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For centuries, banks have influenced the economies and politics of the world. Traditionally, banks originated as places where businesses could secure loans to purchase inventory, and thereafter collect the funds with interest once the goods were sold. The origin of the word bank is derived from the Italian word, “banco” or desk. During the Renaissance, Florentine bankers conducted their transactions above desks covered in a green tablecloth.

It has been speculated the earliest banks were actually religious temples in the ancient world, where deposits of grain and other goods were made. Considered sacred places, these temples were well protected from potential thieves. There are also historic records which point to loan activity extended by priests to merchants in ancient Babylon. Hammurabi’s Code, the oldest, best preserved law code in existence was created circa 1760 B.C. and includes laws which were used to govern bank operations.

Not surprisingly, the Ancient Greeks further developed the concept of banking. Transactions such as loans, deposits, currency exchanges, and more were conducted in temples as well as private and civic components. Evidence also points to the concept of credit. In return for payment from a client, a creditor in one Greek port would write a note of credit that the client could later cash in another port city. This convenient method saved the client from the danger of carrying coinage with him on his journey. Historic records indicate that a Pythius of the early 5th century B.C. operated as a merchant banker throughout Asia Minor.

The rise of the Roman Empire brought about greater administrative and financial regulations for banking. The charging of interest on loans was further developed by scrupulous financiers, making the system highly competitive. However, the bank system eventually broke down in large part to the Roman preference for cash transactions. Following the fall of Rome, Western Europe essentially abandoned banking. It did not experience a revival until the need for financing the Crusades stimulated its re-emergence.

Interestingly, the world’s oldest bank has been in existence since its founding in 1427. The Banca Monte dei Paschi di Siena SPA (MPS) was created in the city state of Siena, Italy. The bank today is comprised of nearly 1,800 branches, 28,000 employees and more than four million customers in Italy and abroad.

Fast forward to Western banking history, which is generally traced to the coffee houses in London. Founded in 1565, the Royal Exchange acted as a center of commerce for the city. A hierarchy of banking started at the top with bankers who conducted business with heads of state, followed by city exchanges, and at the bottom, pawn shops. In 1609, the Amsterdamsche Wisselbank (Amsterdam Exchange Bank) was established, making Amsterdam the financial center of the Western world.

Concepts of capitalism extolled by Adam Smith, considered the father of modern economics, and the advent of the Industrial Revolution gave way to a massive growth in the banking industry in the 18th and 19th centuries. In the United States, the first banks required special permission from the state government to operate. The state’s supervision proved inadequate as individual banks began issuing their own notes. By 1860, more than 10,000 various bank notes were circulating throughout the country. Counterfeiting was rampant and hundreds of banks failed. Government reforms created a new system of banking which included an involved method for producing authentic bank notes.

With the onset of the worldwide depression in the early 1930s, banks took a hard hit, which led to Congress’ creation of federal deposit insurance. President Franklin D. Roosevelt oversaw the implementation of laws aimed at limiting risks to banks and restoring Americans’ confidence in the banking system.

Since then, banking has undergone a revolution with technology transforming the way Americans bank. First telephone banking, and then ATMs, debit and credit cards, have lead the way to new innovations. Today, online banking and electronic money are evolving. Banks strive to serve the greater public in a competitive market that ensures a safe and sound banking system. From religious temples and Italian desks to coffee houses and the Industrial Revolution, banking has forever changed the way we live.

If you belong to the generation that feeds on technology then Internet banking shouldn’t at all be an issue for you. The Internet for you is the place to get things done quickly without actually going out. Banking is one of these things. For those who are a bit older, the concept of not interfacing with a human inside the bank will be a bitter pill to swallow. They still are yet to be convinced so it is necessary to weigh the advantages and disadvantages for Internet banking.

Apprehensive people know about the many wonders of the Internet and they have heard so much about Internet banking but they are still paying their bills by mail and depositing checks at their branch.

Many people are already using the Internet to shop for items, or even financial packages for mortgages and loans but when it’s time to finalize, they still opt to go to the office of the company they chose and seal things with an agent.

Before comparing the advantages and disadvantages for Internet banking, let us first define the concept so others who do not know yet can have an idea.

The What and Who in online banking

When the Internet started to become very popular and computers began to become more and more advanced, many businesses started to shift their attention to the trend and established their online presence. This same trend also started to reshape the banking industry.

In the past, banks used computers to automate their daily transactions. These days, there hardly is any paper work at all since everything is done online via the bank’s network system. The only thing that serves as a transaction record is the receipt a shopper gets when she’s at the POS of her favorite boutique.

For banks, their Internet presence is a value-added service for existing and new customers.

Online banking goes by so many other names like PC banking, home banking, electronic banking, or Internet banking.

The first ones to test the waters were the large national banks. Soon, regional banks, smaller banks, financial companies, and credit unions joined in and implemented their own electronic banking system based on the Internet. These institutions that have expanded to online have since then referred to as brick-to-click banks as opposed to brick-and-mortar banks. The latter refers to those, which are yet to offer online banking o their customers.

Aside from the brick-to-clicks, there are “virtual” banks that have emerged. These are banks that do not have physical offices or branches, and any tellers or agents. These banks exist only in cyberspace but they still are covered by the same federal regulations that cover the ordinary banks.

Nowadays, the large banks have sites that provide fully secured and fully functioning online banking services that give their customers ultimate convenience. The smaller ones which are a bit more cautious to go full circle offer access to limited banking services like viewing of account balance and history viewing only.

The more banks that go online and succeed in making their services secured, the more that people will have lesser doubts about the advantages and disadvantages for Internet banking.

