return to repay a high interest amount, a project must have strong fundamentals and be able to guarantee a return that justifies taking on expensive capital.
You have mentioned in earlier interactions with the media that the Financial Services Commission has more extensive powers than the central bank. What are some powers you want BOM to be invested with?
Our counterpart in the non-banking financial services space, the Financial Services Commission, has the power to investigate the financial services firms under its regulation, which was a power that was earlier denied to the Bank of Mauritius.
While we were conducting regular examinations of banks and could conduct special examinations at the instigations of the banks themselves, we had no investigation cell to look into the banks under our purview.
It was only when a Ponzi scheme was suspected that the BOM decided to summon all legal resources at its command, and invoked the clause which allows it to ask any new bank to give access to their books within 14 days of being asked to do so. Despite not having any prosecution powers, we did all that was in our capacity and also threatened the bank with prosecution by the Director of Public Prosecutions (DPP) in case we were denied access to their books. In the face of our threat, the bank buckled in but requested for an extension of the time of 14 days.
Well, what happened after that is history. The Ponzi scheme was unearthed and, as a response to the chaos that prevailed at that time, the central bank now has its own investigation cell allowing it to examine the banks under its purview as and when needed.
Of the 21 commercial banks in operation as on 30 June 2013, the international banks were represented by eight foreign bank subsidiaries and four branches of international banks. Which form of presence – a subsidiary arm or branch operations – does the central bank advocate and why?
Well, the central bank was quite relaxed in its approach to the mode of operation of international banks, till the global financial crisis happened. That gave us the trigger to start monitoring their presence in terms of branch or subsidiary operations more closely than was warranted before.
Especially critical were the learnings from the West African experience, as the region saw some large banks which had only branch operations, move out of the concerned African country and suck back the liquidity into their parent countries.
Also, more than the fear that large international banks would move out of Mauritius in times of crisis, we felt that such banks were increasingly finding themselves out of touch with ground realities in the island economy. Hence, we advised that, besides restructuring their branch operations into subsidiaries to evidence their commitment to the local economy, the companies must set up local advisory boards to advise them on ground realities. Well, a few of the banks set up local advisory boards, while others decided to set up ‘local’ advisory boards comprising their international representatives!
Also, even after acknowledging that the subsidiary route was the more comfortable form of international bank presence for the host regulator, we came up across a couple of speed-bumps when we tried to implement the restructuring of branch operations into subsidiaries. It emerged that there was no special law in the financial space to allow such restructuring by banks. Hence, banks had to apply through the usual corporate law route. More seriously, other banks with branch operations contested their peers’ moves to convert into subsidiaries, claiming that the quality of collateral held by them as branches was superior to the quality of collateral they would be left holding as subsidiaries. Now, however, the law has been amended to allow restructuring by banks and can be invoked easily for international banks to convert their branch operations into a subsidiary arm.
A final word on this topic, the central bank does not mind small or boutique international banks with limited presence in Mauritius to take the branch route as they do not pose a systemic risk to the financial system.
BOM reported a net profit of around Rs 71 million for financial year 2012-2013 but had to draw on reserves to avoid going into the red since the fiscal year ended with an operational loss of Rs 1.8 billion. What were the main factors responsible for the operational losses?
First of all, I would like to make it clear that there is no concept of a ‘loss’ as such for the central bank as there is no profitability objective for us, being primarily a regulatory authority. Thus, the accounting for central banks is different from the usual corporate accounting norms. The central bank is required to keep aside 15% of its profits as general reserves and these reserves are built up in times of good profitability. Besides the general reserves which reflect in the books, a second reserve is created below-the-line to park paper funds arising upon fluctuations in foreign currency.
Essentially, the central bank is required to hold a portion of its reserves in foreign currency, and, of late, the return on reserves has been a paltry 0.25% while the processing fees for acquiring foreign currency averages 5%. This gives rise to a negative carry, such that the difference between the costs of acquiring the foreign currency reserves outstrips the return on reserves by a wider and wider amount.
The central bank had to go out of its way to buy more and more USD and Euro to combat rupee appreciation, barring which the economy would have collapsed. However, as a result of taking steps to protect the economy from an unduly expensive rupee and the consequent erosion in our export competitiveness, the central bank had to face the brunt in the form of higher negative carry, translating into greater ‘operational losses’.
The annual report of BOM for 2012-13 showed that, even as the banking sector performed better with profits up 7.7%, however, bad loans also shot up by 16.6%. Also, 3 of the 4 banks that declared losses saw their incomes being wiped out by bad loans. What spurred the rise in bad debt and have any steps been planned to keep it under control this year?
The global financial crisis is the main driver of bad debts. In fact, the Mauritius banking sector managed better than most. We were lucky that there was no bank which went under and had to be bailed out. However, it cannot be denied that loan books have lessened and banks can no longer display the ‘exuberance’ that they earlier evidenced in their lending decisions. Lending uninhibitedly to sectors such as tourism and construction, where everybody in Mauritius appear to have a finger in the pie, is not such a great idea. Sectoral caps have been set by us for lending to different industries, and are expected to help in diversification of banking credit as well as prevent bad debts.
Regarding the 4 banks that went under, each did so for reasons that were different and it is not possible to generalize the rationale behind their losses. One bank had just started in February 2013, and it was beset by incorporation charges and other preliminary expenses. Two other banks suffered losses as the Indian clients they were dealing with went under, and one of the two burnt its fingers with derivative products. The fourth bank, a domestic bank, incurred bad loans as it had extended credit to the construction sector and the construction firms it had lent to could not complete their contracts.
We took all the losses with due seriousness and advised all loss-making banks to create provisions and write off all their bad debts. We further recommended injection of fresh capital to ensure that the equity of the banks did not get eroded. And, one of the banks did in fact infuse fresh capital in response to our recommendation.
BOM recently warned the public against virtual currency. What is known, if at all, about the circulation of bitcoins and other forms of virtual currency in Mauritius? Is it possible to take concrete steps against an unregulated currency?
Well, while I found out about the Ponzi scheme at a garden party, I was left to discover virtual currency at a cocktail party! A friend asked me if it was a good idea to ‘invest’ in bitcoins and I told him that I have nothing against virtual currency except that it is pure speculation and cannot be deemed an investment. If individuals who use virtual currency in the same way as electronic payment credit, such as PayPal for instance, as it provides them a cheaper and faster way of making payment, they are free to use the same. However, they must remember that it is completely unregulated, has no recourse in case the other party decides not to honour its payments, and there is always a possibility of heavy losses if the value of virtual currency plummets.
A recent communique alerted the public regarding SWIFT messages asking individuals for bank account details against big sums of money to be credited to their account. How sophisticated are such fraudsters, given that any individual with even a rudimentary knowledge of banking would be aware that neither do SWIFT messages pertain to individuals, nor does the central bank deal with individual accounts?
In fact, I would argue the opposite. The fact that they used the logo of the central bank, and invoked a financial term such as SWIFT which is commonly used in banking circles, makes it appear that the fraudsters knew what they were up to. Incidentally, the fraud broke at Rodrigues around New Year time, when people were busy with year-end festivities and the first time we heard of it was when an individual landed at the doorstep of the Bank of Mauritius and requested for the SWIFT message to be honoured. Of course, financial literacy and consumer education can go a long way in ensuring that such instances are not repeated.