Capitalizing on Banking

Published on 7th June 2005

It is clear that many private banks in developing countries play an important role in reducing poverty and raising incomes through capital and deposit provision. Surprisingly, they provide a tiny fraction of what they need to if we are to be successful in reducing poverty around the world.

A well-developed banking industry will subsequently contribute to economic development.  The problem however is that the statistics over how capitalized the industry is, do not seem to get better. We still hear of the same 1.3 billion people living on less than a dollar a day.

Most African economies reformed their banking sectors in the late 80\'s and 90\'s.  Among the major policy reforms were the removal of interest rate controls, the requirement of banks to only lend to specific sectors, privatization of most state owned banks and allowing easier entry of private sector banks and Non Bank Financial Institutions.  At the same time, Prudential Regulations and Guidelines were strengthened to promote sounder banking and help protect bank\'s deposits.

Despite all the regulations, it is still very difficult for commercial banks to build commercially viable loan portfolios, for domestic private sectors are often weak and only few credit worthy borrowers exist.  At the same time, the banks rarely have sufficient info to qualify a client for a loan.  In addition, most African countries are faced by high inflation and exchange rate volatility, which increases the risks of lending.  An increased borrowing by the government through the sale of treasury bills and bonds to avoid the inflationary rates of money has also contributed greatly to this.  

Such reforms, coupled with financial liberalization have changed the nature of risks facing banks in the continent.  One may doubt the extent to which liberalization has been effective because liberalized financial markets require strong impartial supervision independent of political interference.  Most countries have brought their banking laws into line with what is regarded as best practice, better enforcement of prudential regulations is essential.  

One of the major problems that has downplayed the functionality of many banks is lack of discipline by internal sector players, who include bank owners and the management. Bank owners must ensure that the management is qualified, independent and able to appreciate the gist of key banking risks like the liquidity risk, currency risk, interest rate risk, credit risk, regulatory risk and operational risk.  Risk management should become the centre of banks management.  Risks should also comply with best practice banking and proper corporate banking.  Some banks have been forced to pay huge fines to regulatory bodies due to poor reporting of company\'s accounts.  

It has also been noted that there is the lack of innovation by most banks that have clang to the core activities established by their founders.  Banks should aim at modifying and investing in new customized products.  This will rekindle customer product demand by creating a need in the market.  Banks should also encourage their customers to save rather than just borrow.  Among the workable strategies are the one stop account maintenance, attractive terms and savings repackaging.  

Another important factor to consider is the listing of not only one country\'s stock exchange but also various regional stock markets.  The advantage of being listed is the accountability and responsibility to shareholders, which in some way encourages better performance.  Besides the increased capital base, listed banks face increased reporting requirements and transparency discipline under reporting rules.  If you went to the core of most banks strategic plans today, the focus is on opening up new branches, which after sometime will be rendered non productive due to poor client base and increased competition.  Therefore, there is need for most banks to rethink their strategies and act before making big losses.  The market has already offered enough lessons to even seek for more.

Measuring our current state of banking regulation against those of the developed countries, there is still room for improvement.  Specific areas that can be considered are : Capital adequacy measure changes (moving from the standard blanket to multiple subjective requirements like the Basel II), stricter Anti- Money Laundering (AML) rules, improved customer loan insurance and deposit protection fund, increasing the range of foreign exchange products in the local foreign exchange market, local yield curve establishment and maintenance and credit rating where the banks should be well-informed on creditworthiness as a vehicle for its development and growth. Formal credit rating agencies for businesses and individuals needs to be initiated so that local credit ratings are available to guide banks and businesses in debt pricing and credit related transactions. Official bank credit ratings can also be used by the regulators as a supervision and monitoring tool for banks for example in determining deposit insurance premiums. The global credit rating used by most banks may not give an industry specific score as the economic conditions differ from region to region.

Another key area to consider is the completion of the privatization program for previously state owned banks.  This would create an equal competitive ground for more players to emerge in the industry.

Directors should therefore keep working hard to drive their teams through a pro-active approach towards product development and good governance.  In so doing, the millennium development goals could be closer than anticipated.

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