We have a bank-centered financial system. Total assets of our financial system are currently estimated at around 385 per cent of Gross Domestic Product (GDP). The banking sector alone accounts for around 300 per cent of GDP which goes to say that banking accounts for 80 per cent of the total assets of our financial system. Total assets of the most domestic systemically important bank in the country are nearly 70 per cent. The assets of the insurance sector are equivalent to 33 per cent of GDP while those of pension sectors stand at 25 per cent of GDP. Nonbank deposit taking sector inclusive of leasing companies and finance companies have assets equivalent to 16 per cent of GDP. These ratios suggest that the importance of banks in our financial system cannot be understated. If the government ever had to bail out banks in order to protect the economy from collapsing, our debt-to-GDP would fly through the roof. It goes to say that regulation and supervision of banks are a function of the Bank of Mauritius that cannot be taken lightly and politicians should stay out of the regulatory and supervisory arena. In particular, licensing of financial institutions should be free of political influence in the first place.

(…) In the last 46 years, the Bank of Mauritius revoked the banking licences of five banks. (…) In 1996, the Bank of Mauritius had revoked the banking licence of the Mauritius Cooperative Central Bank Ltd. (MCCB). The MCCB as the bank was popularly known suffered from serious capital deficiency. (…) Final outcome: MCCB was put on liquidation. A large chunk of the funds injected by the Bank of Mauritius into the ailing bank has not yet been recovered; it never will be. Tax-payers lost what was then a colossal sum of about Rs 375 million. (…)

One more dramatic episode. Same play, different acts. (…) The Bank of Mauritius revoked the banking licence of the bank in early 2002. Still, he had refused to show up. But he battled from afar to win back his enterprise the liabilities of which had far exceeded its assets. The battle was just a public show; he abandoned the game - eventually. The bank was Delphis Bank Ltd and the chairperson’s name, just in case you have forgotten, was Ketan Somaia, a brilliantly nefarious thespian who finally failed to malinger his way out of prison in Kenya and the UK, just over a year after the revocation of the banking licence of his bank in Mauritius. (…)

Several reasons have motivated me to come up with narratives regarding the revocation of the banking licences of the two banks in quite a distant past. (…) Revocation of the banking licences of the two banks had attracted unjustified criticisms. Aspersions were violently cast on the Bank of Mauritius by a specific section of the population for not having done enough  to bail out the two banks and let down that ethnic group having affinity to those two banks. Extending liquidity to a very badly managed bank owned by almost a single person was tantamount to giving more liquor to an alcoholic to sooth his tremors – a shortterm fix that does not do anything to solve the problem.

Make him feel good enough, and soon he won’t feel anything again. In one of the three cases, an ailing bank needed a massive amount of liquidity from the Bank of Mauritius. The Bank of Mauritius does not lend to ailing banks, however desperate the situation, against fake collaterals – collaterals that have been already and secretly sold by the ailing . (…)

Three of the five banks whose banking licences the Bank of Mauritius has revoked in its history have a common thread that runs through to their demise. Like a piece of an Indian classical raga, a theme plays throughout in different variations, tempos  and pitch. In small, heavily politicized, clan-based societies ,relations between politics, banking and business tend to become too cozy, not to say incestuous. The politically well-connected CEOs or the politically well-connected biggest shareholders have had a domineering influence in their respective banks. They found it difficult to imagine that anything bad could happen – a phenomenon known as ‘disaster myopia” – which makes them develop an infallible instinct to self-destroy and ruin their own banks. Another striking feature of the three defunct banks under reference is specific management weakness, particularly in the lending area, a frequent initial cause of financial distress known even to the most stupid external auditor of banks.

By the way, external auditors generally have the right nose. Tragedy! They pretend to have sniffing deficiency. Bad lending practices, often motivated by considerations other than normal, opened the door to credit weaknesses and left the banks vulnerable to adverse economic cycles. One of our latest discoveries was massive lending to sister companies having fantasy science fiction balance sheets or no balance sheet at all. The tantalized regulator wondered whether he or she should believe in astrologists or physicists in astronomy. Non-performing loans and associated problems accumulated rapidly. The attitude and behavior of top management permeated middle management and other organizational layers. A bad management culture is very difficult to change. The change for the better may take as long as the change for the worse. The regulator finds himself in an impossible position. From technical mismanagement, the defunct banks shifted to cosmetic management and then to desperate management. And finally, to fraud. It’s a sobering reminder of man’s capacity for folly.

Ladies and gentlemen, this year a distressed insurance group involved in shadow banking fell tragically. At least Rs 25 billion, that is, as big as 6 per cent of our 2014 GDP, passed through the shadow bank like the proverbial “dose of salts” to elsewhere. The insanity underlying the mind-boggling interest rates set to deceptively attract funds drove savers to fateful ‘sweet dreams’. A profile of the holders of the funds in the shadow bank reveals that they were mostly households, not necessarily low-income households. Those who held the funds as part of their portfolio of savings were of course merry and felt wealthy. The ‘wealth effect’ on consumption expenditure, particularly on non-essential items, appears to have been significant. The loss of wealth seems to have  had a dampening effect on consumption of nonessential items this year and is likely to last in the months ahead. (…)

Regulatory authorities are rightly placing greater emphasis on quality human capital in the financial services industry. They have come up with stringent requirements for appointment and accountability of senior officers and board directors. In some countries, the UK for instance, appointment for senior positions including appointment of board directors has to go through regulatory authorities. In the selection process, in-depth interviews of candidates are conducted by the regulatory authorities. This appointment procedure is now binding for the financial services industry. Shareholders, board directors and senior management are being called to assume greater responsibility than before. Failure of a bank does not happen overnight. The politics of credit decision-making and other decisions detrimental to a bank are known to the insiders. Over time they build up to a point where the bank finally discovers that its capital is seriously impaired, its liquidity position is perilous and finally it is insolvent. The question is: should such a bank be bailed out without any accountability of the senior officers, directors of the board and shareholders? The latest trend is a set of new norms of conduct and accountability for senior officers and directors. They are being made personally liable in the event of malfeasance. A major improvement in the culture of banks is now an economic necessity.

To the external auditors of banks, I have a few remarks that I do not believe should be restricted to private room conversations. When you make errors, make sure they are errors of judgment, not errors of principle. (…) Firms of accountants do have a universal standard of conduct. Like a reckless and non-performing schoolboy who did not do his homework, an external auditor has no right to say at trilateral meetings with the regulator that his family dog ate his homework. Lately, I personally noted unethical behaviour and signs of rivalries that breached professional decency between what appeared to be gangs of external auditors. One firm turned into a guerrilla game player in order to grab an even bigger piece of the pie. It was an ugly sight. You might not like your neighbour across the street. But is it in your best interest to cause his property value  to plummet? When external auditors fail in their duties because of greed and recklessness, they put an entire financial industry in jeopardy. Greed is good only if it leads to honest wealth creation. (…)

Our bank supervisors have observed that one of the key reasons for loan delinquency and rising nonperforming loans is due to borrowers diverting funds from the main activity for which funds are directed. The ease with which a client in arrears opens another operating account with a new bank with a view to diverting funds for financing non-business related activities is a serious concern from the standpoint of financial stability. Disaster lies in wait for bankers who smoke the same hashish they give out to other bankers. It is no doubt the duty of a banking industry to put a stop to such diversion of funds. Any well-meaning and competent association of bankers with a sense of purpose for the promotion of a robust banking industry ought to have resolved this issue already. An effective association of bankers has to be representative of all the banks, not to be a representative of one or two persons.