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February 16, 2009	Monday	Safar 20, 1430

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BANKING sector results for 2008 are yet to be unveiled, but for understandable reasons, market watchers are concerned about the sector’s health in 2009 and beyond. Given the look of things their concern is justified, but the suggested revival strategies are visibly unbalanced, which is more worrying.

It has been suggested that supervisors review banks’ risk profiles, allocate risk (as high as four times of the possible losses) to loans with the potential for going bad, and grade banks accordingly. Supervisors should also ask banks with high risk profiles to set aside larger chunks of their capital as a pre-emptive strategy to avoid being caught off-guard when the losses materialise.

There can’t be two opinions about protecting banks against losses to ensure that they don’t lose public trust. Prudence demands nothing less. The advice is right as far as pre-empting loss impact is concerned but it misses out on the more critical aspect of lending – as the first step, focused risk-specific monitoring of borrower businesses to ensure loan health and timely repayments to minimising losses.

Should saving banks be our sole target, and is immediate recoding of losses imperative for going about achieving even this isolated objective? By making excessive loss provisions banks will end up diluting their equities at a pace prudent only under normal business circumstances, which isn’t the case. The issue demands taking a dispassionate view of the extraordinary set of circumstances we face.

Soft bank supervision permitted the build-up of a big weakness in banks – the absence of research on the demand, supply and pricing trends of the assets banks have been financing. As a result, fallout from the global financial crisis hit banks suddenly and severely. While banks suffer from this regulation-inflicted misery, insisting on ill-advised prudence would only escalate the chaos.

Textile industry (consuming a fifth of bank credit) has accumulated bad loans of over Rs320 billion. Besides being the after effect of the worsening energy shortages (raising production costs), global recession (reducing exports), and recent crash of the over-valued rupee, fundamentally it is the fruit of lending on floating rates to borrowers lacking financial literacy - another regulation-inflicted misery.

Indeed, regulators (hopefully, awakened) must examine banks’ risk profiles in greater detail, and require accurate recognition of losses, but persisting with the current deadlines for booking total loss (within one year in case of short-term loans and two years in case of long-term loans), may lead to closure of some banks or their merger on unfair terms dictated by the crisis.

Besides threatening the already troubled banks, emphasising bank survival at the expense of business and industry can be lethal since it could lead to social chaos. The idea is not to frighten anyone, but it would be imprudent to forget so quickly the after-effects of the December 27, 2007 tragedy; it starkly manifested the limits to law enforcement.

Even if those limits had expanded, closing one troubled business after the other to save banks wouldn’t make economic or moral sense. All responsible governments in Europe and East Asia are preparing to avoid social chaos. They are reminding bankers into remembering that recessions test their calibre in keeping essentially good but temporarily distressed businesses alive until the recessions recede.

All weak loans must be identified and losses assessed accurately, but banks should be permitted to spread booking losses over a longer period than allowed at present so that, while banks focus on recoveries, loss booking doesn’t force bankers to close good businesses that face genuine hardship, nor de-capitalise their banks by booking losses in time spans that apply to periods of normal market activity.

Allowing the benefit of 50 per cent of the forced sale value of assets securing the loans in calculating losses on bad loans, was an odd move for two reasons: with question marks hanging on asset valuation practices banks may benefit unduly from this relief, and prudent re-scheduling and re-structuring of loans for their eventual recovery may lose the importance this crucial effort deserve.

Prudence demanded stretching the loss provisioning period by a year for both short- and long-term loans because it offered breathing space to bankers and borrowers to devise workable revival strategies. This would also have diluted the pressure for auctioning borrower assets in a hurry at throwaway prices (more so in a recession) that will hurt both banks and the distressed borrowers.

Distributing profits resulting from postponement of booking losses could have been forbidden. Slowing the process of loss booking could have slowed the erosion of bank equities to the benefit of their shareholders. Losses could still be recorded but their booking could be delayed until the economy picked up. Far more importantly, this approach would have helped banks sustain public trust and therefore bank liquidity.

In spite of predictions by the prophets of doom, economic chaos will begin to fade after 2010; historic realities suggest so. At the end of WW-II, practically the whole of Europe and Japan resembled heaps of rubble. Starting virtually from zero, they were back on their feet by early 1960s. Today’s economic mess hardly compares with that confidence shattering scenario.

Today banks face the challenge of retrieving wealth from assets that have fallen sharply in value, rationalisng consumption habits, and reviving a savings culture. Given the interaction aids available now (many non-existent until 1960), this effort requires imagination, planning, and a commitment to meeting these objectives to revive saver trust on a lasting basis, not rash, self-destructive courses of action.

Banks or businesses can’t survive in isolation; they are complimentary. Banks projecting a ruthless loan recovery posture will dilute saver trust as will businesses that cause unfair losses to banks. Even Goldman Sachs boss Lloyd Blankfein admits that he never witnessed a wider gulf between the financial services sector and the public because people justifiably believe that Wall Street lost sight of social responsibility.

On February 11, bank bids for T-bills amounted to Rs377 billion against government’s borrowing target of only Rs130 billion. That wasn’t all; bids were at profit rates less than the cut-off rates at the last auction portraying banks’ aversion for lending to business and industry. It amounts to starving the private sector, and is a bad omen for economic revival.