DEMOCRACTIC DEFICIT IN AN INDEPENDENT CENTRAL BANK: THE QUEST TO BALANCE THE SCALES

By

Leonard Nkole Kalinde*

• 1.0. INTRODUCTION

Central banking is of cardinal importance in any country because of the legal right normally granted to central banks to create money. This money can serve as a means of payment, a unit of account and a store of value. One of the important issues immediately arising after granting this right to a central bank, is whether this function should fall under the ultimate control of the executive branch of government – the cabinet and its administrative departments – or whether parliament should leave this responsibility to be freely executed by an independent, autonomous powerful institution run by unelected people.

The traditional argument in favour of a strong, independent central bank is that the power to spend money should in some way be separated from the power to create money. Numerous episodes in the world’s economic history testify to a government’s potential abuse of its power to create money. However, one potential objection to a completely independent central bank is lack of democratic accountability and transparency. This paper discusses the challenges of ensuring central bank accountability and transparency in an environment where the central Bank is independent. Part two discusses the concept of central bank independence. Part three examines and analyses the need to have democratic accountability and transparency in the operations of a central bank. Part four concludes that proper democratic accountability and transparency in central operations is not a counterweight to the principle of central bank independence.

• 2.0. THE CONCEPT OF CENTRAL BANK INDEPENDENCE

Nowadays it is widely believed that a high level of central bank independence coupled with some explicit mandate for the bank to restrain inflation are important institutional devices to assure price stability. It is thought that an independent central bank can give full priority to low levels of inflation, whereas in countries with a more dependent central bank other considerations, notably, re-election perspectives of politicians and a low level of unemployment, may interfere with the objective of price stability. Indeed, there is considerable evidence for a negative relationship between central bank independence and inflation. The extent and nature of central bank independence can be assessed on the basis of its legal provisions However, central bank independence also hinges on a broad series of factors and customary practices, which are partly determined by historical developments in the different countries. In particular, the way in which certain conflicts with other bodies of government have been resolved influences the extent to which a central bank is effectively protected against external interferences and marks the boundaries of independence.   

Central Bank independence refers to three areas in which the influence of government must be excluded or drastically curtailed, that is to say, independence in personnel matters, financial autonomy and policy independence.  These are now discussed hereunder:

2.1. Personnel Independence

The nomination and dismissal of the Governor and members of the central bank’s decision-making bodies pertain to the political authorities. In practice, it is not feasible to exclude government influence completely when appointments are made to such an important public institution as central banks. Personnel independence thus refers to the influence that government has in appointment procedures. Various criteria are relevant here, like governmental representation in the governing body of the central bank, appointment procedures, terms of office and procedures governing dismissal of the board of the bank.

The legal framework for central banking in Zambia, which is the Bank of Zambia Act No. 43 of 1996, in Section 10, vests the power of appointing the Governor in the President of the Republic of Zambia. However, this is subject to ratification by the National Assembly. Furthermore, Section 13(1)(b) vests the power of appointing Members of the Bank of Zambia Board of Directors in the Minister of Finance and National Planning. Finally, Sections 10(7) and (14(2) gives the power to disappoint the appointment of the Governor and Members of the Board of Directors to their respective appointing authorities. Their tenure of office is specified in sections 10(1) and 14(1), which gives the Governor five years and Directors three years, respectively.      

Financial Independence

A central bank cannot operate credibly in an independent way without proper financial means. It is clear that politicians can influence central bank policy if the government is able to finance its expenditure either directly and or indirectly via central bank credits. In that case there is no financial independence. The concept of financial independence should, thus, be assessed from the perspective of whether any third party is able to exercise either direct or indirect influence not only over the central bank tasks but also its ability to fulfil its mandate. In this regard, four aspects of financial independence – the right to determine its own budget; the application of central bank-specific accounting rules; clear provisions on the distribution of profits; and clearly defined financial liability for supervisory authorities – are particularly relevant in this respect.

The Bank of Zambia Act has several provisions that regulate how the Bank is to conduct its financial affairs and what the government responsibility is towards its financial well-being. In the first instance, Section 6(3) makes it clear that the Government is the sole subscriber to the paid-up capital of the Bank and its holdings of the paid-up capital is not transferrable in whole or in part nor can it be subject to any encumbrance whatsoever. According to Section 6(5), whenever the Bank of Zambia Board certifies that the assets of the Bank are less than the sum of its capital and other liabilities, the Minister is required to cause to be transferred to the ownership of the Bank negotiable and interest bearing securities issued by the Government for such amount as is necessary for the purposes of preserving the capital of the Bank from any impairment. In addition, Section 7 has elaborate provisions on how the net profits of the Bank are to be determined for each financial year, and where the Bank makes a loss on its profit and loss statement, as certified by the auditors, the Minister is again required to cause to be transferred to the ownership of the Bank, cash or negotiable instruments bearing market interest rates and such securities shall be delivered to the Bank within sixty (60) days from the date of certification of the accounts by the auditors.   

2.3. Policy Independence

Policy independence is related to the room for manoeuvre given to the central bank in the formulation and execution of monetary policy. It may be useful to distinguish between goal independence and instrument independence. A central bank has goal independence if it can decide on the formulation of its ultimate objective(s). In practice, most central bank laws formulate one or more objectives. For instance, Section 4 of the Bank of Zambia Act provide that the functions of the Bank shall be to formulate and implement monetary and supervisory policies that will ensure the maintenance of price and financial system stability so as to promote balanced macroeconomic development. However, if the central bank has been trusted with various (possibly conflicting) goals – such as achieving low inflation and low unemployment – it has considerable scope in deciding on its priorities. In that case, the central bank has considerable goal independence since it is relatively free to set the final goals of monetary policy. It could, for instance, decide that price stability is less important than output stability, and act accordingly. Finally a central bank must wield effective instruments in order to defend its objective(s). A bank that has instrument independence is free to choose the means by which it seeks to achieve its goals. Clearly, if government approval is required for the central bank’s use of policy instruments, no instrument independence exits. Perhaps, the most disconcerting provision of the Bank of Zambia Act is Section 5, which provides that the Minister may convey to the Governor such general or particular Government policies as may affect the conduct of the affairs of the Bank and the Bank shall implement or give effect to such policies. This provision could lead to serious interference with the operations of the Bank.      

