Despite numerous bank failures in the
recent past around the world, and the grubby, shady deals regularly
entered into by bankers, it is, by and large, a pretty respectable
profession.
It is one that many young people still aspire to, and it is
an industry no economy can do without. The odious aspect to the
profession owes its origins to history. Bankers started out as a bunch
of self-serving money changers. The biblical reference to the role of
money changers is unedifying, as they once incurred the wrath of Jesus
Christ himself, who angrily chased them out of the Temple. “Banco” is
the Italian word for bench. In ancient times, money changers would sit
on it whilst displaying their wares to customers. Their initial
institutional customers were the old merchants (remember merchant
banks?), who needed deposit facilities to store their precious metals,
especially gold. The money changers soon realised that these deposits
could be recycled and put into other commercial and industrial
activities. As long as they do not deplete the deposits in their
custody, they could carry on generating lucrative trade for themselves.
The rest in the development of modern banking is history.
However, the problem then, as now, is
what to do if the depositors start retrieving their gold and precious
metals simultaneously? Short answer is they go bust. Whenever that
happened to the money changer-cum banker, in the past, the bench, i.e.
“Banco” on which he sat was symbolically broken in the open for people
to see. This was known as “Bancarotta” or, a broken bench, otherwise
called bankruptcy in today’s parlance.
The process whereby people withdraw
their deposits simultaneously is called a bank “run”. Bank runs are
generally understood to be a terrible occurrence, but the process also,
paradoxically, provides the means to eliminate inefficiency and bad
(toxic) investment or asset from the system. Closure is the result of
irreconcilable problems in a bank’s fundamentals. More often than not,
financial authorities tend to step in to save a bank under stress
because of the risk of contagion, that is, the possibility of a closure
spreading like bush fire onto other banks, creating a systemic risk for
the whole sector and beyond. Nowadays, though ordinary customers enjoy a
degree of protection from bank runs. Their deposits are often
guaranteed by the banking regulator up to a certain amount.
Institutional investors in the banks, however, are more exposed to all
types of speculative runs. It is the game they understand and indeed,
enjoy playing. They look and model the action of other players in the
game on their computer software, and try to anticipate what the other
may be up to at a given period. At times, they join in the stampede of
mass withdrawal and other times they ignore such.
A good example of this was provided by
the Hungarian hedge fund manager and philanthropist, George Soros, in
September 1992. By the way, hedge fund management simply means a private
investment house, where people with gargantuan amount of excess cash
deposit their money to be used to make even more money, by playing
high-risk and highly rewarding bets on the exchanges. The amount
involved is usually so large that placing it in the run-of-the-mill
commercial bank for a pre-determined interest rate makes no sense. When
the calculus comes right for a hedge fund manager, it comes really big,
and when it goes wrong, well, billions of dollars could go up in flames
in minutes. Soros, whose family brought him to London, fleeing Communism
in his home country of Hungary in the 1960s, graduated from the London
School of Economics, and thereafter set out to play the capitalist game
of making money. He soon made enough to set himself up for life in the
UK, but he wanted to apply his canny to something bigger and even more
exciting. So, he left for New York, in the United States, whereupon he
coaxed enough wealthy individuals into entrusting their money unto him
to “manage” (or gamble with), depending on your taste and financial
sense. His big break came when, in 1992, he put all the billions of
dollars at his disposal into betting against the UK staying in the
Exchange Rate Mechanism of the European Union. This prompted a run on
British banks, and the government intervened multiple times with a hike
in interest rate to put a brake on the outflow of capital from the UK
economy. Undeterred, Soros threw even more billions of dollars at it,
steadfast in his hunch that the UK would be forced out, then, others
joined in the stampede which, true to prediction, eventually forced the
UK out of the ERM. Soros and his clients became multi-billionaires
instantly. How I wish I had his genius!
Interestingly, when Malaysia was going
through a similar financial turmoil and became aware of a rumoured plan
of Soros’ imminent trade on their exchange, the Malaysian Parliament
hurriedly passed legislation to impose the death penalty on anyone
caught speculating on their hard won effort at stabilising their
currency. Soros, then in his late 70s, understandably opted not to take a
chance, and has since returned to Hungary a hero with his “loot”.
In a situation like we have just
discussed, it is always open to the country’s central bank to step in as
the bank of “last resort”; a view enunciated by none other than the
English economist, Walter Bagehot (1826-1877), who advised central banks
to, among other things, announce in advance their readiness to lend to
banks without limits to make them stay solvent. This doctrine was first
put into practice by the Bank of England in the “Barings crisis” of
1890. Others around the world have since followed the logic to this day.
The Central Bank of Nigeria has carried this responsibility furthest.
It has moved from simply being a regulator to supervisor of banks in
Nigeria. It imposes term limits on Chief Executive Officers of banks,
suspends and dismisses management of banks at will, countermands major
investment decisions made by banks, etc. In addition to this, the CBN
has the additional support of the country’s Assets Management
Corporation of Nigeria, whose primary function is to “manage” (take over
if you like) the assets of any entity critical to the economy, found to
be in distress. Nothing could be more cast-iron for the solvency of
Nigerian banks than this, you might think?
Well, risk-taking is part of the raison
d’être of commercial banks, it is written in their DNA. This, however,
is more apparent than real in the case of Nigerian banks. The CBN ought
not to overegg their supervisory remit too much lest it stifles thrift
and innovation. Moreover, try as the CBN might, Nigerian banks cannot be
protected from the headwinds of globalisation and the constant clarion
call for deregulation in international finance. Moreover, increasing
penetration of financial services by non-banks, providing high-quality
banking services will eventually force the banks out of the CBN’s
protective (comfort) zone. By any acceptable yardstick of international
banking services, Nigerian banks live a much sheltered life at the
moment for a good reason; they have ran amok before, costing the Federal
Government a whopping one trillion naira to bail them out. That said,
the current philosophy of the CBN to the effect that any bank in Nigeria
is always worth more alive than dead is untenable in the long run.
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