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Recent developments in banking industry and regulatory capture

M S Siddiqui | July 07, 2018 00:00:00

A regulatory authority is a public authority responsible for exercising

autonomous power over any particular sector(s) to formulate policy and
implement those to keep the sector(s) p erforming with a desired objective. It
is independent from other branches or arms of the government. One such
'very important' regulator is central bank (CB) to have discipline in a
country's financial sector.

A CB is created by the law of the land. The mo dern banking system provides
CBs with considerably more rights and responsibilities. It reserves the rights
and authorities to monitor and control the commercial banks and regulate
them to maintain financial stability in the economy. Financial stability is of
paramount importance for any economy to be able to prosper.

The CB ensures healthy competition that is beneficial to the consumers, but

not necessarily detrimental to the banks. The promulgation of regulations by
the CB is typically a response to a per ceived market failure.

The most important regulatory power that a CB has is regulating the reserve
requirements of commercial banks. It is the ratio of deposits that any
commercial bank has to maintain with the central bank. Thus, if this ratio is
increased, commercial banks have to deposit more money with the CB which
may reduce the loanable funds of the banks. By this way CB can reduce
money in the market and increase the interest rate.

On the other hand, banks get more funds to lend if this reserve requi rement
is relaxed. The interest rates will go down due to more liquidity. So central
bank is in a position to significantly influence the operations and profits of
the commercial banks.

But the bank owners in Bangladesh at present seem to have great influe nce
in formulating banking and financial laws and policies. The Banking
Companies Act has been amended to accommodate four instead of two
directors from a single family. The tenure of Directors has been extended to
consecutive nine years from six years.
The Finance Minister and the BB Governor seem to have taken a policy
decision at a recent meeting with the bank owners. It was not a mere
consultation with the stakeholders. They discussed the CRR (cash reserve
requirement or cash reserve ratio) reduction in itiative in a meeting with the
Bangladesh Association of Banks (BAB). Accordingly BB revised the CRR at
5.5 per cent for commercial banks on bi -weekly average basis from the
existing 6.5 per cent.

BB also re-fixed the repo interest rate from 6.75 per cent to 6.0 per cent. The
repo interest rate determines the rate of interest a commercial bank has to
pay on a loan from the BB. It has also reduced the 6.0 per cent daily basis of
average total demand and time liabilities down to 5.0 per cent.

The BB Governor called a meeting with the bank owners and finance ministry
officials for discussion on provision of keeping deposit money belonging to
various government departments. As per the decisions made at the tripartite
meeting, the government organisations have be en instructed to keep 50 per
cent of their funds in private banks, which were 25 per cent of the total
deposit.

Corporate tax of banks has been reduced from 45 per cent to 42.5 per cent in
the current national budget although there is no change in corporat e tax rate
of other sectors.

BAB in a recent meeting decided to bring down interest rate to 6.0 per cent
on deposit and 9.0 per cent on loan. But they also asked for deposit of
government funds with their banks at a rate of 6.0 per cent interest. Ideally,
such a change in interest rate should have been regulated by the mechanism
of BB.

Government uses its authority to compel its citizens and businesses to pay
taxes and follow rules. By trying to influence how the state uses its coercive
authority, businesses seek to 'buy' one or more of the government's four
main mechanisms -- subsidies; control over competitive entry; regulation of
product substitutes or complements; and the fixing of prices.

Nobel laureate economist George Stigler was the first to note tha t
businesses seek to influence regulatory agencies to their advantage. The
Theory of Economic Regulation was published in 1971 wherein Stigler
argued that regulation is a product that, just like any other product, is
produced in a market, and that it can b e acquired from the governmental
'marketplace' by business firms to serve their private interests and create
barriers to the entry of potential competitors. He also argued that regulation
is instead 'acquired by the industry and is designed and operated pr imarily
for its benefit.'
Stigler challenged the conventional idea that regulation arises solely to serve
the public interest and demonstrated that important political advantages held
by businesses can contribute to 'industry capture' of the regulatory pro cess.
He illustrated his insights with empirical evidence from state -level regulatory
schemes, including trucking regulation and occupational licensing.

A significant insight emerging from capture theory is that a regulator may act,
either intentionally or unintentionally, in a way that results in personal or
institutional gain.

Regulatory capture in financial sector occurs when regulators become, at

least partly, advocates for the financial institutions they are supposed to
regulate and supervise rather than being strict enforcers of rules. This leads
to lose application of regulatory rules, forbearance to regulatory infractions
resulting in poor application of supervision. Frequent personal moves of
individuals between regulatory institutions and private f inancial sector,
relatively higher pay in the private sector, limited tenures, political pressures
and human nature combine to encourage regulatory capture and supervisory
forbearance.

Stigler's theory brought to the foreground what remains one of the most vital
questions about regulatory institutions: how can they be made to work better
to advance public welfare. An essential insight of Stigler and other
economists who followed his lead was that all players in the regulatory
regime - firms, bureaucrats, interest groups, and legislators - act as
economic agents who have the interest and opportunity to advance strategic
actions.

More than forty years have already elapsed since Stigler published 'The
Theory of Economic Regulation'. Much has changed during this time in the
global economic policy of opening up with less regulatory regime, but
policymakers still know too little about how to design regulatory institutions
to resist capture and enhance the broader issue of social welfare.

MS Siddiqui is Legal Economist.

mssiddiqui2035@gmail.com