• 3.0. DEMOCRATIC DEFICIT IN CENTRAL BANK INDEPENDENCE

At a glance, the concept of central bank independence seems to be in conflict with the democratic principle that government policies should be controlled by elected officials rather than by an elite group that is insulated from the political process. Although there are plenty of other areas of national life where decision-making is delegated to independent unelected officials, the judiciary being a prime example, there is a fundamental confusion here between being independent and lacking accountability and transparency. It is often argued that central bank independence and democratic accountability are contradictory. This is, however, only correct as far as decisions about the ultimate goal of and final responsibility for monetary policy are concerned. In other words, a central bank should not be goal independent but must be granted instrument independence.

The corollary of this view is that the institutional commitment to macroeconomic stability should come from the government in the form of an explicit, legislated mandate for the central bank to pursue, for instance, price stability as its overriding long-run goal. Indeed, as Issing argues, the more clearly and precisely this mandate is defined, the easier it will also be in a democracy to monitor the performance of the central bank. Moreover, in order to maintain credibility, an independent central bank must not only be open and clear about the reasons for its actions but it must also be accountable to democratic institutions.

3.1. Central Bank Accountability

In any evaluation of the democratic accountability of the central bank, the relationship between the central bank itself and the legislature has to play a major role. No central bank can be totally independent, in the sense that it is not answerable to anyone. Even the most independent central bank has to report in some form or another to the legislature, which in any case also has the ultimate power to change the laws governing the central bank. In this regard, it has been argued that the legislature holds the ultimate responsibility for monetary policy since it can change the legal basis of the central bank. The mere threat of a change of the law may induce even independent central banks to ensure that monetary policy will in general be in accordance with the wishes of elected politicians. However, there is a difference between a situation where policy decisions are under continuous scrutiny and an arrangement where the central bank reports to the legislature periodically.

In the Zambian context, Section 9 (1) of the Bank of Zambia Act requires the Bank, in consultation with the Minister, to publish in the Government Gazette, every six (6) months interval, a policy statement that shall contain: (a) a description and an explanation of the reasons for the monetary policies to be followed by the Bank during the following six (6) months; (b) a description of the principles that the Bank proposes to follow in the formulation and implementation of monetary policy during the next two years or such other period of time as the Minister may decide; and (c) a review and assessment of implementation, by the Bank, of monetary policy during the period to which the last proceeding six months policy statement relates. The Minister is required, within the first sitting of the National Assembly next after the receipt of the monetary policy report, to lay it before the House.

In addition, Section 27 requires the Board of the Bank of Zambia to, as soon as is practicable but not later than six months after the expiry of each financial year, submit to the Minister a report concerning its activities during such financial year. The Minister may also request the Board to submit to him such other reports, returns or statements, duly certified by an auditor, as he may consider necessary. Furthermore, the Bank of Zambia is also required, under Section 28(1), to cause to be published in the Government Gazette a return of its assets and liabilities, and to deliver to the Minister a return of its monthly assets and liabilities whenever he so requires. 

It is important to note that the issue of independence and accountability also turns on the nature of the relationship between the government and the legislature as the political authorities on the one hand and the central bank on the other. Without encroaching on the independence of the central bank, there should be a legal requirement for the central bank to report to the legislature and/or explain policy actions in the legislature. The legislature should have the opportunity to review the performance of the central bank with regard to monetary policy on a regular basis, while the central bank at the same time can explain and justify its conduct. In the European case, the Treaty establishing the European Community imposes precise reporting obligations on the European Central Bank. The European Central Bank must deliver an annual report on the activities of the European System of Central Banks to the European Parliament, the European Council and the European Commission. The European Parliament can also summon the President of the European Central Bank and the other members of the Executive Board to appear before it and make the necessary presentations.

Furthermore, a central bank may not only be directly accountable to the legislature but also to the government, which is, in turn, accountable to the legislature. In that case, it is important that the government is able to influence the central bank’s behaviour. Without such influence, accountability would not go beyond mere reporting by government to parliament of central bank policies, for which government cannot be held responsible. Finally, the dismissal procedure for a central banker can amount to a mechanism of ex post accountability if a central banker official can be dismissed on the grounds of bad performance, that is to say, not realising stated objectives. Dismissal may function as a sanction for poor performance by linking the tenure of central bank officials to policy results, that is to say, meeting the predetermined monetary policy target. This is the case for the Reserve Bank of New Zealand where the policy target agreement between the Governor of the Bank and the Minister of Finance lays down the policy targets, which the former has to achieve. Inadequate performance can result in the dismissal of the Governor.     

3.2. Central Bank Transparency

Another very important element of central bank accountability is central bank transparency. In this regard, central bank transparency cannot be logically separated from accountability. This is because whatever other arrangements concerning democratic accountability may exist, their scope is limited without transparency because information concerning the behaviour of the central bank is crucial for the evaluation its performance. Where the reasoning behind, and strength of opinion supporting, certain monetary policy decisions are transparent, it is easier to make a judgement and to hold central bank officials accountable for their behaviour. Indeed, as Buiter argues, the entire monetary policy process must be transparent for democratic accountability. Therefore, a central bank should be required to report at regular intervals on its current and future plans for monetary policy in accordance with the monetary objective. This is even more important where a clear monetary objective is missing because in such cases the central bank can only be judged on the basis of its own statements.

