Risks of having too many banks

Policymakers in Bangladesh perhaps forget that the country's banking system has been modelled on the British system, not on the American one. In our textbooks on banking, we learned that there are two types of banking -- unitary and branch banking. The unitary one is the American type where a bank has no branch.  In this system, there can be too many banks depending on demand. In the unitary type of banking, if a bank goes bust, the depositors are saved through an insurance coverage. The founders or owners of such banks bear the cost of bank's failures.

The other type of banking is the British system known as branch banking. In such banking, every bank has its headquarters in a certain city with many branches spreading all over the country. Prospect of business of a bank determines the number of its branches. New branch and location of the same are to be permitted by the regulator. The regulator can be the central bank or the monetary authority created solely for the purpose of banking regulation.

In the branch banking system, the number of banks in an economy cannot be many; they may be few in numbers or many, depending on the size of the economy and the country.

If a bank fails or goes bust in a branch banking system, it means whole of the bank, including all branches under it, goes bust or fail.

In the branch banking system, the regulator always keeps an eye on what is going on in individual banks. Having a license for such banking is not easy. The regulator examines the need for a new bank in the economy and the details about its promoters.  If the findings are positive, it fixes up the amount of equity capital in such a way that the interests of depositors are protected.

If a bank goes bust under the branch banking system, it sends domino effect through the banking system, better be called down the financial system. That is why the regulator becomes tough with an errant bank or the bank which drifts toward collapse under the burden of non-performing loans (NPLs).

The regulator normally does not allow a bank to go bust; sometimes it injects fresh funds from its own account in the failing bank. Sometimes it asks the equity holders to give more of capital to it. Sometimes, it, as a last resort, dismisses the management board and appoints an administrator.

If a bank fails in such a system of banking, the main concern will be with the security of the depositors' money. To protect the depositors' interest, the licensed banks are highly capitalised. The regulator does not allow a bank to distribute dividend to the equity holders by keeping a deficit in the provisioning requirement against the default loans.

Bangladesh's banking system is modelled on the British system of branch banking. We inherited such banking first from the British colonial rulers, and then from Pakistan when present Bangladesh was a part of the former. At the beginning, there were a few state-owned banks in the Bangladesh economy. In fact, in the initial phase, policymakers, who leaned toward socialism, did not want to make a room for privately- owned banks. But later, the Bangladesh economy slowly opened up towards a market economy and the policymakers in the first part of the 80s of the last century allowed commercial banks in the private sector.

Thereafter, more banks were permitted at intervals, and such a practice is still going on. Now, the economy has 57 commercial banks. Three more  commercial banks will reportedly be allowed soon. The last time new banks were permitted was in 2013, but out of those banks at least two are now on the brink of going bust. An independent study was never undertaken to ascertain the need for permitting new banks in the economy. It is alleged that some influential persons want banks and the government also obliges them. Unfortunately, the regulator is found to yield to such wishes of the government. Now the new aspirants for banks think that it is easy to have licenses for banks provided they have good relation with the government.

While the Finance Minister himself thinks that the economy does not need any more banks, still we see more banks are coming! The cost of having too many banks in the economy may be huge. God forbids, if any one of licensed banks go bust it will send domino effects down the banking system. If the government time and again comes up with fresh fund to save the non-performing banks by giving away the taxpayers' money, then it is, in some sense, collaborating with the people who are siphoning the public money in the name of doing business in banking. We think, the huge default culture that developed in the banking system was partly because of the fact that the bank owners got easy money from the government when they asked for it.

Too many banks lead to an intense competition in the business of banking. In fact, many businesses that have an excessively high ratio of debt capital to equity capital is the result of competitive credit offering by the banks. At the end, the overleveraged businesses become defaulters.

The writer is Professor of Economics University of Dhaka

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