“To weather a storm, it appears to me that you should in the first place not unleash the storm itself”

Interview: Anil Gujadhur, former Deputy Governor BOM & Chairman FSC

“All alternatives are usually considered before ‘wielding the axe’ on banks. Revocation is really the last recourse”

“By killing the smaller banks, we are pushing business away towards more concentration in our banking sector, thus resuscitating the risk of ‘moral hazard’ when people move increasingly towards the ‘Too Big to Fail’ banks, thinking they would be safer”

“ I am not quite sure the Financial Services Commission would have allowed the BAI to operate if it was a Ponzi scheme”

Anil Gujadhur, former Deputy of the Bank of Mauritius and Chairman of the Financial Services Commission, has had a long career in the country starting as a junior at the Bank of Mauritius in the late 1960s and gradually climbing up the ladder and assuming higher and higher responsibilities. Having also headed a regulatory institution, the FSC, he is well placed offer his considered views on the current crisis involving the Bramer Bank and the BAI and associated companies. In this interview he provides an insightful overview of the matter at hand, explaining what exactly is a Ponzi scheme and raising some very pertinent questions about the manner in which events have unfolded, and about what may have motivated such a drastic nocturnal action.

Mauritius Times: The fear has been expressed that one of the fallouts from the British American Insurance case is the harm that its handling by the Government as well as by regulators, namely the Bank of Mauritius and the Financial Services Commission, would cause to the reputation and image of Mauritius as a dependable and trustworthy financial centre. We have yet to see what else will come out of this Pandora’s box, but it does look like the Government has been able to weather the storm by moving fast – ensuring within five days that the ex-Bramer Bank is partially up and going, and by giving the guarantee that policy holders of British American Insurance are not going to lose their savings. What do you think?

Anil Gujadhur: I don’t agree that the Government ‘has been able to weather the storm’. Storm, there has been by the very precipitous and mysterious nature of the decision taken by the Bank of Mauritius (BoM) to revoke the banking licence of Bramer Bank at 0.45 hrs in the night of Thursday to Friday last week.

It’s striking that section 11 of the Banking Act 2004 gives the power to the BoM to revoke banking licences under specific circumstances. It is a domain which belongs therefore to the BoM which has been vested with the administration of this Act. Surprisingly, it was not the BoM that came out in public to explain its decision. The Prime Minister, along with other Ministers, offered the reasons for the revocation of the banking licence.

And then the Minister of Finance announced in the course of another meeting with the media in the afternoon of Friday 3rd April that the State Bank, a largely public sector controlled bank, will handle the Bramer Bank’s business. Storm there has also been by characterizing part of our financial business as being “a massive Ponzi scheme”. You can’t deny the negativity this taints our financial sector with. I believe the Prime Minister was ill-advised on this wording.

Besides, we’ve seen the dramatic shifts which have taken place from then on. When the State Bank, a listed entity, issued a Cautionary Announcement on Saturday 4th April that it was proposing to make a ‘conditional’ offer to purchase the assets of the Bramer Banking Corporation Ltd (in Receivership) after carrying out a ‘due diligence’ thereof, the storm had not been weathered yet. From what we gather now, the SBM has declined to go ahead; this casts doubt on the quality of assets of the revoked bank, which was not an issue when the Bank of Mauritius sent out its Communiqué in the night of Friday last; for the BoM, it was merely an issue of persistent illiquidity of the bank.

It is now proposed to reincarnate the Bramer Bank as yet another entity, the ‘National Commercial Bank Ltd’. I don’t know how the change of name takes care of the illiquidity problem which was brought forth as the cause for the revocation of the bank’s licence in the first place.

On the morning following the Friday nocturnal decision of the BoM, the Board of the Financial Services Commission (FSC) took the decision Friday 3rd April morning to appoint Messrs Bonieux and Oosman of PwC as Conservators of the BAI Co (Mauritius) Ltd, (BAI), the same group’s 45-year old flagship insurance company, ‘to safeguard the interests of policy holders’. In its Notice regarding this decision, the FSC has clearly stated that its decision to appoint the Conservators is prompted by the systemic risk posed by the revocation by the BoM of the licence of the Bramer Bank – a sort of chain reaction to the original decision taken by the BoM – not because of any inherent failure of the Company to meet the requirements of the Insurance Act 2005.