As transparency should not be left to the discretion of the central bank, the law should prescribe certain procedures for explaining monetary policy. There are various possibilities, ranging from reports, minutes and other communication devices. Transparency will certainly be improved if the monetary authorities have to explain the extent to which they were able to reach the final objectives of monetary policy. In the European case, Article 15.1 of the Statute of the European System of Central Banks and European Central Bank requires the European Central Bank to publish reports on the activities of the European System of Central Banks  at least once every quarter. However, in its attempts to enhance transparency, the European Central Bank has committed itself to go beyond the reporting requirements specified in the Treaty. The President explains the reasons behind the Governing Council’s decisions in a press conference and details of the Governing Council’s views are published in the ECB Monthly Bulletin.  

4.0. CONCLUSION

This paper has argued that at a glance, the concept of central bank independence seems to be in conflict with the democratic principle that government policies should be controlled by elected officials rather than by an elite group that is insulated from the political process. The basic principle of democracy, which expects the public to be able to exercise control over government actions, strongly suggests that elected politicians should decide on the explicit definition and ranking of the objectives of monetary policy. Central bankers should never forget that they are ultimately accountable for their policies to the elected politicians and to the public at large (including future generations). In this respect, it is misleading to think of proper accountability and transparency as a ‘counter-weight’ to central bank independence. On the contrary, accountability is the ‘other side of the coin’ of independence and the two concepts are mutually reinforcing rather than antagonists, as is sometimes suggested. Any weakening of the democratic control over an independent institution may lead to excessive discretion and unclear objectives, which risks creating political backlashes against independence and may overtime undermine independence itself. Therefore, independence is sustainable in the long term only if accompanied by strong accountability and transparency in the operations of the independent institution. The legal provisions can more easily be circumvented if there are no provisions ensuring central bank transparency and accountability.

