Banking Soundness and Monetary Policy


Charles Enoch, and J. Green
Published Date:
September 1997
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Frederik Musch has given us a very informative and balanced presentation. It is worth noting, in particular, his emphasis on the flexibility of the cooperative arrangements that unite supervisors outside the G-10 countries. One would not normally feel very much in a position to add to this presentation were it not for the fact that these issues are of keen interest to the countries in Africa and, of course, by extension to my colleagues in the African Department. This interest has been reflected, as Musch noted, in the creation of two original groups of supervisors in Africa: the Committee of Banking Supervisors in West and Central Africa and the East and Southern African Supervisors Group.

The interest in these issues is rooted in two considerations. First, there is a realization that the same factors that led to the development of established prudential standards in industrial countries are also at work in Africa. Essentially, confidence in financial institutions is necessary to sustain economic growth, and it is accepted that such confidence is better grounded in the performance of the institutions than in some ill-defined government guarantee. This is the domestic consideration. The second consideration is external: unless African banks meet international standards, they will not be able to participate in the globalization process that is going on elsewhere. These are important stakes, and it follows that the standards that are applied to African banks must be fully appropriate. Most African countries have endorsed the Basle Committee standards, and Musch’s remarks indicate that there is a clear preference among supervisors for a single set of criteria. There is evident merit in this.

It is not evident, however, that the Basle criteria are always sufficiently strong. Some African countries are exposed to significantly large external shocks and, for that reason, may wish to have higher capital asset ratios than are standard. Such countries as Guinea-Bissau, Mauritius, and Zambia have chosen to go that way. The choice of risk weights also needs examination; in particular, the fact that in the Basle Committee standards, claims on government carry zero weight. Not all African countries have public debts of the first quality; some have experienced domestic arrears in the recent past. More important, there is an ongoing effort to create a level playing field in which governments are subject to market discipline exactly in the same way as other economic agents; the idea of giving zero weight to claims on government when calculating the capital asset ratio may not be compatible with this concept.

In any case, the choice of appropriate standards is only one in a range of measures that, together must ensure the integrity of the banking system and of the financial institutions more generally. These other measures include stringent supervision by a central authority and rigorous in-house evaluation procedures. Both require the development of strong training capabilities and local expertise, and there is a lot of effort in that direction. Considerable progress is being realized but there is still a long way to go. In addition, there is another requirement that may be a little bit more specific to African countries and will take time to fulfill. This is to change the credit culture. The view has been too widespread, as a cultural matter, that bank credits do not always have to be repaid. This view is changing, but it will take time to meet the standards of industrial countries.

My last point concerns the observance of the standards. I think one needs to recognize that even though most countries have chosen appropriate standards, de facto banks do not always meet these standards yet. The cost of increasing bank capital to bring it up to standard is high—traditionally, the rates of return that are expected from this kind of investment in Africa are very high and the availability of financing is limited because of what is perceived as a risky environment. Not all banks will meet these standards instantly, and a strategy must be developed for how to get from here to there. Two guidelines will be useful. First, whichever strategy is chosen must be realistic in the sense that it must be pursued without reversal. It is better to proceed gradually and to be firm in implementation than to be overly ambitious. However, as long as banks do not meet the appropriate standards, they are at high risk. Therefore, the second guideline calls for stronger, more effective supervision.

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