In order to weather a storm, it appears to me that you should in the first place not unleash the storm itself. Obviously, as you state, it would be naïve to assume that apart from racking the nerves of investors in the local finance industry, these decisions will not travel outside Mauritius. Given our puny size in the international financial market, however, it will not really hog the international headlines. But people who were or are investing in the domestic financial sector will heed the explicit warning that the series of decisions taken in this matter will give to anyone not minded not to be submitted to arbitrariness. All this hurts at the core.

* Whether the image of Mauritius takes a beating or not, that is really besides the point anyway, for it is bound to take a beating in any case. But one could argue that doing nothing in the light of the gradual weakening of Bramer Bank, for instance, over the past months as highlighted in a ‘mise au point’ by the Bank of Mauritius, this week, was not an option. Right?

What do you mean by ‘doing nothing’? It appears the BoM was already dealing with the Bramer Bank’s liquidity shortfall. The bank had apparently been facing a drain of its deposits since December 2014 when there took place a change of guards at the BoM. In the circumstances, the BoM states in its Mise au Point of 4th April that it had been providing liquidity support to the bank all along. Eventually however, a while before the revocation of the licence, the BoM decided to turn off the tap.

It should be clear that for a relatively small bank such as Bramer, the untimely exit of one or several of its large deposits by public sector entities will precipitate a structural liquidity problem, until it has time to bridge the gap so created by raising other deposits. It is the case for all banks which have a limited and relatively narrow deposit base on which they depend to carry out their lending activities. One or two major such deposits shifts almost simultaneously, and you have to solve the resulting liquidity problem. Given time, you overcome this kind of problem if your portfolio of assets is sound.

The real question was not one of liquidity. It was about the quality of the assets on the books of the bank. If this is unhealthy, it usually prompts a regulatory action, not an accidental liquidity shortfall. But, from the very start, we’ve been hearing about a liquidity shortfall which its main promoters were unable to fill up, which is what would have prompted the revocation of the licence.

* One commentator from outside Mauritius, expressing his views on this matter, says he is still trying to understand whether it’s for real or whether it’s politically motivated, adding that ‘the logic of the situation suggests that it must be for real as it is too economically damaging otherwise’. You have supervised commercial banks for many years before taking up the post of Deputy Governor of the Bank of Mauritius in which capacity you had presided over the closure or the censoring of wayward banks. Tell us: when do you know that it’s for ‘real’ and it’s therefore time to wield the axe?

This is what I am referring to as the ‘soundness of the assets’ the Bramer Bank would have accumulated over time by utilising the public deposits at its disposal.

Focus should be on the realizability of those assets – i.e., mostly loans to customers — over time. Will they be repaid according to the agreed schedule? Does the bank hold sufficient real security to get its borrowers to repay the facility given, in case of difficulties? Or, is the borrower’s normal flow of business sufficient to ensure repayments as and when they fall due, not requiring recourse therefore to securities, etc.? If these are assured, the bank regulator would be expected to ‘save’ the bank by helping it make good temporary liquidity shortfalls – arising out of hasty unexplained withdrawals of deposits in this case – until the situation is redressed. This does not entail pronouncing a death sentence upon the illiquid but otherwise solvent bank.

I can tell you that while I was regulating banks in the good old days, we had put in place safeguards enough to make banks pay up the bill almost immediately if they committed grave errors of judgement when granting facilities to customers. This should be continuing today as it is an international practice for the good governance of banks.

According to our regulatory guidelines, all banks are required to set aside ‘provisions’ as and when faced with non-performing loans. When borrowers do not repay as agreed in the lending contract, the bank has to set aside ‘provisions’ against the bad debts. The more provisions made against bad debts, the less the amount of profits/dividends banks would be able to distribute to shareholders each time they have to set aside additional provisions when loan facilities fail to perform.

I am assuming that the Bramer Bank was abiding by this ‘provisioning’ requirement; otherwise, its auditors would not have issued a clean opinion on its financial statements year after year. Had the Bramer Bank accumulated an irrecoverably huge amount of failed loans, it is this and not its illiquidity that would have been given out as the prime cause for the revocation of the licence. This was not the case. It is the failure by its owners to inject an additional amount of Rs350 million to make good the bank’s recurring liquidity problem after the presumed massive outflow of public sector deposits in the recent period that has been advanced as the reason for revoking the licence.

