Banking & Research - II

Bimal Jalan, the governor of Reserve bank of India in his address at the 24th Bank Economists’ Conference held in Bangalore on December 27-29, 2002, has observed that the recent international financial developments have underscored the critical role of the regulatory and supervisory function in ensuring the health and stability of the financial system. Though the present depressed state of economic activity is exerting conflicting pulls on the extent of supervisory rigour, the governor asserted that worldwide, there is a debate on how to strengthen the financial regulation further so that the systemic stability of the financial system is ensured.

The article “Optimal Bank Regulation and Monetary Policy” by John J Seater, expounds similar issues. True, it is an age-old theory that banks not only function as financial intermediaries between those who have savings and who need investments, but also, play a key role as the “conduits of the monetary policy.” It is in this context that central banks have assumed the natural responsibility of regulating financial institutions to ensure that the system is sound besides providing useful information for the conduct of the monetary policy. As rightly observed in the article, this pursuit of conflicting interests by the central banks obviously, raises a few questions: “What is the optimal structure of the institutional framework for both monetary and regulatory policy? Should two types of policies be carried out by separate agencies or a single agency? If,  by separate agencies, what should be the nature of coordination in them?” Indeed, similar rumblings are heard in the corridors of the Indian financial system too. The analysis in the article, asserts that “bank regulation should be active rather than passive, continually changing in response to economic conditions”. The other important conclusion of the study is that “optimum regulatory and monetary policy should be simultaneously chosen, implying that the institutions responsible for them must at least co-ordinate their activities and perhaps should be combined to be one agency”. This indeed, vindicates the model being practiced in india and in that context, the issues discussed in the article merit a serious thought.

There is a general belief that weakness in the banking sector may have wider effects as problems in one bank could spillover into widespread difficulties in the sector. Against this backdrop, the Basel Committee on banking supervision prescribed international minimum standard capitals in 1988, and the same has been enshrined into domestic bank regulations by more than 100 countries. The article, “International Financial Regulation and Stability” studies the reasons for international agreements on financial regulation and considers whether the drivers are the same as those behind domestic financial regulations, in particular regulation of banks, and concludes that it is essential to have international minimum standards for effective domestic regulation of banks. The article also raises a pointer that fixation of minimum capital requirements under Basel could create credit crunches and there are now concerns that pro-cyclical requirements under Basel II may exacerbate the effect.

The criticality of banking soundness for realizing the much sought after economic growth is perhaps felt more essential among transition countries as it was vindicated by the banking crises experienced by the Baltic States during 1992-93, 1998-99. The crisis was mainly attributed to—poor central bank regulation and supervision, mainly accounting and excessive taxation, an inadequate legal infrastructure for lending and pervasive corruption coupled with weak banking skills and management. These evils are perhaps not unheard of in the Indian scenario. The article: “Development of the Financial Sector in the Globalizing World: An Emerging Market Economy Case” analyzes the performance of the Estonian Commercial Banking System by using a modified DuPont financial ratio analysis, a novel matrix approach and traces the inter-relationship between different financial indicators.

There is an apprehension that geographical concentration of branch networks is vulnerable to local economic downturns. Hence, such banks in the US are often directed to take special measures to reduce their vulnerability to such economic downturns. There is also an argument that small banks have a comparative advantage over large banks in small business lending, for small banks can originate and monitor relationship loans at a lower cost than larger banks. Against this conflicting backdrop, the article “Are Small Rural Banks Vulnerable to Local Economic Downturns?” presents the findings of the empirical study conducted to investigate the relationship between the performance of geographically concentrated small banks and the local economic activity.  The study revealed that there is no statistically significant co-relation between the performance of the small rural banks and the economic data of the respective geographic areas. These findings may have a relevance to the functioning of our regional rural banks as well as the  recently introduced local area banks.

In the recent past, banks across the globe suddenly woke up to operational risk and started paying greater attention to their identification, measurement and management. And, Indian banks are no exception to this phenomenon. With the increased volumes of transactions and falling NIMs, Indian banks today are threatened by operational risk more than ever. The international regulations that are in offing under the proposed Basel II encasing operational risk is yet another cause for the anxiety of the banks. The article “Operational Risk Management in Indian Banks: A Critique” traces different sources of operational risk that impact Indian banks. It also discusses about the relevance of business strategy in impacting operational risk, though it was excluded by the accepted definitions of operational risk.  It proposed for establishing a separate hierarchical setup at the corporate headquarters to draft operational risk management practices and ensure its implementation across the bank. The article also suggests source-specific management practices to mitigate operational risk in banks.  

In the ultimate analysis, what matters in execution of all these policy directives by banks is the availability of right leadership at all levels. The literature identifies two major types of leadership: Transactional and Transformational leaderships. It is reported that transformational leaders, by virtue of their ability to inspire trust and respect in their subordinates by placing a vision before them, make the followers “do more than what they were originally expected”.  Against this theoretical underpinning, the authors of the article, “Performance in Banking Organizations and Transformational leadership” Alois Geyer and Johannes Steyrer have analyzed the relation between transformational and transactional leadership dimensions and subordinate ratings of effectiveness as well as objective performance indicators of banking organization.  The empirical study involved collection of data on performance indicators from 20 different Austrian banks and the findings revealed that “leaders have to generate higher motives through visions and by acting as representatives of the value system of their organizations so that it strengthens the self-esteem and self-confidence” of their subordinates. This was found to sustain long-term performance. The findings of the article sound quite relevant to the Indian context as well, calling for further research on similar lines.

(ijbm Vol II No1 Feb, 2003)