Microfinance: NGO vs Banking
Sadaket Malik**
The role of non-governmental organisations (NGOs) in microfinance (MF) needs reviewing from an operational perspective. Based on research of selective studies and experts’ opinion, selected literature on microfinance, and the author’s own experience over the last decade, this paper seeks to establish two main points. First, it asserts that with a few notable exceptions, the record of NGOs in mainstreaming microfinance is a modest one viewed from the context of NGOs as microfinance institutions (mFIs). When judged by the two criteria of success that much of the microfinance world has adopted – outreach to the poor and financial sustainability – the results are not encouraging [Nair 2001]. NGOs as mFIs have thus far had trouble achieving both objectives simultaneously. There is also little evidence of any aggregate impact on poverty reduction as the result of mFIs’ forays. The success of NGOs has however been laudable where facilitating and social intermediation criteria are applied. It is here that the author feels that the strategic partnership between banks and NGOs is poised to change the developmental intervention map of India. Second, the essay suggests that banks, for all their laudable work, will be making a strategic error in focusing on financial intermediation while ignoring partnership with NGOs. While microfinance is never easy for other types of institutions trying to practise it (e g, NGOs or credit unions), it is not, as will be explained, a field where a banker has natural advantages.
Why Partnership?
To the extent that banks incorporate NGOs’ activities in mainstreaming their self-help group (SHG) portfolios, they stand to gain. To the extent NGOs reorient their mission, vision and personnel towards the microfinance agenda, as a large number have done in the last decade, they risk drawing themselves away from work they are uniquely suited to do. Some of this work, moreover, would play a critical role in preparing the ground for mF among poor people. In other words, NGOs have to move away from pure financial intermediation to investing in human and social capital at the grass roots and bankers have to tap this invaluable experience of NGOs in mobilising, graduating and enabling rural communities. This will prepare the ground by enhancing credit absorption capacity of SHGs and enhancing their creditworthiness. The following account will explain how.In 1997, the World Bank’s Sustainable Banking for the Poor (SBP) project completed an ambitious survey. Until then those interested in microfinance had an intuitive sense of the movement’s growth, but no systematic attempt had yet been made to gauge its dimensions, nor look comprehensively at its results. The findings were unambiguous: NGOs acting as mFIs did not have any significant outreach vis-à-vis other financial institutions purveying microcredit.
Interestingly, commercial banks accounted for 78 per cent of the total number of outstanding microloans, and credit unions 11 per cent. NGOs accounted for only 9 per cent, and savings banks (which are not primarily in the credit business) just 2 per cent. Also, commercial banks accounted for 68 per cent of the total outstanding loan balance, savings banks 15 per cent, credit unions 13 per cent and NGOs 4 per cent. In terms of numbers of clients, commercial banks and credit unions showed significantly greater overall outreach than NGOs. While NGOs’ outreach, on average, was deeper, it was also narrow – NGOs reach some very poor people, but they do not reach many. On the other hand, credit unions and commercial banks also serve some wealthier clients so that their average outreach to the poor is not as deep. Still, the indications are that overall, credit unions and commercial banks serve more under-served poor clients than do NGOs.
This is not to rule out the role of NBFCs, NGOs with inchoate mFI activities or pure mFIs. The demand for financial services is high and as stated by the High Level Task Force on mF: “At least 25,000 bank branches, 4,000 NGOs and 2,000 federations of SHGs involving over 1,00,000 personnel of these institutions would have to be associated for scaling up and bank linkage of one million SHGs. Many of these NGOs will transform themselves into mFIs and will not only facilitate microfinancing, but will also themselves do the necessary financial intermediation. Similarly, many federations of SHGs will take on financial intermediation and act as mFIs.”
Indian TaleWe shift the focus to India.In the current context with over 4,60,000 SHGs credit-linked with banks, the SHG-bank linkage programme of microfinance has emerged as the biggest in the world. But besides banks, the major role played by NGOs in facilitating this transformation cannot be overemphasised. The National Bank for Agriculture and Rural Development (NABARD) which plays a role in promoting and facilitating bank linkages while networking and coordinating the activities of all players in the field has underscored the crucial role played by NGOs as facilitators in purveying bank credit to SHGs..
The writing is on the wall. The success story has been to a great extent co-scripted by both banks and NGOs. However, it is pertinent to draw attention here to the vast network of rural banking outlets that precludes the necessity of a new breed of mFIs which as per experts’ opinion are ‘slow and expensive to develop’ [Harper 2002]. In fact as aptly put by Harper “the SHG system uses existing marketing channels, the banks, to bring formal financial services to a new market segment, the poor and particularly women”.
Relationship Banking vs Parallel Banking
The distinct bloodline of mF in India can be traced to this genre that is indigenously developed and called ‘Relationship Banking’ as opposed to the Grameen model of ‘Parallel Banking’ [Chavan and Ramkumar 2002]. The ground truth for SHG financing on a sustainable basis in India is that bank-linkage is the bottom line with exceptions proving the rule. Inherent to this success story but understated is the fact that NGOs have played a major role in effecting SHG-bank linkages. Relationship banking is the result of NGO-bank interface to leverage funds for SHGs. NGOs have achieved significant success as promoters (helping and enabling SHGs to access bank credit) and not as providers (direct purveyors of credit). This writer would juxtapose the SBP study’s evidence against NGOs in mF with their success as facilitators in India to make a case for NGOs as social scientists or change agents rather than financial intermediaries. The latter role is arguably the banker’s domain. Moreover, there are compelling institutional and regulatory factors which counsel against any such misadventures.
First and foremost there are legal constraints to NGOs acting as mFIs as noted by the Task Force: “Many NGO-mFIs are mobilising savings from their clients/ borrowers with the sole objective of inculcating a habit of thrift and savings among the poor and for enabling the use of such resources for acquisition of assets or linkage with credit from mFIs or banks. In the context of the amended Section 45 S of the RBI Act, the appropriateness of NGO-mFIs in mobilising savings is questioned. Although NGO-mFIs provide very useful financial services to the poor, including the opportunity to keep their very small savings safe, almost at their own doorsteps, they cannot convert themselves into other modes of constitution like NBFCs, banks or cooperatives due to various intrinsic constraints. Hence, NGO-mFIs may have to be given a special dispensation in regard to Section 45 S of the RBI Act. Accordingly, it is recommended that they be allowed to mobilise savings only from their poor clientele as part of the financial services provided to them and the same may not be treated as violation of Section 45 S of the RBI Act.”
The ‘intrinsic constraints’ noted above are not difficult to guess. Moreover, some NGOs that are mobilising savings purely may also face other risks. The problem for NGOs in dealing with savings is that from a risk-bearing standpoint, savings mobilisation and microcredit are not the same. That is why the law treats them differently. From the client’s point of view, the risks of saving with an NGO are masked by their growing confidence as NGOs show that they are here to stay. But NGOs are not in most cases operating in regulatory environments that permit them to mobilise deposits; they do not benefit from deposit insurance nor can their operations be controlled by bank supervision agencies. And when covariant risk is high, as it is when group members are all from the same sector and necessarily from the same community or locality, the tenuousness of the NGO position is even more dangerous to the saver. Besides propriety and prudence, savings custodianship necessitates statutory provisioning and creation of reserves to cover liquidity and other risks.
Credit MinimalismWhile ‘savings only’ is a limited disaster story, the other side of the tale relates to NGOs who are employing ‘credit first’ or minimalist credit principles. When savings form part of the basis for credit in a financial institution, that institution does not have to take a problematic, often tortured, path to sustainability; it starts out on a more naturally sustainable path. But, NGOs have gone into microcredit with donor monies, and aim towards sustainability without, in most cases, the enormous benefit of voluntary savings mobilisation. In short, sustainability in NGO-run programmes is hobbled from the start. It looks as if the poor want its product (credit) less than they want savings, and all by itself, credit does little for productive asset creation.
The one-shot single dose attack on poverty is the sustainable development planner’s biggest nightmare. A case in point is CARE’s Credit and Savings for Household Enterprises (CASHE) project in India which is more of a lending programme than a sustainable financial institution. Unfortunately the credit and non-credit financial needs of the clientele community are expected to outlive the six year shelf-life of one of the most ambitious projects in micro-lending to hit Indian shores. The flawed-in-conception status is palpable from the fact that the CASHE budget does not include an income generating component for skill-building. The best intentions are to give a shove across the poverty line without imparting financial sustainability to households or providing for repeat finance.
The incompatibility between the tendency of NGOs to upscale (for sake of grant continuance) and financial sustainability is aptly summed up by William F Steel, World Bank consultant, according to whom, “Grant-based methodologies are poorly suited for financial intermediation, especially providing credit funds (for which recovery, not disbursement is most critical)”. The other type of NGOs turned MFIs with both credit and savings services have a limited success which as the SBP study has shown is nothing to write home about in terms of outreach or sustainability. Many are facing teething problems while a few have folded up.
These dysfunctional aspects are further highlighted by Kanta Singh (WISE Development Authority) during a CARE-sponsored case study of its CASHE programme: “Low size of loan and long cycle time for loan disbursement are reported to be the largest irritants. Many groups that have successfully managed loans in the past lose energy when they do not get subsequent (credit) linkages.” Absence of training and handholding on income generating programmes are felt to be a major gap in the CASHE design by SHGs. This need is also felt by (partner) NGOs who are trying to increase loan demand and the ability of SHGs to handle larger loans.In India the demand of the poor for safe and liquid savings instruments is very high. In fact, NGOs, with their sensitivity to the poor and intimacy with individuals, overcome the trepidation that illiterate and destitute villagers harbour about bank personnel (not known for their civility). The World Bank’s Consultative Group to Assist the Poorest (CGAP), part of whose mandate is to help microfinance institutions improve performance, has concluded “…most microfinance clients want to save all the time, while most want to borrow only some of the time.”
However, NGOs face a dilemma when savings overstrip credit demand, i e, interest paid out drastically cuts the margin from interest income. Their limited expertise and avenues for investing elsewhere compound this problem. CARE/Guatemala’s Village Banking Programme fuelled by donor monies, expanded lending outreach heavily in 1994. As a result outstanding loan balance grew at an annual rate of 78 per cent between 1993 and 1995. By contrast, voluntary savings mobilisation grew during the same period at an annual increase of 215 per cent.
Trade-Off TribulationsThe record from the SBP cases (a score of which were NGOs) suggests that as NGOs in microfinance, often encouraged by donors, come to accept the two goals of sustainability (subject to tough measurements) and outreach, (measured increasingly by loan size as a per cent of GNP per capita) the following trade-offs and adjustments are observed:(1) Concentrating portfolio growth in high population density areas (thus focusing less on rural areas).(2) Emphasising rapid initial loan volume growth, leading to poor portfolio quality.(3) Keeping field staff salaries low (or alternatively raising the number of clients per loan officer) in order to control costs, thus tending to high turnover and low morale.(4) Moving towards the retail trade and service sectors with high cash flow that enable high repayment rates, thus tending away from manufacturing and fixed asset lending.(5) Emphasising short-term loans as a strategy for high repayment and loan size growth, thus eliminating cyclical sectors like agriculture.(6) Tending to move up the poverty scale away from the very poorest in order to maintain loan demand and repayment rates (75 per cent of the SBP NGO cases showed this ‘upward creep’).Competitive Advantage of NGOsNGOs have a crucial role in group formation, nurturing SHGs in the pre-microenterprise stage, capacity building and enhancing credit absorption capacities. Group-based forms of lending (e g, solidarity groups, village banking) originated mainly for the benefit of the lender as solutions to two problems faced by microcredit organisations: (i) the problem of lack of collateral, and (ii) the problem of high transaction costs involved in loan appraisal, monitoring and enforcement. In theory, the group serves as a set of co-guarantors operating through peer pressure and the group members’ incentive to keep each other solvent so that they themselves do not lose the opportunity to receive a loan. The group serves also as a way to get around imperfect information, since members of the group know each other. Thus the transaction costs involved in loan appraisal are reduced if not eliminated.
It is here that NGOs play the crucial role in transforming the atypical destitute village woman with two children to fend for into a responsible individual with group commitments and group resources. This is a fact repeated in village after village. Whether NGOs empower women in thrift and credit groups is a moot question but it is an empirical fact that such groups provide effective ‘coping mechanisms’. Peer pressure is the best collateral. The banker in India needs to recognise that high repayment rates of SHGs is not an inherent structural feature of SHGs but a commitment to group values. The role of NGOs in investing groups with values through human capital is an undeniable specialisation. In the words of economist Jagdish Bhagwati: “Those values (of civil society and of democracy) are better advanced…by the political and financial support of the numerous and growing NGOs, both here and abroad, that work ceaselessly to nudge the world in the right direction.” The banker must accept that this is a role which the NGO, as a committed social engineer, is better suited to execute. This is not to deny qualities of empathy, humanism, social engineering to bankers. But the stark truth is that there is a need for a sensible division of labour. If bankers want to reach the poorest with financial services, they need to face certain realities. First, what they are doing is poverty lending and not economic development or enterprise development. Second, they should realise what the likely impacts may be. Changes in people’s lives will be immediate in terms of lightening the burdens of poverty, but small loans to the poorest will not bring them permanently out of poverty.Arguably, banking is more of a system than an art. Unarguably, working to facilitate the productivity of small businesses is really an art. And again, because of their grass roots orientation, because of their commitment, because they are less bureaucratic and encumbered than large development assistance organisations, NGOs are capable of overcoming a subtle but important barrier to successful facilitation – the ‘packaging of knowledge and skills’.
Once again, this is no case for discouraging NGOs from mF but to emphasise the role of emotional capital which will bring in an element of quality. The more NGOs, who are in microfinance, face the challenge of helping to bring about an increased articulation of the parts and the players in a local economy, the more they may need to get involved in such non-financial services. The effects of such services are difficult to measure in the short run. But NGOs can take on such tasks, many already do so.Thus, NGOs will fill up an important void in quality at the grass roots level which will help the poor not only to borrow but also to become good investments for banks. This will help boost business at rural branch level and cover up inadequacies and constraints that might hamper a banker with the conflicting demands of his workload. Many banks and FIs have recognised the role of NGOs and have effected suitable policy initiatives. A larger recognition of this need is reflected in the statistical evidence on linkage patterns, which we have cited earlier (see the table), which establishes NGO-bank partnership over the Indian mF spectrum. A truer recognition at individual banker level might lead to business sense replacing customary scepticism for NGOs. This will be the strategic turning point in making India’s relationship banking a showpiece and paradigm for the world’s NGOs and bankers.
The author is a freelance columnist based in Jammu and Kashmir***and can be contacted at sadaketmalik@rediffmail.com

