Do not spread the financial contagion

We must not make sick those who are in relatively good health for the present

Witches: “Are there not some in good health who we should make sick?”

The above is a free rendering of what the three witches were setting out as their mission on meeting Macbeth in William Shakespeare’s play by the same name. It is striking how, writing in the early seventeenth century, at a time the intricacies of finance were yet to unfold, the witches misled Macbeth into stumbling from one disaster into another until his complete undoing, once having engaged himself on his wrongful path of vaulting ambition.

In the world of finance, the strong interconnectedness of market participants plays out an almost identical scenario. It begins with one important trespassing of the accepted rules of good conduct for the problem to become amplified and get increasingly out of control and become ultimately unmanageable.

The financial crisis of 2008, which sent the global economy into a downward spiral, is a perfect example of how, once the boundaries had been crossed, it proved intractable to get the wild animal under control. The prevailing global economic weakness is a consequence of the drama that was unleashed by the financial crisis. Central banks and governments have exhausted almost all the ammunitions they have without being able to turn the situation around to normal as they would have wished.

Debt mountain

A number of years before 2008, financial institutions especially those of the West, instigated by the quick profits they were making after each round, went on lending at breakneck speed, a lot of it to borrowers having little or dubious repayment capacity. The housing market was booming just like credit card lending. A debt mountain was building up.

Whenever they ran short of liquid funds to support this explosive lending activity, the financial institutions borrowed overnight funds from each other on the interbank market or from the central banks at extremely low interest rates to tide them over by issuing IOU’s (certificates of indebtedness) the supply of which appeared to be unlimited. Then came the day of reckoning when someone asked the serious question as to how some of the most highly geared financial institutions – notwithstanding how they hid the reality through the constant “cooking of their books” they had recourse to in the process – would repay what they were borrowing from each other.

It was then realised that each one of the major market participants in the interbank market was deeply mired in huge irredeemable indebtedness. This was enough to abruptly dry the tap of the interbank market where financial institutions borrow from each other to overcome what they thought were “temporary” liquidity shortfalls. The domino effect was at hand, with Lehman Brothers giving the first signal of financial collapse in America and Northern Rock in Britain.

Other global financial institutions were lined up for disaster in the ensuing liquidity and solvency crisis. All of this took financial pundits by surprise, which led Queen Elizabeth II of Britain to ask them why none had seen the disaster coming. No answer. Trillions disappeared into thin air overnight. Millions of jobs were lost.

All of the exaggerating financial institutions had been Macbeths, following the short-term profit trail without pausing to think of the consequences of this mad race. Despite governments and central banks having intervened massively to try to salvage the situation, it has not gone away yet. This story illustrates how easily contagion spreads across financial institutions and how grave its consequences are.

Wholesale disaster

We have been prudent enough in Mauritius, by enforcing strict regulations for banks and non-banks to comply with, to steer clear of this kind of wholesale disaster. Certain recent cases involving banks seem to indicate however that, while they may not have operated all holds barred as did the American and European financial institutions, some of our financial institutions have not been immune from the sickness to overdo, to lend money without making sure it will come back.

An example is the DBM which was led to disaster most probably due to political interferences. The appetite to exceed all decent bounds of safe lending seemed to be unstoppable until, ironically enough, a bank which was set up with the noble objective to provide capital to support newer sectors of economic activity and foster development in Mauritius, was itself killed by importing misconduct into it.

Take the attempt made last year to turn over to the SBM the Bramer Bank, which was de-licensed by the Bank of Mauritius in April 2015. The SBM refused to take over the bank ultimately. It must be having reasons for so doing, which it did not disclose.

At best, one can presume that the Bramer Bank’s assets were not to its liking. At worst, one could presume that the SBM would have come to the view that taking on the Bramer Bank on its lap might have brought contagion to it. In the latter case, an otherwise healthy bank, the SBM, could have become sick and thus spread the malady to what is today the second largest local bank in Mauritius. If so, it was a good decision taken by the SBM from the point of view of the country as a whole.

Now that the Bramer Bank is lodged alongside another bank that was allegedly mismanaged too on the lending side, notably the Mauritius Post and Cooperative Bank, the merged entity out of this, the MauBank, was threatened recently with partial dismemberment by the Special Administrator of the ex-BAI. The latter wanted to take away assets belonging to the erstwhile Bramer Bank to meet BAI’s obligations to ex-BAI’s Super Cash Back Gold (SCBG) policy holders, the effect of which would have been to put into serious question the viability of the MauBank itself, short of immediately injecting an equivalent amount of fresh capital into the bank.

A court action has stopped the ex-BAI’s Special Administrator for the time being. It wasn’t clear from which source such additional capital injection would come, to make good a loss of portfolio assets that would have made worse off a new institution – the MauBank — still trying to overcome its handicap.

Super Cash Back Gold

The sequel of the dismantling of the BAI group last year is being felt again. Not having raised enough money to pay back SCBG policyholders as promised from disposal of the ex-BAI’s assets so far, efforts have been ongoing to seek new sources of funding. The further amount needed — on top of a Rs 3.5 billion loan that was provided to redeem liabilities of ex-BAI last year by the Bank of Mauritius and which is yet to be repaid – by the Special Administrator to bridge the remaining gap by 30th June 2016 towards the ex-BAI’s SCBG policy holders is Rs 2.5 billion. This is a large sum.

It is reported that efforts are currently being made to secure this amount of money by selling shares of the ex-BAI, now National Insurance Company, to state-controlled companies, notably to SICOM, SBM Holdings, the NPF and Mauritius Telecom.

The decision whether to buy up those shares belongs to these state-controlled entities which run their own separate business activities and are accountable to those who trust them for their own continued financial and economic viability. If they expect significant sustained streams of income and buoyant demand for the shares they are being called to buy up, well and good. If however they become saddled with an encumbering investment which is fundamentally flawed, they’ll be harming all those who trust them for being prudent in their investment decisions and not being swayed by untested rosy pictures painted of the ex-BAI’s portfolio.

All this shows the numerous almost insuperable difficulties surfacing up following the hurried dismantling of the BAI group last year. The efforts being deployed to sort them out show that it must not have been foreseen by those who led the initial assault as to how to measure up to these consequences.

What is important at this stage is not to allow the resulting financial contagion from travelling to other public institutions that are facing their own lot of difficulties in the current tepid global economic environment. We must not make sick those who are in relatively good health for the present.

 

*  Published in print edition on 25 March 2016

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