I browsed hurriedly through the Report by the Task Force set up by the BoM. I might have missed some issues raised therein. In this article, I focus on the essentials and share with readers fragments of my thoughts on some of the issues brought to light. The Report documents, amongst other things, reported malpractices and excesses in the banking industry. That there have been and there still are cases of wrongful banking practices cannot be denied and dismissed. A decade ago, they were believed to be remediable by an appropriately empowered Banking Ombudsperson, more or less like the one in New Zealand. This was the basic consideration that had motivated the BoM to make provisions for a Banking Ombudsperson in the BoM Act 2004. Although the number of hapless and discontents as a proportion of total number of bank customers is minimal, there is a compelling need for sanitizing the grey areas in banking practices. They do require some kind of market-friendly interventions but they, however, do not warrant the distortionary interventions of hands arbitrarily setting fixes in areas where the verdict of the market is the ideal option. The unintended consequences of unwarranted interventions would have serious implications for the healthy growth of the industry. The Task Force invites the BoM, the regulatory authority responsible for promoting soundness of banks and for financial stability, to take regulatory actions that directly affect banks’ profitability and reserve in an economic context characterized by flagging growth and heightened risks of loan defaults. Does this piece of music make harmonic sense? It’s a moot question.

It appears bankers did not get the ears of the Task Force; they, of course, deserve a good hearing. For the sake of natural justice, the Task Force ought to have conducted an exercise similar to Maxwellisation in order to enhance credibility of its Report. The gap between perception and realities about our banking industry is too often deepened by retaliatory sentiments of the hapless and the discontents. Often, they don’t fess up. Years ago, at the height of a political turbulence surrounding a banking scandal, a local celebrity from the political-cum-business class, known in some quarters to be The Cock that habitually claims credit for the dawn, had let go in my office an insolent but revealing question, “Why are you on the side of that bank?” The audacity of the celebrity had hit a highly sensitive nerve in me, like the one in a dental treatment with no anesthetics does. Momentarily, I had lost self-control and I distinctly recall having retorted, “Sorry, Old Cock. You have several deposit accounts with that bank. Every rupee you have in those accounts is a vote of your confidence in that bank. YOU are the one on the side of the bank. I am just doing my job to check the reputational damage to our banking industry and by extension prevent a meltdown of the economy. Understand?” I have been in the thick of it for years and personally handled many discontents, including a particularly irksome former Board member of the BoM (who came to believe that his bank had become his legitimate quarry), only to discover that many of them did not deserve the regulator’s attention. Nobody hates a banker so much as someone sunk deep in debt. The pain of a rupee repayable to any lender is often far greater than the pleasure of a rupee borrowed. The problem with trying to gauge the heat in our banking industry is that it depends where you insert the thermometer. 

In the 1970s (sugar boom years) and the1980s (during the boom years) some banks had adopted a strategy to charge introductory lower rates to borrowers in order to establish a lending relationship with them. It was a kind of relationship based on the prospect of charging higher lending rates in the future to those who were eventually successful. This strategy of initial subsidization and subsequent participation in the profits of successful businesses was possible to the extent that the bank had market power. Bankers banked on the fact that successful firms would not be poached by competitor banks in the future. As the number of banks increased, competition between them stiffened. Banks that had incurred the initial cost of subsidization found their ability to retain successful borrowers severely weakened. The banks that were bold enough to take huge risks with the borrowers then decided to make it harder for them to shift to other banks. Keeping in mind that this strategy positively benefited society as a whole, would it make sense to conclude that this practice is outright ‘foul’ or ‘fair’? Readers might wish to think over and over again on the economy-wide implications of sweeping regulatory rules that kill such initiatives by players in a free marketplace and make their own judgment.

Way back in 1947, a year after the death of J M Keynes, Time Magazine had reproduced a memorable piece of his wisdom on sterling debts: ‘If you owe your bank manager a thousand pounds, you are at his mercy. If you owe him a million pounds, he is at your mercy.’” This statement has more profound operational and risk-management significance for bankers than it suggests to the lay persons. Bankers stand somewhere between the two positions constantly striving to minimize risks. A balanced position is most efficiently achieved by unfettered markets for deposits and loans, not by the arbitrary hands of an individual or a group of individuals. The market can best decide on what is ‘optimal’ from the standpoint of the banking industry but not necessarily on what is felt to be ‘fair’ to consumers of banking services. What may be ‘fair’ to a bank may be perceived as ‘foul’ to consumers of banking services and what may be ‘foul’ to a bank may be perceived as ‘fair’ to consumers of banking services. And what may be ‘optimal’ to a given economic and financial situation may not necessarily be perceived as ‘fair’ to consumers of banking services.