Copyright (c) 2009 Stephen Lau First of all, credit is due to President Obama for his all-out efforts to rescue the country from the ailing economy and the greatest financial crisis the nation has ever faced since the Great Depression. However, this Herculean task may be too overwhelming even for our energetic president. It is like a sinking ship, and the captain is frantically bailing out water: it may be a heroic but fruitless task. The main problem of this current financial crisis is that no one in the financial world could really get a handle on the severity of the innate problem. Just a few months ago, even Bernanke, the Federal Reserve chairman, also an expert on the Great Depression, thought the initial financial bailout would stop the bleeding of the whole financial system. Now, the magnitude of the crisis is beyond every one’s guessing. In short, nobody in the financial world had expected the catastrophic impact of the fallout of this financial implosion. It is by no means the fault of President Obama, or that of Bernanke. Both have reacted promptly, efficiently, and relentlessly to the crisis. The problem is multifaceted and just too complex for any human mind to get a grip on until it began to unfold itself. There are simply too many bubbles involving too many levels of the financial sector – and they all bust one after another, causing the rippling domino effect across the financial globe. Over-priced bonds backed by bad subprime mortgages, packaged by unethical Wall Street firms sold to greedy investors. It was a pack of lies, myths, and phony prosperity that had fed on itself for decades, and now is the time of reckoning. The result is delinquent mortgages, bad loans, bankruptcies, leading to little or no cash flow – and hence the financial world is grinding to a halt. The root of the problem is that the prosperity in the past decades has been a phony one – created out of thin air. It was an illusion, and now everybody has become disillusioned. It is like waking up from a wonderful and mesmerizing dream, and one still clings desperately onto that dream, refusing to be brought back to the real world. Why President Obama’s bailout plan may not work! The explanation may be quite simple. According to Albert Einstein, insanity is repeatedly doing the same thing and yet expecting a “different” result. This is precisely what the U.S. government is striving to do with the bailout plan. We have got ourselves into this financial mess, because, for years, the Americans have been spending the money they don’t have to buy the things they don’t need. The current crisis is a product of reckless spending and euphoric optimism. Now, the bailout is similar in that it intends to spend trillions of dollars that the government doesn’t have to bail out the banks and firms that don’t deserve – or may not even eventually survive after the bailout. The bailout is creating an illusion that things will improve, just as the American people have created an illusion of prosperity that would go on forever. Recently, the Treasury Secretary blasted investors for not knowing what they were buying, which led to this current financial crisis. Ironically, isn’t this is exactly what the government is currently doing – repeating the same mistake? Part of the bailout plan is to buy troubled mortgages and bonds at a fair price so that the banks will take the cash and therefore be able to make new loans. However, buying these troubled financial instruments is not only difficult but also risky. It is tantamount to what the American people have been doing – buying things they do no need with the money they do not have. President Obama’s bailout plan may pump trillions of dollars into the financial world, but whether it will solve the problem is everyone’s guessing. Robbing Peter to pay Paul is never a solution to any problem – at least not a problem of this magnitude.

