Is having a sound financial system in a country wishful thinking?
Each time our financial sector has gone amiss one way or another, there have been questions asked about the parameters within which it operated, whether the rules of operation were fair to customers, whether someone was in charge to prevent operators from abusing and, most importantly, whether the public was in safe hands for the money they entrusted to financial operators.
In the sugarcane days, brokers (courtiers) who were also money-lenders were variously accused of cheating on the more or less illiterate planters and producers, depriving them surreptitiously of their lands at times or charging exorbitant interest rates. Moneylenders were often accused of the same abuses.
In reply to such concerns, the colonial government enacted various laws to ensure a more balanced relationship between operators and their “clients” – Companies Act, Banking Act, Insurance Act, Cooperative Societies Act, Money Lenders Ordinance, etc. The laws made financial operators answerable to the colonial Financial Secretary. A Comptroller of Insurance was set up to see to it that insurance companies did not invest policyholders’ money in smoke screens. The Chamber of Brokers (Chambre des Courtiers) regulated itself under the guidance of the elders for the rather sparse stock trading which used to take place infrequently at the time.
Financial institutions have become much more complex over time just like the range of services they offer. This has not only required new legislations to be enacted from time to time. It has also been accompanied by a battery of regulations issued by specialized regulators to ensure the safe conduct of business by our numerous financial institutions.
Nevertheless, accidents of varying degrees of importance have kept happening in our financial sector. This has sparked questions as to whether those who have been put in charge to regulate them have actually been doing their jobs. The answer is not so simple but here are a few examples of recent miscarriages in the local financial sector.
Things that misfired
A couple years back, Mauritius was suddenly taken in by some unusual financial scandals. The business was hosted by fake financial companies called Sunkai, Whitedot, and what have you. Their product marketing had mostly been done by discreet “satisfied” previous customers against “interesting” commissions. It was discovered that there was a black hole at the heart of these operators; most of the money entrusted to them had somehow vanished.
Despite the law providing that even individual moneychangers have to first obtain an authorization before engaging in financial operations, these companies had not deemed it fit to seek any such authorization. For the simple reason that they presumed they were conducting the unmarked financial operations, which they felt were uncircumscribed by existing financial legislation and regulations.
The authorities appear to have become aware of them only when the scandal came out in public, that is, at the time the first victims of the scheme exposed them. All the fantastic returns they had promised those who had entrusted their funds to them melted into thin air. Liabilities ran into the several hundreds of millions. The matter is unresolved to this day.
Months back, we were informed that the Vacoas Multipurpose Cooperative Society, which falls under the responsibility of the Registrar of Cooperatives, had developed a big gap in its resources. Victims are members of the cooperative society who had entrusted their savings to it. It appears this would be a case of misappropriation of funds by controllers of the cooperative society which had increased its scope of activities much beyond ordinary cooperative societies. The matter has yet to be sorted out.
The latest to occupy centre-stage in this chapter is the British American Investment Group. This conglomerate ended up housing a multiplicity of a centrally-controlled finance and non-finance companies in a rapid horizontal expansion mode. All this got stitched up around its big insurance company at first. Despite the risk represented by the centralized control of the variety of its financial and non-financial activities, the group was even able to secure a banking authorisation in principle end-2006, which became de facto in August 2008.
With such a panoply of finance activities, there was a clear risk that the Group’s accountability was being stretched too far. This was a dangerous prospect in itself inasmuch as the arms-length rigour with which lending should be undertaken by objective and independent finance companies in the ordinary course of business would risk being much too relaxed when it came to borrowing from within by group related companies. In turn, that could endanger the recovery of money entrusted to it by the public.
The inherent risk from out of this situation materialized when the Group started facing its official dismantling as from April 2015. Needless to add, this precipitation to deal with an otherwise delicate situation had serious negative consequences on those who had entrusted their savings to it. It was next to impossible to get back value-for-money from all the distraught group entities in the process in the wake of this clumsy trust-busting exercise.
You cannot get the same value from loosely-given facilities to group companies facing a forced-sale situation than when you take time to nurse them up to good health until they are strong enough to pay back their debts. Long-term investments will lose value – often drastically — if you want to realize them in the short term. This is elementary business economics. This is what explains partly the big gap in resources of the conglomerate vis-à-vis its financial obligations to the public. There could also have been bad investments due to faulty judgement (as it happens in almost all financial businesses), accounting for the loss in value. Yet another factor would be misappropriation of funds.
There was a public outcry: what were the regulators doing to prevent such a situation? It echoed back the same kind of accusations against regulators when the Whitedot, Sunkai financial scandals came to light. That was also the accusation being levelled when the Mauritius Commercial Bank came out in public in 2003, stating that it had been defrauded by over Rs 800 million rupees by insiders.
The public assumes that having a financial regulator insulates them from mishandling of funds or malpractices indulged in by executives of finance companies to their detriment. It is an assumption that does not hold in practice. All the regulator does is to impose pre-emptive rules and regulations for the safe conduct of financial business. If the regulated finance company flouts them, the regulator almost always becomes aware when the harm has already been done. This is true not only for Maurtius. But if the regulator comes across malpractices before they reach the public domain – which happens during onsite or offsite inspections — he will “sit down” with the financial institution until the deck has been fully cleared and the impending catastrophe averted. This part usually goes unreported.
One just has to go to the financial crisis which erupted in 2007-08 in the developed countries to realize that despite what the best regulators can do in given circumstances, the world’s biggest and (supposedly) best controlled financial institutions are prone to systemic failure. So many years after having cautiously prevented the kind of debacle precipitated in the case of our BAI Group, those countries’ regulators are still fixing the rules that will make their financial institutions “safe” again. For how long? No one really knows.
Mark Carney, Governor of the Bank of England, who also chairs the international Financial Stability Board at the Bank for International Settlements, is foreseeing that the next big crisis in the world’s financial system will come from “shadow banking”, a quasi-banking huge financing activity undertaken by numerous non-banks in various countries with the blessings of governments. Mountains of debts are involved and if they crash, there would be dire consequences across the board. Hopefully, his board will parry the blow before it hits us all in the face. It shows that regulators must keep adapting to the dynamically changing financial landscape to avert further meltdowns of the financial system. We are no exception.
Despite all the economy-wide damage done by often reckless management of the financial system, we’ve hardly seen punishment inflicted on the wrongdoers acting as a deterrent to wilful defiance of regulatory rules. On 3rd August 2015, Tom Hayes – who was accused of having masterminded the rigging of the London Interbank Offered Rate (LIBOR) along with accomplices from eight other banks and money brokers since 2008 — was sentenced to 14 years in prison. The LIBOR rate affects trillions of dollars of global financial borrowings, including by countries such as ours. But his managers and the CEOs of the banks he worked with (UBS and Citicorp) got nothing even though it is said they knew about the rigging and did not object. In 2009, Bernie Madoff got 150 years in jail; that did not prevent our Sunkai and Whitedots to have a go at it.
No doubt, other financial misfeasors will be tried and condemned. But that should not stop reckless chaps undermining the confidence people place in financial institutions from time to time. We will have to live with it even though that should not prevent us taking mitigating actions so as not to sap the essential element of public confidence in our financial institutions.
What all this goes to say is that the financial system is so deeply imbedded in the very heart of our economies that we have to keep repairing the flaws which surface up from time to time provided we succeed to maintain the essential public confidence in it. One would have loved to have a perfectly operated and flawlessly regulated financial system but things like this are made only in heaven. Provided we do not wilfully take decisions which risk aggravating this element of public confidence in our financial system.
- Published in print edition on 14 August 2015