Fairness is a vague notion. It’s almost impossible to define precisely. Milton Friedman said it eloquently in the 1980s: “‘Fair shares for all’ is the modern slogan that has replaced Karl Marx’s ‘To each according to his needs, from each according to his ability’. ‘Fairness’ like ‘needs’ is in the eye of the beholder. Who is to decide what is ‘fair’?” Does this not remind readers of George Orwell’s Animal Farm?

Historically, most good quality borrowers in the country elect to bank with the biggest banks. Medium quality borrowers with a credit profile judged to be fair and promising are generally picked up by medium sized banks. Left-overs and low quality borrowers shop around the small banks. This broad pattern of borrowers’ relations with banks – which is somewhat less obvious to-day than in the past - is not specific to Mauritius only but also to most small economies, particularly island states. Add to this the very well-known finding that the average quality of a bank’s pool of borrowers declines as the number of banks competing in the market increases. Over the years the number of banks in the banking industry has grown from six in 1968 to eleven by the end of the 1970s and further to twenty-three (offshore included) today. Each bank in the country has to do with a pool of borrowers the average quality of which has declined, more so when economic growth is depressed for several years. A loan applicant – high or low quality – who is rejected continues to apply to other banks. The more banks there are, the higher is the likelihood that a low-quality loan applicant obtains credit. The bank that agrees to extend the loan may be winning the right to fund a lemon – the winners’ curse. Fortunately, bankers have learned the hard way over time that they should never leave the liquor cabinet unlocked when they have dipsomaniacs as guests.

Regulators must be familiar with another finding that bad loans are generally made in good times. In the context of a flagging economy characterized by uncertainties, bankers’ inclination to take risk with depositors’ money diminishes considerably, more so when loan defaults become pre-occupying. In other words, they become highly protective of their balance sheets. This protective instinct of bankers in unfavourable circumstances has a smell of risk aversion but it actually isn’t risk aversion as is ordinarily understood. Banks end up looking for only borrowers who clearly satisfy most of the core lending criteria and borrowers look for banks that are not only good to them but also sympathetic to their plight. They both fall in the kind of a trap that was once expressed by Warren Buffet as the man who was looking for a perfect woman for years; he finally met with one, only to discover that she was looking for a perfect man!!!  

A key point of fundamental importance that is blissfully ignored by the lay persons is the fact that a bank is an enterprise in a financial industry that is characteristically far different from, say, a shoe-manufacturing firm in a shoe-making industry. In a perfectly competitive environment, a shoe-manufacturing firm eventually ends up making zero profit and consequently shuts down. (Micro-economics!!!!) The shareholders of the firm are usually the only ones to bear the brunt of the business failure. By contrast, banks are, by definition, the most highly leveraged business firms known to exist; they are deposit-taking institutions and as such they carry huge liabilities in their balance sheets. True, risk-taking is their main business but no single person who is not responsible for their balance sheet management can decide for them which risks are a safe bet.  If bankers are expected to run their businesses and compete in the same way as do the typical shoe-manufacturing firm, one should of course expect banks to go bankrupt as often as it rains in the country. It’s virtually impossible to walk between raindrops without getting wet. In this case, not only the shareholders, but also the depositors would lose their money with all the resulting adverse consequences for the economy.

Because banks do not yell like sellers in fish markets or scream like the rowdy money-changers at our airport (as they used to) is not a conclusive proof that competition does not exist in the banking industry. Nor is the prevalence of more or less the same prices for services throughout the banking industry a conclusive evidence of the existence of a cartel. Any A-Level Economics student knows that the prevalence of the same price for identical products throughout an industry is also an evidence of competitive forces having effectively settled prices to an equilibrium level. Do the more or less same Fees, Charges, Commissions and deposit rates and lending rates that prevail across the banking industry reflect the existence of a cartel or the end result of competitive forces? The oft-repeated surmises that banks have a cartel arrangement is an unkind spin; it’s often transmitted infectiously with cheerful brutality. The constant pounding of the mind incapacitates even the well-meaning observers to think that the system suffers from a confluence of factors that deter vigorous competition. The saddest thing of all is that the spinners begin to believe in their own ridiculous spins.