THE CHALLENGES AHEAD OF BANKS

                                                                     *G.JAYALAKSHMI., Ph.D Research Scholar

INTRODUCTION 

India’s banking industry is at a watershed. Evidence from across the world suggests that a sound and evolved banking system is required for   sustained economic development. India has a better banking system in place Vis a Vis other developing countries, but there are several issues that need to be ironed out.

A strong performance in the current year, strengthening the positive trends of the past, will certainly improve the short-term risk perception but focus must rest on key structural changes that have to occur if Indian banking is to be a positive force and not a drag on the rest of the economy.

It has met and successfully overcome several challenges over the last decade. But bigger challenges lie ahead. In this paper, we try and look into the challenges that the banking sector in India faces.

Interest rate risk

The first and most obvious challenge will come from rising interest rates. The current perception is that interest rates have stopped falling and are likely to remain steady, but if demand for resources picks up as firms start to invest in new capacity and boom conditions fuel consumption demand, then there may be a tightening of liquidity and upward pressure on interest rates.

Interest rate risk can be defined as exposure of bank’s net interest income to adverse movements in interest rates. A bank’s balance sheet consists mainly of rupee assets and liabilities. Any movement in domestic interest rate is the main source of interest rate risk.

            Over the last few years the treasury departments of banks have been responsible for a substantial part of profits made by banks.

Now as yields go up (with the rise in inflation, bond yields go up and bond prices fall as the debt market starts factoring a possible interest rate hike), the banks will have to set aside funds to mark to market their investment. This will make it difficult to show huge profits from treasury operations. This concern becomes much stronger because a substantial percentage of bank deposits remain invested in government bonds.

Banking in the recent years had been reduced to a trading operation in government securities. Recent months have shown a rise in the bond yields has led to the profit from treasury operations falling. The latest quarterly reports of banks clearly show several banks making losses on their treasury operations. If the rise in yields continues the banks might end up posting huge losses on their trading books. Given these facts, banks will have to look at alternative sources of investment.

Non-performing assets

The best indicator of the health of the banking industry in a country is its level of NPAs. Given this fact, Indian banks seem to be better placed than they were in the past. A few banks have even managed to reduce their net NPAs to less than one percent (before the merger of Global Trust Bank into Oriental Bank of Commerce, OBC was a zero NPA bank). But as the bond yields start to rise the chances are the net NPAs will also start to go up.

This will happen because the banks have been making huge provisions against the money they made on their bond portfolios in a scenario where bond yields were falling.

Reduced NPAs generally gives the impression that banks have strengthened their credit appraisal processes over the years. This does not seem to be the case. With increasing bond yields, treasury income will come down and if the banks wish to make large provisions, the money will have to come from their interest income, and this in turn, shall bring down the profitability of banks.

Capital adequacy norms

            A third and a key challenge will be the introduction of Basle II capital adequacy norms. These will make two demands on banks.

They will have to measure the risks they bear much better. For this they will need to overhaul their management information systems so that they have a clear and quantifiable idea of their risks.

            Then they will have to look for capital to back that risk and ultimately earn enough to be able to service that capital. R Ravimohan, managing director of Crisil, feels that the future is all about technology and risks.

There is a huge potential for undertaking risk assessment by using technology. It is imperative for banks to grow but the key issue is deciding where and how.

            New ways or managing risk and asset-liability mismatches, like asset securitization, which unlocks resources and spreads risk, are likely to be increasingly used.

Competition in retail banking

            The entry of new generation private sector banks has changed the entire scenario. Earlier the household savings went into banks and the banks then lent out money to corporate. Now they need to sell banking. The retail segment, which was earlier ignored, is now the most important of the lot, with the banks jumping over one another to give out loans.

