How Safe Are Our Savings With Our Banks?

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I had wanted to post the following article on Sunday the 24^th June, 2012. But I stopped posting it because I thought that it was inappropriate for me to unravel another issue of national concern, while the historic Wangdue Phodrang Dzong was ablaze.

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I routinely follow the Opposition Leader’s Blog (http://www.tsheringtobgay.com). Among the most recent posts are “Responsible Government?...” and “Trowa”. These two posts continue to generate some seriously trashy and indecent comments from the blog’s numerous followers but there are also some powerfully pertinent issues being raised, particularly by the likes of Sonam, ProOL, Jamyang, Guardian and others. The discussions that pertain to the past failures of Bhutan’s central bank, RMA to control the imprudent lending practices of the banks are particularly revealing.

In one of his comments, Jamyang writes; “As far as I am concerned, yes, the banks themselves decided into going for a complete ban for all new loan proposals from the day the RMA’s nonresident accounts closure notification came into effect”.

I was shocked by that comment. This is something totally contrary to what I had believed. It was my belief that:

a.     The ban was only on select sectors such as housing and vehicle; and

b.     The regulatory authority (RMA) ordered the suspension of the loans.

I had no idea that the total freeze on loans of all types is/was a decision of the banks themselves. If this is really true, then I am afraid that the problems may be even grimmer than I had thus far assumed.

We have to understand that the most fundamental and principal business plan of a bank is that it will accept deposits from people and institutions and lend out a large portion of it to people and businesses. They make their profits from the interest they earn from these loans they give out. Therefore, if a bank has to suspend lending, they cannot generate profits and if they cannot do that, they cannot pay interest on the deposits they have accepted from their depositors. They cannot accept fresh deposits because those deposits will be costly. Even worst, if a large number of their depositors decide to recall their deposits, they may run into serious liquidity problem.

There can only be one reason why the banks have stopped lending, of their own accord: they may have overstretched themselves to the point that they are dangerously outside the required reserve ratio set by the central bank. Or, they may have run out of cash!

Being overstretched is not so much a problem provided that all their loans are safe and secured. That majority of their loans are serviced in time and that there are no major defaults in loan repayments. But it can be a problem - if and when extraordinary events occur - such as if unusually large withdrawals take place at short notice. Then the balance is upset.

Such an extraordinary event did take place recently - as a result of the central bank’s order requiring the closure of all accounts held by nonresidents. Consequent upon that order, few hundred, possibly even thousand million in deposits belonging to nonresidents were withdrawn in a matter of days. That caused an enormous and dangerous dip in the banks’ available reserve funds, in the process, rendering all traditional calculations and assumptions meaningless. This meant that the banks now did not meet the central bank’s minimum required reserve ratio rule. Even more dangerous, it is possible that their overall lending now far outstripped their available reserve/deposits.

Have the banks endangered our hard-earned money as a result of their indiscipline and greed? Have they tied up our small savings in bad loans? Do they have enough reserves, as required by law, to pay us our money as and when we want to withdraw them? How safe is our money in their hands?

The sudden and complete freeze on lending by the banks is bad for the country’s economic and developmental activities. This is not only bad for ongoing activities but effectively halts new ones. The RMA cannot allow this. But the central bank has a problem - a problem of their own making.

What was the need for RMA to order the closure of the nonresidents’ accounts? It not only did not help curtail Rupee outflow, it aggravated it further. Additionally, it is the main culprit that triggered the flight of extraordinarily large amount of deposits that the banks needed to offset their lending.

To be fair, I believe that the central bank ordered the closure of the nonresidents accounts for a reason. And perhaps that reason is justified, given our compulsions. But now that the end has been achieved, the onus is on the RMA to restore normalcy.

There is no denying that the banks have been very, very irresponsible. They need to be disciplined. However, it is also true that the precariousness of their current state is, to a limited extent, caused by the RMA’s order requiring the closure of the nonresidents accounts. For that, the RMA has to assume part responsibility for the mess that the banks are in.

There is no point talking about what could have been. The situation needs to be corrected before it aggravates further. I think it is fair to assume that the banks’ problems go far beyond the need to remain within the stipulated minimum required reserve ratio rule.

I think they are completely broke!

I think the only answer is to restock the banks with cash immediately. RMA has to do it or, they have to go to the source at whose behest they ordered the closure of the nonresidents’ accounts and get them to bail the banks out.

Before I close, I have to ask two more questions:

Is it legal for nonresidents to open accounts in our banks? If not, how did it happen that the banks accepted their deposits?

What was the RMA’s rationale behind committing and delivering on the promise that all amounts withdrawn from the closed accounts of the nonresidents will be paid in Indian Rupees? These accounts were local currency accounts and, therefore, it is not obligatory on the part of the banks to pay off the nonresident depositors in foreign currency.

Something fishy?