Ensuring stability of financial system

The stability of the financial system is a prerequisite for a steady growth of an economy over the years. The financial system stability is a steady state in which the financial system efficiently performs its key economic functions especially allocating resources, spreading risks and settling payments. It is able to do so even in the event of shocks and stress situation, and periods of profound structural changes.

The growth of economy of a country depends on the steady or smooth functioning of its financial system. The term 'financial system' means the systems in operation of (a) all formal sectors like banks, financial institutions, capital markets, investment companies and funds, insurance companies, merchant banks, credit rating companies, co-operative societies etc. (b)  semi-formal sectors like micro-finance institutions like the Grameen Bank etc. and (c) all informal sectors such as private intermediaries and money lenders (mahajon), etc. The operating system of those institutions should be steady and smooth for good functioning of economic activities of a country. How will it work and who is responsible for ensuring such financial system stability?

Before finding out the responsible authority, we should know the framework of financial system stability. Under this framework, central bank, ministry of finance, all other regulators of the insurance companies, capital market, co-operative society and others, and some other international institutions like Financial Stability Board /IMF, G20 and other international bodies affecting the economy of any country work together with a view to ensuring financial system stability. The central bank, Bangladesh Bank for our country, is responsible for monitoring and reporting through a department titled Financial System Stability Department (FSSD), providing policies like monetary policy, credit policy and other regulatory directions and policies as response to the findings upon review with a view to regulating the financial system as needed for smooth functioning of the economy. The central bank is primarily responsible for such stability because of its functions of adopting and implementing monetary policy and control of credit facility. All other regulators issue required directives, circular and policy for regulating respective member institutions for smooth functioning of institutional operation and economic functions altogether. Here, the ministry of finance updates and enacts the required fiscal policy as required for smooth functioning of financial system and economy.  In short, based on the findings on monitoring, the regulators issue macro-prudential and micro-prudential policies and directives. The Bangladesh Bank issues and implements monetary policy, issues credit policy and controls credit and the Ministry of Finance works for enacting fiscal policy. In adopting all of these policies and directives, the required impact of world economy is considered on the basis of opinion or findings of international bodies working for financial system stability.      

Apparently, it is not the responsibility of the central bank only. The regulators of capital market, insurance companies, credit rating companies, merchant banks, investment companies and funds and others, and the ministry of finance are also responsible to ensure financial system stability. The regulators generally issue prudential guidelines to operate the member institutions for regulating and smooth functioning of the member institutes. The member institutes may not be operated in the way they are required to keep the market stable or smooth for good economic functions.  As such, it is the responsibility of all member institutions under each regulator, their officers, credit analysts, risk managers, management, boards, auditors, and management boards of all corporate companies. Along with regulators, the followings are the key persons/institutes responsible for financial system stability:

l Credit analysts: Credit analysts are responsible for assessing credit worthiness and recommending credit based on prudent and diligent process. Unless due diligent process is appropriate, the loan will be at risk, the non-performing loan will increase and the banking sector will not be stable.

l Risk managers: Risk managers are responsible for identifying risks and taking steps for minimising risks with a view to securing credits. Unless credit is secured properly, it will be at risk, the rate of non-performing loan (NPL) will increase and the banking sector will be unstable. 

l Management of member institutes of regulators: Management of each member company of regulators-banks, financial institutions, insurance companies, stock exchanges, cooperative societies, merchant banks, credit rating companies, micro-finance institutions, etc. must comply with policies and guidelines as approved by the board of each company in line with the directives of regulator. Unless such bank companies, insurance companies, members of stock exchanges and others comply, the financial sector will be unsmooth and unstable for good economic functions.

l Board of directors of member institutes of regulators: The board of the member institutes of the regulators should be strategic and good planner under the directives of regulators. Board issues policies and guidelines as advised by regulators and management implements those in the interest of a stable financial system.

l Management and board of corporate entities availing financing facility from financial system: Over and above the related parties in the financial sector, corporate houses that avail credit facility or collect funds from the financial market in any form have to comply with good corporate governance system with a view to performing well. Good performance by those will contribute to good performance of the financial sector ensuring financial system stability.

l Auditors: Finally, auditors will be responsible for auditing the financial statements of all-regulators, member institutes of regulators, corporate bodies availing loan or debt or equity from the financial market. The financial audit of regulators will ensures efficiency and effectiveness of operational result, i.e, how efficiently and effectively regulators ensure implementation of different functions for members. Financial audit of corporate bodies is essential as loans, debt and equity are provided to those on the basis on audited financial statements.

Thus the stability of a financial system is the result of combined efforts of central bank, regulators of financial institutions, member bodies of each regulator, all their key officers dealing with corporate entities, management and board of member institutes, corporate enterprises, and auditors.  If all the parties work together, the financial system will be smooth and stable to accelerate economic functions enabling us to have a safe and sweet home with foods, clothes and chocolates for kids.

Dipok Kumar Roy, FCA is a Fellow Member of ICAB.

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