Many persons I have known are victims of an institutionalized confusion about competition in our banking industry. Part of the confusion is due to a failure of appreciation of the distinction between a ‘cartel’ and a system in which one or more than one bank plays the role of ‘market-maker’ that is a critically important part of functional financial markets. Market-making constitutes an important process in financial and forex markets. In any fully functional financial system there are one or more than one big player that take prices from the previous day’s closing prices and collect latest information on markets worldwide for inputs in setting starting prices every morning and get the market moving for the day. This essential component of our financial and forex markets (however informal and deficient) has often been mis-construed as an element of collusion by even those who claim to hold certificated tickets to speak authoritatively. On the contrary, the system sorely lacks a solid arrangement (with brokers fully in the game) for market-making in our financial system. Institutional improvements in this direction are highly desirable.

That competition in the banking industry is necessarily welfare-enhancing is found to be misleading. Instead, channels through which bank competition may generate negative economic effects – more so in small economy like ours - have been identified in the current body of research. The principal conclusion of the current body of research is that neither monopoly in its extreme form nor perfect competition is the most desirable market structure for the banking industry. What is the optimal degree of bank competition for Mauritius? What’s the mathematical formula that takes into account the specificities of the market place to give the optimal degree of competition in the banking industry? In the real world there is no dependable method of determining the optimal degree of competition. The use of coercive means to kick off competition to the tune of pedestrian’s scripts would do more harm than good. The BoM faces a trade-off; it’s best to keep off the grass. Besides, the two largest banks in the local rupee marketplace (with one of them having the very unfair advantage of full Government support) account for over 60 per cent of banking transactions. After all, is there any level playing field in the system? The game is fudged. An in-depth investigation that thoroughly explores the specific characteristics of the banking industry and the economy along with the fact depositors and borrowers have traditionally demonstrated revealed preferences for particular banks, often based on non-economic and financial considerations, would suggest that competition between banks in the country cannot possibly be aggressive but mild. Indeed, banks – small or big – with the exception of a dormant one established in the 1960s with quite some amount of non-interest bearing deposits, do compete as far as the character of the playing field and prevailing economic conditions permit. There is no such thing as a cartel in our banking industry.

Are banks being invited to compete for deposits? Why should they if they have unprecedented excess liquidity sitting Buddha-like in their balance sheets? Are banks being invited to compete in the loan market? How far they can go if the quality of the pool of borrowers has declined and prospects for profitable lending have dimmed? The biggest and the least risky borrower in the country, the Government, has instead elected to borrow from abroad in the past several years. This is a Government decision along with other forms of capital inflows that has hatched excess liquidity in the balance sheets of banks. Vigorous competition does not take place when many of the enabling factors are missing. A series of small mis-guided variations in policy decisions in a non-linear dynamical system that our financial system is known to be has produced undesirably large variations in the long term behaviour of players in our financial markets.  Does the architecture of our financial sector provide for level playing field to players in the marketplace? Any bank in our financial sector has to compete not only with its own peers in the banking industry but with several other financial institutions like the National Mutual Fund, the Mauritius Housing Corporation, Insurance Companies, Money Changers and Forex Dealers (Official and Unofficial), Leasing Companies, etc. Worst, banks are regulated more rigorously than all the other financial enterprises in the country. The regulatory costs to banks are not negligible. The playing field is obviously tilted against banks. The criticisms levelled against banks are indeed crowd-pleasing. Most of them are products of illusion. They are not substantiated with well-researched and comprehensively studied findings. Why the huge international bank, the Citibank Corp (USA), (City Bank as it used to be called in the 1970s), had packed off from Mauritius? Why a second international bank sold its business in the early years of the new millennium? Why a third international bank recently decided to get rid of its onshore operations but was stymied at the last moment? There was an agenda of actions – partially implemented since the early years of the new millennium - to level the playing field. I chose not to discuss it here. Suffice it to say, that the architecture of our financial system needs to be gradually re-wired, re-cast and suitably levelled to enable healthy competition. Let’s stop barking at the wrong trees.

Readers would find it enlightening if they were walked through the evolution of the spread between deposit rates and lending rates as well as of Fees, Charges and Commissions over the years. (I may be somewhat imprecise in the following as I can only download what my memory still retains.) During the period prior to Independence, banks lived off primarily on good interest spreads - so good that banks were open for business for half a day on Thursdays. CEOs used to spend the other half of the days in the golf course, Gymkhana Club. The kind of fees, charges and commissions we are familiar with today were virtually non-existent. There was no pressure to disturb this cosy world of bankers.

