Creditors’ losses would put the State’s money at risk

Bangladeshi banks should take responsibility for ensuring financial stability in Bangladesh far more than regulators or legislators. Everywhere in the world, banks are the main contributors and players in the economic development of a country. These days, in Bangladesh, it does not seem to be the same. Banking regulation is often subject to the fundamental mistake of trying to treat banks as market economy enterprises. However, banks do not belong in this category. This money, in turn, finances the banks. In other words, the banks are effectively financed by their customers using a means of payment issued by the state! The Bangladesh Bank provides the banks with the liquidity they need when they need it, thereby implicitly guaranteeing that this money is also safe. Otherwise, customers would not invest their savings, which they do not want to lose under any circumstances, in a bank, i.e., in a company with virtually no equity capital.

This underlines not only the state's dependence on banks but also the fact that banks cannot fail like other businesses. Normal businesses fail when their equity is exhausted. The remaining value is distributed among the creditors. If banks were to fail in the same way, the losses incurred by creditors would put the state's money at risk, something that should be avoided because the systemic repercussions would be guaranteed. Firstly, therefore, it is not surprising that the state is much more involved than in other businesses or that it depends on foreign investment or even foreign financial institutions when local banks run into problems. It is hardly politically possible to tell the banks' lenders that they have to give up their money. Secondly, it also makes it clear that the capital borrowed from the banks cannot simply be written off. If the state no longer guarantees a bank's loan capital, the confidence of other banks is undermined. The risk that other banks will also lose their confidence, and therefore their sources of funding, is by definition high, which is important for correctly categorising the benefits of so-called bail-in bonds.

They were introduced in the wake of the financial crisis to strengthen the capital base of systemically important banks. If a bank is in difficulty, the regulator can decide to convert this debt into equity. As the value of a troubled bank would fall massively, its lenders (bondholders) would have to absorb greater losses. They now hold shares, but these are worth very little. However, banks are only founded on the confidence that the state will protect their loan capital. If it fails to do so and the loan capital loses value, there is a great risk that other banks will be caught in the vortex. So bail-in bonds are no panacea. It is naïve to hope that the next crisis will be any different. The conversion of bail-in bonds into shares, the centerpiece of the current 'Too Big to Fail' regulations, is associated with such significant risks that responsible decision-makers would again look for other solutions potentially costly to the taxpayer, in addition to the provision of liquidity, the risks of which would again have to be borne to a large extent by the state. Bangladeshi politicians would have to face a decision on which direction to take: more government or more personal responsibility for the banks?

Supporters of industrial policy see the advantages of a large global bank and argue that the state should take on additional risks to boost confidence in the bank, notably through the appropriate introduction of a public liquidity guarantee, i.e. a government guarantee to cover losses if the central bank provides liquidity to the bank in an emergency, even in the absence of guarantees. The problem is that if responsibility is delegated further to the state, moral hazards will increase, for example, by encouraging banks to take more risks or to continue to promote foreign activities. From a liberal point of view, this is not the way forward. Making managers more accountable, as intended by the senior management regime and the fine powers sought by Bangladesh's banking regulators, is a good thing in theory. However, it would be unrealistic to think that banks will no longer make mistakes as a result and that bank resolutions will never happen again. It is therefore more important for banks to invest in their own stability first. It is therefore more important for banks to invest in their own stability first. And if state involvement in the mismanagement and resolution of systemically important banks cannot be avoided, it should at least be accompanied by very little risk.

Firstly, the banks can achieve these two objectives by ceasing to incur excessive debt at the expense of the state. This would require a massive increase in (hard) equity. This would make the banks more resistant to shocks. And if capital falls below a minimum level, triggering an automatic resolution mechanism, there would also be sufficient capital to finance the resolution. Secondly, there should no longer be subsidised liquidity protection. This means that banks should be able to cover all their deposits with value guarantees as far as possible so that the central bank does not have to take any risks when providing liquidity in the event of a run on the banks. At the very least, however, all banks should assume this responsibility for their foreign transactions. These transactions can reach a size that could jeopardise stability.

The writer is a Geneva-based private banking compliance security expert, columnist and poet.