Sometimes, certain banks used to repackage with new terms and conditions their previously given loans which had gone bad. They would ‘re-baptize’ them as a fresh loan with the support of their boards in order to escape having to put aside the required provisions. But we had a team of sharp-eyed regulators going on regular onsite inspections of banks and they made sure to set the clock right back, ensuring that banks abide by the safeguard mechanisms in place. No abuse was allowed. This helped avert a sudden surge of bad debts threatening the very survival of the banks. At the same time, this approach helped avoid taking drastic regulatory actions such as having to abruptly pronounce the death sentence on banks.

You can make out now whether the decision in the case of Bramer was for ‘real’, as you state it!

* The Bank of Mauritius in its 4th April 15 ‘mise au point’ states that that ‘the Bank did not wish to travel outside the boundaries of its regulatory authority’ and therefore turned down the Bramer Bank’s request for a special line of credit of Rs One billion against security over its immovable properties. We are not aware if besides the safeguarding of bank depositors’ interest, ‘saving’ banks also falls within the remit of the BOM. One would wish to be reassured whether it had explored all other possibilities before it wielded the axe. What else could have been done?

I believe that after the withdrawal of significant amounts of deposits by concerned public bodies, for reasons unknown, the Bramer Bank was unable to replace the sudden large outflow of liquidity. It had difficulty meeting its day-to-day cash payment requirements. Having exhausted the normal channels to get into needed liquidity for this purpose, it would have offered its immovable properties as collateral to the BoM to secure adequate cash from it to tide over the situation. It may well be that the BoM doesn’t have the power to issue cash against such a security. It was refused accordingly. It was left to the owners of the Bramer Bank to look for the needed cash from alternative sources by pledging, if need be, the same immovable properties. Before that, however, the BoM would have judged that the bank would not be able to bridge the gap. It closed in on the banking licence on the view that the bank was caught in a gridlock.

If you’ve followed the international financial and economic crisis of 2007-08, you would have seen that the best regarded governments of the West (Britain, America, Europe) have done all they could to prevent their banks from going under. Governments and central banks have injected massive amounts of liquidity in affected banks by all imaginable means, even by accepting junk bonds or the banks’ loan contracts as security. This is not only because a bank is like the epicentre of entire hubs of economic activities in the countries which suffer bitterly when their banks cease to operate. It is also with a view not to introduce the element of loss of confidence in financial systems which are the edifices that hold economies altogether.

All alternatives are usually considered before ‘wielding the axe’ on banks, as you say. Revocation is really the last recourse when all else has been exhausted. This is why certain European and even American banks which don’t meet the requirements of ‘stress tests’ (e.g., how resistant will you be against failure if a certain percentage of loans went bad all at once?) are kept alive nevertheless in order to keep up economic growth. Yes, it is one of the prime duties of central banks to save banks from failing.

* Minister Lutchmeenaraidoo spoke of the BAI in his reply to last Tuesday’s PNQ in terms of ‘Ponzi scheme planned and masterminded to steal poor’s people’s money’. One could also perceive the BAI’s downfall as having been politically motivated, given the massive withdrawals of deposits by government bodies from Bramer Bank prior to and leading to a serious deterioration of its liquidity situation. Does it look to you that it had all been ‘planned and masterminded’?

I am not quite sure the Financial Services Commission would have allowed the BAI to operate if it was a Ponzi scheme. That would have defeated the provisions of the Insurance Act 2005, prompting immediate action by the regulator.

Many people misunderstand what a Ponzi is. It involves using funds supplied by the last ‘investor’ into the (Ponzi) scheme to repay previous ones, usually with lucrative returns as an invitation for more such investments to materialize in the hands of the ‘promoter’. The latter appropriates to himself the greater part of the series of ‘investments’ so received, using only as much of them as is needed to keep credulous investors into the scheme believe that money is being returned as promised. There is no counterpart objective assets to back the ‘investments’ received and it is usually too late when participants in the scheme realize this. Neither the FSC, nor the company auditors, nor the Insurance Act would permit such a thing in our case.

