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2 Rocking the land of
Poppins By Chan Akya
to stay in business, and thus they
choose to repay the banks, albeit with loans from
other banks in most cases.
The growth in
retail lending is hamstrung by poor legislation.
It is a fairly lengthy process for banks in China
and India to repossess homes of delinquent
mortgage borrowers, for example. This difficulty
in turn encourages slightly more risky behavior by
some borrowers, although cultural factors such as
the social stigma
attached to being bankrupt
helps keep such risks on the lower side overall.
Additionally, there are not a lot of
avenues for banks in China and India to sell their
risks. The use of financial derivatives to
diminish risk on the asset side of their balance
sheets is quite low, even as the banks are
themselves enthusiastic buyers of similar
instruments originated in the US and Europe. I
blame both the absence of securities regulations
and the lack of investor education for this state
of affairs. Granted that these are broadly the
same category of financial derivatives that got US
and European banks into trouble, their use is
however justified by the sheer scale of risk being
handled by banks in China and India relative to
their capital bases.
Last comes the issue
of supervision. Asian central bankers are in
general less sophisticated than the dictates of
modern financial systems. I rate the Reserve Bank
of India ahead of the People's Bank of China in
this respect, but that's like saying Josef Stalin
was a better human being than Adolf Hitler. The
central banks have a poor understanding of
financial derivatives and their ability to
distribute risk, as well as the benefits of
rigorous risk analysis. Overall staffing levels
are actually too low for their remit, and all too
often officers are promoted for political rather
than reasons of merit.
What to do Rather than let all these issues simmer below
the surface, Asian central banks must act
immediately. I suggest the following measures to
be adopted with great urgency by governments as
well as central banks.
First, merge small
and medium-sized banking entities into larger
operations. Risks are often too localized when
banks concentrate on specific regions. Examples of
this can be found across the southern Chinese
coast, where a number of banks quite literally
only serve a single region and are therefore
overexposed to certain industrial sectors. Merging
these banks with those operating in different
environments would be mutually beneficial.
Second, all public banks must be listed on
the stock exchange, with foreigners allowed to own
shares. While this is not in any way to suggest
that foreigners are smarter than Asians at
assessing risks, they do demand higher disclosures
and transparency. Additionally, the insights of
various dedicated fund managers specializing in
bank stocks cannot but be good for the system as a
whole - witness for example the improvements
brought about in Japan by foreign-owned companies.
Third, securities legislation must
incorporate new classes of financial derivatives
and provide incentives for banks to sell down
their risks (bank regulation). This would allow
the development of proper bond markets across
China and India that could help increase the
flexibility of Chinese and Indian banks in terms
of trimming their balance-sheet exposures to some
assets while providing themselves with additional
sources of liquidity.
Fourth, central
banks must increase their supervision standards.
In the case of Northern Rock, one of the key
failures appears to be that the bank was
maintaining low cash balances with the central
bank to take advantage of the "averaging" of cash
balances. Using averages is pretty dumb for banks
- central banks must monitor variance and step in
whenever balances fall, say, 20% below the
required amount. This requires improved systems
and better supervision.
Last,
government-mandated limits on bank lending must be
scrapped. These limits force banks in China and
India to lend to specific sectors and regions
because of the "priority" focus of the central
government. That is a matter of fiscal rather than
commercial intervention; therefore the direct
responsibility for such loans must remain with the
government rather than individual commercial
banks.
Conclusion China and
India are well positioned now to undertake serious
structural reforms. They should not wait for a
crisis of the Northern Rock magnitude to force
their hands, but rather act immediately. My
suggestions above only represent a start for the
sector. Forget air-conditioning the branches and
providing free tea to the people visiting them;
more urgent work beckons behind the scenes.
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