Financial systems and development

even before portfolio and other losses were recog- table. Supervisors could be empowered to take
nized. Government-owned banks, in particular, certain intermediate steps: impose fines for unoften
operate with little capital. When government sound practices, suspend dividends, deny reofficials
and the public at large believe that state quests to expand the number of branches or unownership
is a guarantee against failure, the man- dertake new corporate activities, issue cease and
agement is not subject to the discipline that capital desist orders, remove managers or directors, and
adequacy requirements would provide for a pri- hold directors legally accountable for losses invate
institution.
curred through illegal actions and willful contraventions
of prudential regulations. The lack of
ASSET CLASSIFICATION AND PROVISIONING. Banks such powers often causes inaction.
in developing countries rarely make realistic provisions
for potential losses or problem assets. Often RESTRUCTURING. Bank supervisors try to minithey
fail to write off or provide for actual losses or mize losses by intervening at or near the point of a
to suspend interest on nonperforming loans. As a bank's technical insolvency. Poor information, an
result their balance sheets and income statements inadequate legal framework, and lack of political
are misleading. Bank supervisors should be able to will often permit banks to stay open, multiplying
require banks to make appropriate provisions for their losses, even after they have lost their book
loan losses, to write off uncollectible assets, and to capital many times over. In many developing
suspend interest on nonperforming loans.
countries banks are subject to the same bankruptcy
and restructuring procedures as nonfinancial cor-
LIQUIDITY. In many developing countries banks porations. While bank restructuring is under way,
have to comply with a short-term liquidity ratio. depositors may not have access to their funds. In
This ratio is often used more as a reserve require- addition, shareholders may retain an equity interment
for purposes of monetary policy than as a est which they use to obstruct plans to recapitalize
prudential measure to guard against lack of liquid- and transfer ownership. If supervisors are to disity.
Liquidity risk arises because banks borrow pose of insolvent banks quickly, they must be
money at short maturities and lend it at long. The granted authority to close a bank; to replace its
risk is not just that a bank will not be able to repay management and directors; to dissolve existing
depositors' money when called, but also that inter- shareholder interests; to purchase, sell, or transfer
est rates on short-term liabilities will rise faster bad assets; and to merge, restructure, or liquidate
than those on longer-term assets. Ratios therefore as necessary.
need to be set and monitored for long-term as well
as short-term liquidity. AUDITS. In some developing countries the authorities
require no external audits of banks. In
PORTFOLIO CONCENTRATION. Limits on lending as others audits are performed, but there are no clear
a percentage of a bank's capital are necessary to guidelines on the standards to be used or on the
prevent the concentration of risk in a single bor- scope, content, and frequency of the audit prorower,
a group of related borrowers, or a particular gram. As a result audits are often inadequate and
industry. Some developing countries set no lend- misleading. Indeed, it is not uncommon for banks
ing limits at all. In others the limits are set at im- that are known to be insolvent to be given clean
prudent levels, in some cases exceeding 100 per- audit reports. The prudential framework therefore
cent of bank capital. Ghana's central bank had needs to set minimum audit standards and to prelegal
authority to set lending limits but until re- scribe the form and content of the related financial
cently did not do so. The resulting concentration of disclosures.
risk eventually led to the technical insolvency of
several major banks. POLICY PRIORITIES AND POLITICAL WILL. To be effective,
prudential regulation must be backed by a
ENFORCEMENT POWERS. In many countries super- political commitment to supervision and enforcevisors
can impose fines and penalties for criminal ment. The supervisory body must be given clear
acts and violations of specific banking statutes. policy goals, and it must be independent. Too of-
There may, however, be little they can do to ad- ten in developing countries, supervisors are undress
unsafe and unsound banking practices. dercut by political interference. Such interference
Their options are either to cancel the banking li- was blatant in the Philippines in the 1970s and
cense or to do nothing-neither of which is accep- early 1980s, when supervisors feared reprisals if
93