As regards the second part, if ‘planning and masterminding’ the withdrawal of the deposits was involved, the real question is: ‘ A qui profite le crime?’ Moreover, another question one would need to answer in the case of those withdrawals of deposits is: did the public bodies in question suddenly need all that money for their cash needs? Why such big amounts and why in so short a space of time? Or, did they withdraw them because they went for higher returns in alternative investments?

If none of this holds and can be proved by reference to actual records, the deposits may have been mischievously withdrawn to deliberately embarrass the Bramer Bank from doing business as usual. I don’t have information as to the purpose for which the public bodies in question needed the money they withdrew in such large amounts from the bank in such a short period of time. Given this, banks which depend crucially on deposits made by public sector bodies with them should think again.

* One could otherwise argue that those government bodies which withdrew their deposits had seen a disaster in the waiting, and that the best thing to do in those circumstances was to move to safer waters. Safe bet, or is that prudential management?

I can answer your question by another question: from which source would the concerned public bodies have learnt about the ‘disaster in the waiting; and acted therefore to protect themselves? Your question presupposes that someone or other knew or anticipated that the bank was on its way out and he/she would have passed to the public bodies this warning, which would have prompted the action of withdrawing their deposits.

In the case of the loss of Rs 881 million from the MCB in 2003, the NPF came to know about the fraudulent use of its deposits at the bank only when the cat was out of the bag, not before. So, unless there is a very privileged person who can anticipate that Bramer Bank was facing ‘disaster’, as you say, no one outside would have known about it. And taken the action which you mention.

* Didn’t you personally see that and other disasters waiting to happen when you were at the BOM or in your capacity as Chairman of the Financial Services Commission (FSC) for many years prior to your retirement?

I did. The local South East Asian Bank had the misfortune at one time to have a Manager who did not carefully nurse his lending portfolio. As expected, many local sharks took advantage of the situation and brought the bank on the brink of disaster in the days that strict ‘provisioning’ requirements by banks were not in place. When they discovered this state of affairs, the Malaysian directors of the bank were desperate and wanted to disband the bank, being prepared to lose their stakes in it.

As a regulator, I thought that it would be a very bad publicity for Mauritius if the bank was allowed to sink in this manner. I persuaded them to get a better CEO at the helm, cure the bank or at least raise its head above water. They allowed themselves to be persuaded, invested the necessary money and efforts only to sell that very bank at a profit later to the self-same British American group. You have to protect the standing and image of your jurisdiction as a regulator by acting pre-emptively and warding off catastrophes waiting to happen.

I adopted the same approach when at the FSC. Some directors/shareholders of a couple of insurance companies had taken away loans to themselves from their companies. Once it became aware, the Board of the FSC (which I chaired at the time) asked them to restore back in a given time period the borrowed funds to their companies as it amounted to a situation where they were effectively sucking away their capital contributions from the companies by taking the personal loans from them. We insisted that the companies be recapitalized within a given timeframe.

When the government changed subsequently, some of the Directors of the FSC, including myself, were asked to go. This was a clear signal from politicians that public institutions will not be allowed to do their rightful duties if the duties are at cross purposes with the bidding of those in power. In the process, we as a country have debilitated many of our public institutions.

* Habib Zurich, First City Bank, Union Bank, Mauritius Cooperative Bank, MCB, White Dot, Sunkai, and now BAI: that’s a rather long list of diasters for a small financial centre like Mauritius, except that the MCB had the wherewithals – at the cost of its shareholders’ wealth — to weather the storm. The temptation to point the finger at the regulators, whether it’s the BOM or the FSC, or towards the political masters of the day may be hard to resist. But would you say that both parties are equally to blame?

I would not amalgamate all of them if only for the fact that some were plain unlawful weeds growing up from nowhere and succeeding to cash upon the credulity of savers. Others, the banks and insurance companies, were/are formal setups and subject to financial regulation.

A bank like the First City Bank (formerly Delphis) was owned by persons who were not fit and proper in the first place. In the other cases, they were fairly small banks and, to my mind, they could have been salvaged with necessary efforts. Only those who are aware of the pain and stress endured by those who managed to get the Mauritius Cooperative Bank on foot finally during the colonial period and the service it provided to uplift those who were heretofore denied banking services, can feel the sadness of such a bank being de-licensed. By killing the smaller banks, we are pushing business away towards more concentration in our banking sector, thus resuscitating the risk of ‘moral hazard’ when people move increasingly towards the ‘Too Big to Fail’ banks, thinking they would be safer.

