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“Bank Risk & Government Safety Net”
Learning objectives: This activity aims to enable the students to get an understanding about safety measures taken by Government in the country’s financial sector for a purpose of:
• Protection of investors
• Protect investors and customers from exploitations; &
• Stability of financial system
Learning outcomes: After going through this activity, the students would be able to know the tools and tactics used by Government to provide a safety net for the protection of depositors/ investors and financial system.
The State Bank of Pakistan has declared a moratorium on KASB Bank. From the last few months SBP was closely monitoring the bank's operation as it failed to meet SBP’s Minimum Capital Requirement (MCR). Presently, KASB has a capital of Rs 1.1 billion as against the target of Rs 10 billion set by the regulator for December 2014. The central bank has allowed withdrawal of up to Rs 300,000 and, is of the opinion that 92.33 percent of the depositors can continue to operate their accounts. This is the first time that SBP has taken such a step. Previously, SBP used to remove the Board of Directors, appoint an Administrator and nominate a big, solid commercial bank to run the banking operations of a troubled bank. It appears that SBP is convinced that the management of the bank is professional and sound and it is the failure of bank's shareholders who have failed to bring in additional capital and maintain the Minimum Capital Requirement (MCR) as required by the regulator under its prudential regulations. The law does empower the Banking Regulator (SBP) to take all necessary steps to protect the interests of creditors i.e. the depositors in a bank. This is not the first time and may not be the last, when SBP is required to step in and protect depositors' savings. However, SBP also needs to cater to systemic risks in the financial system. KASB Bank's deposits may be miniscule (0.6 percent) of the total banking deposits. However, the nervousness caused to depositors would be much more. Depositors in other banks that have threshold lower than Minimum Capital Requirement (MCR), desired by SBP or are on a weaker footing may face a rush in withdrawal of large deposits; thus compounding their problem. So the challenge for SBP to maintain stability in the financial/banking system may be bigger than anticipated at present. In addition, since there is no limit on borrowers who now shall be tempted to borrow to the limit from a weak bank may be another problem. SBP is lender of the last resort So what else could SBP do when despite repeated reminders to sponsors/shareholders of KASB Bank to increase the capital did not materialize. Banking is a difficult business; but no financial business is easy either. If profits are large so are the losses - shareholders have 8 to 10 rupees as capital and 92 rupees or more belong to the depositors. This is precisely the reason why the role of a regulator is so important and all-pervasive in banking. In addition, banks unlike other businesses can leverage much more. Country's constitution and the law empowers the SBP to regulate the monetary and credit system of Pakistan and foster its growth in the best national interest with a view to securing monetary stability and fuller utilization of the country's productive resources. We hope and pray it continues to do so. So far, no depositor has ever lost any savings when a bank has folded. These simpletons know despite the fact that private banks do not carry any deposit insurance. There have been delays but all depositors including big corporations have got their money back. The fact that no liquidator or administrator has been appointed proves that SBP has faith in the present management in KASB Bank and it is also a testament that shareholders have erected a Chinese wall between the directors and management. The rising of non-performing loans in the bank are the real cause of the loss, which has climbed to Rs 6 billion on a deposit base of Rs 15 billion. This was precisely the reason the present sponsors had floated the idea of breaking KASB Bank into good and bad banks and selling the good bank free from Non-Performing Loans (NPLs) with losses to a profitable bank, which could avail the losses against its profits to lower the tax liability of the acquiring bank. Unfortunately, however, there were no takers of the idea or were not in the knowledge of SBP as it took this unprecedented step on Friday.
1. Why there was a need to suspend KASB bank operations against the claim: protection of depositors’ interest? Discuss the risk being faced by the bank.
2. Does a trade-off really exist between providing protection and depositors’ trust?
3. If not suspended by SBP, how does a KASB bank ltd. may lead to financial contagion?
(Support your answers with logical reasoning) Note: Complete your comment within 400 words
1. Your discussion must be based on logical facts.
2. The discussion board will remain open for 3 working days.
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The KASB bank operations needed to be suspended because they didn’t have sufficient deposits to meet the requirements of the borrowers and creditor’s. According to the report the bank’s deposits are (0.6) of the total banks deposits. Another reason was that shareholders failed to bring in additional amount of capital and maintain the minimum capital requirement according to the prudential regulations. The rising of non-performing loans in the bank are the real cause of the loss, which has climbed to Rs 6 billion on a deposit base of Rs 15 billion. If the operation were not suspended then the borrowers would have rushed to the banks for their money that had been deposited in the banks and that would have created a panic in the banking sector.
2. Does a trade-off really exist between providing protection and depositors’ trust?
It depends on the situation and the current condition but i think trade-off provide protection and depositors in the following conditions
1) Bank failure.
2) Deposit insurance.
3) Failed bank resolution.
During the 1980s and 1990s the banks were in failures and most of their problem was resolved with the help of the trade- off. It also helped in handling the liquidity risks in the past.
If not suspended by SBP, how does a KASB bank ltd. may lead to financial contagion
Contagion is a disease that does not affect a single bank but it also creates negative impacts over other banks and the economy of the country. I think it will create the following hurdles in the functioning of KASB bank.
1) Depositors will rush to the bank to withdraw the deposits.
2) With less capital, KASB bank will be forced to contract the balance sheet making fewer loans.
3) It will start to lose its customers.
4) False rumors that a bank is insolvent can lead to a run which renders it illiquid.
Such a run on a KASB bank can cause it to fail.
Answer no 1
The are liquidity problem of KASB banks, who have not enough money of liquidity to fulfill his depositor requirement.
State bank of Pakistan can give least resort offer to KSAB and allow the to withdraw some money from SBP to fill his depositor needs. Because banks have more then 90% money of depositor so SBP take this action to protect depositor.
Answer no 2
Yes it’s important for banks to achieve his customer trust, after viewing this situation I analyze that in a problem that KSAB can face his sponsor cannot invest anymore to solving this problem. Because he know that its such a risky and make a loss for him In case of solvency and default.