The consumer has never been so lucky with so many banks offering so many products to choose from. With supply far exceeding demand it has been a race to the bottom, with the banks undercutting one another. A lot of foreign banks have already burnt their fingers in the retail game and have now decided to get out of a few retail segments completely.

The nimble footed new generation private sector banks have taken a lead on this front and the public sector banks are trying to play catch up. The PSBs have been losing business to the private sector banks in this segment. PSBs need to figure out the means to generate profitable business from this segment in the days to come.

Conclusion

Over the last few years, the falling interest rates, gave banks very little incentive to lend to projects, as the return did not compensate them for the risk involved. This led to the banks getting into the retail segment big time. It also led to a lot of banks playing it safe and putting in most of the deposits they collected into government bonds.

Now with the bond party over and the bond yields starting to go up, the banks will have to concentrate on their core function of lending.

The banking sector in India needs to tackle these challenges successfully to keep growing and strengthen the Indian financial system.

            Furthermore, the interference of the central government with the functioning of PSBs should stop. A fresh autonomy package for public sector banks is in offing.  The package seeks to provide a high degree of freedom to PSBs on operational matters. This seems to be the right way to go for PSBs.

            The growth of the banking sector will be one of the most important inputs that shall go into making sure that India progresses and becomes a global economic super power.

Private banking is derived from Swiss, specialized in the fortune management business of providing special financial services, promoting the cooperative value between commercial banks and customers and prolonging customer relationship value chains. The concept of private banking came out in China after 2005. In September, 2005, Swiss Friends Bank Co Ltd started its business in Shanghai and brought the concept of private banking to Chinese market. Since 2007, the profits of private banking were ten fold of other retail business. Therefore, more and more domestic banks began to involve in the private banking.

In recent years, many banks announced to set up their private banking centers. It is without doubt for these banks to occupy some rich men gathering places as their focuses, such as Beijing, Shanghai and Shenzhen etc. The customers of private banks from China Merchants Bank Co., Ltd grew by 35% than that in 2008. Compared with less than 0.02% private banking customers in the whole customers of China Merchants Bank Co., Ltd, the total assets of private banks accounted for more than 10%, the highest level in all commercial banks. The private banking of China CITIC Bank also rose fast in 2008. Now its customers of private banking are two thousand. The condition of private bank in China Merchants Bank Co., Ltd is 10 million Yuan (1.46 million USD), but China CITIC Bank is 8 million Yuan (1.16 million USD).

In 2007, Chinese private banking rose. Chinese funded banks mainly concluded Bank of China, China Merchants Bank Co., Ltd, Industrial and Commercial Bank of China Ltd, China CITIC Bank, Bank of Communications, Construction Bank of China and China Minsheng Bank etc. The foreign funded banks concluded Hong Kong and Shanghai Banking Corporation Limited

, Citi Bank, Bank of East Asia, Deutsche Bank Group, Swiss Friends Bank Co Ltd, BNP Paribas, Standard Chartered Bank and Edmond de Rothschild.

Chinese private banks are mainly located in the economically developed areas, such as Shanghai, Beijing and Shenzhen etc. foreign funded banks are in Shanghai and Beijing. Some Chinese funded banks, because of its local advantages, also set their private banks in big cities with huge customer potential, their business spreading a wide area.

By the end of 2008, Chinese millenaries were about 0.5 to 1 million. The reason for uncertain numbers is that Chinese millionaires were accustomed to investment in real estate, such as living houses and shops etc. they expected to benefit from revaluation in real estate, so the numbers fluctuated sharply. The definition of millionaire is that individual floating assets are more than one million USD Except housing.

The global financial crisis, stemmed from the sharp decline of American real estate market, seriously stroke the large European and American banks. Although most private banks escaped from direct hit, they were influenced by the financial fluctuation. The crisis made some investors to transfer their investment to more conservative products, leading to the profit reduction in some private banks.

Taking consideration of the infancy of local financial market, many riches are preferential to manage their fortunes offshore in previous Chinese emerging market. The foreign funded banks occupy the most part of market share. The occurrence of financial crisis makes Asia especially China become the minimal negative influential country and the safest market. In the future, Chinese rich families are even preferential to invest at home, which brings huge development opportunities for Chinese private banking.

In the developed countries, the success of private banking is inseparable with politics, society, economy and law, such as steady currency value, natural advantages of tax rate, long financial history, prosperity in financial market, steady bank systems, sound legal and confidential systems and massive rich experienced financial talents.

By contrast, Chinese private banking market, with huge market potential, needs perfection of supporting infrastructure in its infancy. Chinese private banking market mainly faces the following problems: strictly supervision of finance and the adoption of separate supervises models is unfavorable to the promotion of various businesses; Underdevelopment of financial market (regardless of business tools or means); lack of strong investment bank supports; shortage of necessary systems and organizational structures of private banks.

From the part of Chinese private banking, international financial crisis is not only strikes but also opportunities, on the one hand, the slowdown risk existence in the private banking market, on the other hand, the development opportunities of organizations and talents transferring to Chinese market.

As a whole, Chinese private banking market is still in its infancy and hugely demanded for customers. In two to three years, Chinese private banking market will rise explosively.

The author of this report made a profound investigation and investigation of Chinese private banking, and then wrote this report. Readers can obtain more following information:

- Present situations of Chinese private banking

- Analysis on the market demands of Chinese private banking

- Analysis on the foreign funded banks with private banking in China

- Analysis on the local banks with private banking in China

- Analysis on the factors affecting the development of Chinese private banking

- Analysis on the development trends of Chinese private banking

- Analysis on the influences of international financial crisis on Chinese private banking

To get more details, please visit Research Report on Chinese Private Banking Market, 2009