To my mind, there were cases where banks were de-licensed for purely political convenience and it is extremely sad that this should have been the case. I don’t want to open past wounds if only they had served the lesson they imparted to future generations of politicians: let those in charge of running supervision be allowed to do so provided the latter are competent and have the country’s at heart.

If we allow our institutions to function professionally and independently, the country would break new grounds in the financial sector – instead of losing the good track record we’ve painstakingly earned piecemeal and at great effort over a fairly long stretch of time. It would not lose the goodwill it has so earned due to one rash action or other by incompetents.

* In any case the FSC has taken a good beating these last few days as regards to its supervisory record with respect to what has been termed as ‘Ponzi scheme’ of the BAI. That has surely to do with the BAI’s ‘Super Cash Bank Gold’ offer to investors. The question that arises is : isn’t there any policing institution out there to decide whether such offers or the earlier White Dots’/Sunkai’s are/were inacceptable and had to be withdrawn in the public interest ? Surely regulators are paid to police their respective boundaries, aren’t they?

As I told you earlier, the Ponzi scheme may eventually turn out to be a figment of the imagination. Insurance products are regulated and subjected to prior approvals. Insurers have always competed with institutions like banks, offering better returns to investors in insurance products because they are at a second level of competition on the financial market, compared with common bank products. One should not read too much in that. All long-term insurers may be involved in the same kind of hyperbolic product offer.

I understand that actuaries are only now being appointed to evaluate the worth of BAI’s assets. You could not have known they were Ponzi even before you embarked on a serious investigation. It may well be that some of the assets could lose drastically their value, given the regulatory actions already taken, eroding the values attributable to policyholders. But that is a subsequent effect, not the result of any prior Ponzi scheme.

* Good governance minister Roshi Badhain has been saying lately the the law will be amended to ensure that there is no repeat of such disasters as we have encountered these last few years. Would that suggest that the law as it now stands does not in fact empower the regulators to carry out effectively their policing functions?

Regulators discover new flaws in the legislation from time to time and they take action to pre-empt any abuse that could be made of loopholes in laws/regulations. The Finance Bill is an opportunity par excellence to update and chase down emerging potential abuses putting at risk the prudent conduct of financial business in the country.

The Minister may have ideas of his own and he is free to convince others that they would be useful to keep our jurisdiction safe and clean. It is something that policy-makers in the most advanced economies of the world keep doing. We have to catch up with financial misbehaviours and harness them for maintaining our reputation.

One should not read in all this however that regulators are failing to do their duties or aiding and abetting in the commission of financial abuses because there would be gaps in the existing legal framework. We have to be cool-headed about all of this.

* Whatever happened to auditors, particularly the external ones? Too bad the rotation of the latter has not been enacted, isn’t it?

Mauritius chose in 2004 not to embed into the law, at least as far as financial institutions are concerned, that there should be compulsory rotation of audit firms. The decision has been rather to rotate the partner in charge of the audit firm from time to time even if the same audit firm was in charge over along number of years. This presupposes that a partner replacing another would be independent enough to point out important issues the previous partner overlooked when he was in charge and which may have wrought serious damage in the, say, financial firm being audited.

Audit firms are strongly opposed in several jurisdictions to the idea that their rotation would bring about significant improvements in the level of audit provided to individual firms.

We must realize that audit firms – rotating or not — state in their Letters of Engagement that it is the boards of individual institutions, such as the BAI’s, that are responsible for identifying and dealing with frauds, if any, in the firms under audit, not the auditors themselves. In such a case, it is the Risk Monitoring Committees (RMCs) of company boards that assume greater importance towards tracking and dealing with potential cases of fraud. For this to be an effective mandate, RMCs have to be well equipped forensically and be fully independent. We need to know whether, in the case of a country like Mauritius, private sector boards are not obedient to the sway rather of their dominant shareholders who may have other dreams to chase?

 

* Published in print edition on 11 April  2015

Tags:BAI, Cautionary Announcement, Financial Services Commission, former Deputy Governor BOM, Interview: Anil Gujadhur, Letters of Engagement, Minister Lutchmeenaraidoo, Ponzi Scheme, Risk Monitoring Committees, Roshi Badhain