Between 1968 and 1982, the floor deposit rates and maximum lending rates for each economic sector were fixed by the BoM. Even the quantum of credit a bank could extend in any year used to be fixed by the BoM. It was financial repression, par excellence. Sometime in the second half of 1982, at the request of the MoF the BoM had worked out the spread (weighted average deposit rates on the liabilities side of banks’ balance sheet and lending rates plus zero return on cash ratio requirement and other cash balances plus weighted average yield on Government papers on the assets side) for every bank and the banking system as a whole. The spreads were in the range of 9 to 12 percentage points. (The 12 per cent was an outlier as a large chunk of the deposit base of one bank was non-interest bearing; they were deposits made under Sharia rules.) But Fees, Charges and Commissions were not a source of concern as they were relatively small. A gradual move to interest rate liberalisation was initiated shortly thereafter. The BoM and the MoF had expected that the spread would consequently narrow.

Subsequently, as growth rate of the economy had picked up firmly and a mood of optimism had taken hold in the early years of the 1980s banks competed vigorously for deposits. Banks were regularly short of liquidity despite their efforts to mobilize deposits; they had daily recourse to the BoM window for funds to tide over liquidity shortfalls. Banks used to borrow even at very penal rates from the BoM. The tightness of the market for funds had induced tough competition. (As an aside, it’s also worth mentioning that it was one of the few occasions when the BoM had a firm hold on the domestic money market and monetary policy transmission mechanism was at its best). Competition for market share had culminated into a very large number of bank branches selling their services in rural and urban areas.  At the height of competition banks employees were sent, after working hours, on daily missions to attract deposits from and offer financing facilities at competitive rates to householders. Some banks paid interest on 7-day deposits and even on current account deposits. Lending rates (except those on non-performing loans) had remained reasonably low due to competitive forces. Spreads had narrowed, largely due to buoyant economic activity and optimism about a bright economic future. Fees, Charges and Commissions did not bother consumers of banking services. Still, banks were said to be operating in a cartel arrangement. One little ill-fated bank, the MCCB, that had survived for more than a decade on the strength of a vitally important subsidy from the BoM had lost this support and was asked to join the competition game in the late 1980s. The greed of this bank to grow big and fast a la BCCI was maddening. In the heat of competition, the deposit rates offered by the bank were one of the craziest ever seen in the history of banking in Mauritius. And its lending rates were seductively attractive. The bank was clinically dead long before its licence was revoked. Unlike the now-prohibited Chinese tradition of corpse-walking, this corpse-walking without fire-crackers was indeed very expensive. The key take-away point is: higher growth rates of the economy combined with a tightness of liquidity with banks and a promising economic outlook fertilize the competitive spirits of bankers. Level playing field is equally necessary. We obviously don’t have them for years.

Offshore banking was launched in 1989 with Barclays bank as the first to open up for business. By 1994 when the financial sector liberalisation was completed the number of banks onshore and offshore had risen. One would have ordinarily expected interest spread to keep narrowing and Fees, Charges and Commission to remain a non-issue due to the forces of competition. But the lie of the land had changed dramatically in the second half of the 1990s. Money Changers and Foreign Exchange were introduced to instill further competition in the industry. Banks lost their foreign exchange retail business. At the same time in anticipation of the abolition of the Multi-Fibre Agreement and of the Sugar Protocol nascent export enterprises that were still on their learning curve lost their bearings. The pace of economic transformation had slowed down and the mood of optimism of the 1980s had gradually fizzled out. The late 1990s were eventful in terms of export companies going bust. The ‘hollowing out’ of the Mauritian economy was cheerfully greeted when it ought to have been read as a precursor of the distasteful future trends of the economy. The economy had ceased to expand. In 1999, non-performing loans in the balance sheets of banks computed on the basis of the norms set by the Basel Committee (and not as reported by banks) were in the range of 15 to 30 per cent. These ratios are baffling to any regulator; they are terrorizing. Worked out on  stricter prudential norms, these ratios were actually much higher. Some of the balance sheets of banks looked more like Pakistani buses or rather old and rusty buckets on wheels freighted with passengers gone broke struggling to cling on to the roof. At least one bank had crashed; it was incurring losses for the third consecutive year in 1998. The business climate was dull and drab and prospects for stronger growth performance were uncertain. The uncertainties were further exacerbated by the pre-announced introduction of the euro in 2000. Coincidentally, the BoM had started coming up with a series of new Guidelines setting out prudential norms that banks have since been required to adopt. A unique mix of disruptive forces, game-changing events and regulatory policy alterations had drawn banks in the ‘nautical twilight’, that is, navigation using the visible horizon was no longer possible in the 1990s. July 7, 1999 marked a watershed in the history for the BoM as the regulatory authority of banks.  Banks sailed against the wind of change and competition between them eventually and rightly grew milder. The gradual reduction of the non-performing loans to prudential levels (that obviously takes years to materialize) and the emphasis on the soundness of banks and financial stability in the early years of the new millennium appeared to have weighed heavily on the banks’ decision to raise revenue by various means. Spreads did not narrow. Fees, Charges and Commission did not diminish.

