Financial Times

Do banks routinely exceed the law?
By Nous
Among the powerful and the ordinary alike, there has never been much respect for the rule of law in our country. It might seem a little churlish therefore to single out the banking industry for criticism on a matter that many in the country feel has long been settled - that might is right and justice is what you can get away with.

Yet it was difficult to resist the temptation to yield to a little churlishness, once lured into the subject by a recent news item in The Sunday Times FT on insider trading offences by Duruthu Edirimunni.

It was a powerful piece of reporting in its suggestiveness of an atmosphere, permeating at the Securities Exchange Commission, of pandering to a select few especially its own, perhaps to the detriment of the institutional building role with which it is charged. The report also succeeded in exposing an underling attitude of fear, cowardice, and cynicism among analysts and brokers.

Yet how much better are the accustomed ways of doing things in the banking sector? Taken as the dominant and more mature player in the financial services industry in this country, it should inspire faith in human nature. But does it?

Regrettably, the institutionalised habits of the banking sector do not all reveal a rock solid basis in the rule of law. For example:

* The banks love to look after the staff of the Central Bank's Supervision Department - giving employment to the relatives of the staff being one approach and the recruitment of retiring staff being another.

* Though a single person or firm together with related parties could own no more than a mere 10 percent of the equity of a bank, some appear to exercise control over banks as if they were personal fiefdoms.

*The interests of minority shareholders are imperilled by the presence of executive directors and by the absence of any real supervision of the activities of the directors as well as by lax control over inter-company and directors-related company transactions.

* The practice of extending the payment schedule of a loan without any additional disbursements or proper restructuring in order merely to underestimate bad debt provisioning and frustrate the exercise of capital adequacy rules is widespread at some banks.

* The capitalisation at inflated values of the properties obtained through foreclosure on collateral too is a practice that appears to be beyond the control of both the Supervision Department and the Arthur Andersons of this world.

If these practices seem only ethically challenged and merely bordering on illegality, consider this.

In a case involving the recovery of loans act, the Supreme Court recently ruled, by a four to one majority, in favour of the petitioner-appellants whose counsel, M. A Sumanthiran and K. Kanag Iswaran PC had submitted that the bank officials often corruptly abused the "harsh provisions" of the Act against guarantors who were not the actual borrowers.

The truly alarming thing about those corrupt abuses was that they took place in plain sight of the actual limits of the law.

The proof of the banks' awareness of the limits, as the counsel had argued, was the fact that the former Finance Minister K. N. Choksy had sought unsuccessfully to amend the Act to cover guarantors or non-borrowers - an amendment that was deemed unconstitutional at the Bill stage.

Yet in fairness to our banks, it must be asked, what is compelling them to act, at times in contemptuous disregard of the rule of law, and routinely as if bound by a desperate ethic?

There is an interesting finding on the workings of banks, credited to the veteran banker Faisal Salih, which might throw some light on the source of this desperation.

His research reveals that the credit decision-making process in this country is largely an instinctual exercise. Financial analyses are used mainly for post-decision rationalisations.

Now, gut feelings do play an important role in decisions. In fact, in the pursuit of knowledge, gut feelings are often said to be the foundation of hypotheses. But these are the intuitions of well-trained and highly knowledgeable minds with the strength to subordinate those intuitions ultimately to the pursuit of knowledge.

What we are here dealing with, however, are the gut feelings of our bankers, and we must remember that banks are faced with a serious problem of retaining better-trained minds, partly because of the deep-seated practice of cronyism. In any event, the typical mindset one is likely to encounter at banks is the type characterised by insularity and even cynicism.

Is it any wonder then that when we think of banks, we can only lament?
The World Bank laments that our banks are unable to discriminate between loan applicants based on merit. The entrepreneurs lament that bankers are indistinguishable from moneylenders.

The banks themselves lament about their nonperforming loan portfolio, while their shareholders, having no one else to blame, are howling about dividends.
Surely, there is an urgent need for banks to change radically, from their personnel to their institutionalised habits, if they are to become genuine allies of progress.

(The writer could be reached at ft@sundaytimes.wnl.lk)

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