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Deposit protection scheme could spur reckless lending

MBONGENI MGUNI
Pelaelo says small savers need to be protected
The Bank of Botswana says while introduction of a Deposit Protection Fund (DPF) could see commercial banks engage in riskier lending, the cost-benefits are still in favour of establishing the shield for depositors.

The central bank continues to consult on the DPF, which would insulate customers’ funds in the event of a bank default, with a focus on small savers. By September, commercial banks held deposits of about P75 billion, with about P15.3 billion of these owed to individual customers.

While the Financial Stability Council, made up of the BoB, NBFIRA and the Financial Intelligence Agency, has already concluded consultations on the macro-prudential policy framework, talks with the banks are ongoing.

As the DPF looms, analysts have warned that ‘moral hazards’ could arise, raising reckless lending and playing havoc with the banking sector. Moral hazard is said to exist “when a party to a contract can take risks without having to suffer consequences”.

Answering BusinessWeek enquiries recently, BoB governor, Moses Pelaelo said the trade-offs involved in introducing the DPF outweighed the moral hazard risks.  “There’s a moral hazard argument that when you have these schemes, the standards of lending may be lowered by those lending knowing that if they fail, someone else will help,” he said.

“Many people have realised that not withstanding that, the trade offs or cost-benefits are really important. “The good news is that we are talking about this when there’s no financial crisis in the country. “It’s a preparation you have to build up over time so that in the event of any problem, you are able to deal with it.”

Very few banks have failed in the country’s history with the list including the Bank of Credit and Commerce Botswana, Botswana Cooperative Bank and Kingdom Bank Africa.

However, the country’s banking sector has occasionally suffered liquidity crises due to risky lending and the bursting of credit bubbles. In 2014, the local banking sector suffered one of its worst liquidity crises caused primarily by years of unsustainably high credit growth set against stagnant deposit growth.

Several banks fell below the statutory liquid asset ratios, incurring

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penalties from the BoB, which was later forced to inject P2.3 billion into the banking system to shore up liquidity by reducing the banks’ primary reserve ratio.

Recently, the BoB introduced ‘reserves averaging’ under which the primary reserve ratio targets have been met on a monthly basis, rather than daily. The central bank also lifted the cap on the issuance of Bank of Botswana Certificates, its main instrument for mopping up excess liquidity. Analysts say, read together, both moves would ultimately improve banks’ liquidity management, reducing the tendency towards reckless lending. Pelaelo told BusinessWeek the BoB had its eye on the ball in the DPF debate.

“There’s no contradiction between safety nets and encouraging sound lending,” he said.

“Banks are accident-prone animals. We know from history that accidents do happen and banks fail. “So what we have done is that we have contingency plans around safety nets that in the event of a bank fault or failure, there must be a system that deals with depositors.”

He added: “When you look at the infrastructure and effectiveness of financial systems broadly, there are certain things you need to have.

“The backbone is macroeconomic stability, then market infrastructure that you have to have in place, then supervision that’s well-resourced, then well-run banks with fit and proper people there.

“The DPF, which is still at discussion stage and not yet adopted, is widely used all over the world to reduce the expectation gap between licensing and supervision of banks.

“It makes sure that when a bank fails, at least the small savers should not lose their money.

“This also encourages lending and increases financial inclusion.”

According to the liquidity stress tests conducted by the Financial Stability Council in June, in the case of a run on deposits, large banks showed they could survive for 17 days under severe stress conditions while small banks could for 11, indicating sound resilience.



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