In the past several years, the pace of economic growth has failed to firm up. Many more enterprises have closed down operations. The mood of pessimism that had crept in in the mid-2010s has persisted. As a matter of course, the healing of banks’ balance sheets wounded in the 1990s have been frustrated by many more loan defaults in recent years. These are the kinds of factors as well as those listed below that appear to have settled interest spread, Fees, Charges and Commissions to the levels where they currently stand:       

(i)     The cash ratio that banks are required by the BoM to maintain has gone up a few times in recent years. The imposition of a cash ratio on banks tantamounts to a tax on banks and that tax has actually gone up. In other words, it costs banks much more than it did before to accept deposit from the public. Non-bank deposit taking institutions are not required to maintain cash ratio.

(ii)   The 3 per cent contribution by banks under the heading, Corporate Social Responsibility, mandated in the Government budget is in fact a tax on banks;

(iii)An annual licence fee payable by banks was introduced some eight years ago. One of the few reasons - apart from the fact that the BoM has to run a Banking Supervision Department - that had motivated me to introduce this fee was that taxpayers can no longer be made to pay for the cost of any investigation conducted by the BoM following irregularities in banks. Taxpayers had to unfairly bear the brunt of the cost of the nTan Report. The annual Licence fee collected by the BoM is certainly not insignificant;

(iv)Banks have been holding unusually massive excess liquidity with a much lower yield for several years.

(v)   Massive capital inflows have crowded out banks in the financing of a large chunk of economic activities thus depriving them of interest income; and

(vi)The new Guidelines of the BoM require banks to maintain a capital base as a function of the risks taken by them. Higher the risks taken by them, the more capital they are required to maintain. It’s indisputably a good requirement but the flip side is that it adds to the cost of risk taking.

Our traditional investors have a world standard business acumen. Most of our bankers and foreign investors (speculators and non-speculators) do have a good reading of our macro-economic and financial statistics. I have met with many, many and many foreign investors throughout my career in my office. Their first shot has systematically been a very probing one on our current account balance. A deficit above 5 per cent has always been a source of serious concern to non-speculating foreign investors with a long term horizon and an important input in their decision making. This is one reason why I have been so blunt on the question of current account deficit since 2008 in the media. When businessmen with a sharp mind and bankers with a shrewd sense of appreciation cast a glance on the huge and unsustainable current account deficit of approximately 10 per cent year in year out that has implications for the exchange rate of the rupee which ultimately has a strong bearing on the balance sheets of banks and enterprises, they cannot but step back, review the risk profile of borrowers and re-assign risk weights in their respective loan portfolios. Many of the issues highlighted in the Report pose immense public relations challenges for banks.

Finally, is the pace of economic growth sluggish because banks are more risk averse than they need to be? Or, have banks become more protective of their balance sheets because of the low growth performance of the economy for several years? The number of loan defaults and the number of enterprises that have closed down operations in the past several years combined with the mood of pessimism expressed by the business community should amply explain the causation. From afar, I suspect the numbers are not insignificant. A ratio of around 3 per cent of non-performing assets to total assets in the balance sheet of any bank is generally viewed as a good indicator of its strength, soundness and viability. A ratio exceeding 3 per cent necessarily implies that a bank has over-indulged in risk taking. Does not the actual (as opposed to the reported ratio) ratio of very far above 3 per cent for our banking industry for years rubbish the oft-repeated view that commercial banks in the country are risk averse? It’s difficult to depend on your eyes when the imagination is out of focus. Abraham Lincoln had once illustrated this point during a trial when he had told the jury the story of a young boy who came running up to his father excited and out of breath. ‘Pa, you gotta come quick. Sis and the new farm-helper are up in the hayloft. She’s gotta her skirt up and he’s gotta his pants down and they are gettin’ ready to pee all over your new hay.’ The farmer looked down at the excited boy and said, ‘O Son, you got your facts right, it’s your conclusion that’s wrong.’ It would be well to remember this parable before falling victim to a hoax.

*The author would most welcome critical comments on the views expressed in this article. E-Mail Address is rbroi@intnet.mu