Business Page – September 10, 2000

The FIA - Villain Of The Peace?

This piece has been written for the October newsletter of the Caribbean Association Of Indigenous Banks (CAIB). It is printed herein with the kind permission of the CAIB and the commercial banks operating in Guyana.

Introduction

The Financial Institutions Act introduced in Guyana in May 1995 is under the microscope of the public as commercial banks are forced into a financial straight jacket by its rigid provisioning requirements. One of the country’s weekly newspapers in its issue of August 4, reported that the banks had repossessed twenty-eight properties in one week in an apparent downturn in the economy. What is not good for the country is that not only is that the key rice sector is so badly hit but that the slow down is affecting most sectors of the economy and across the country.

The FIA was a first rate, first world piece of legislation adopted and enacted as part of the restructuring of the country’s economy under the terms set out by the IMF in return for assistance under a series of programmes going back to 1989. The principal objectives of the FIA were:

  • To establish an internationally accepted system of capital definition and minimum capital levels for banks;
  • To provide strict guidelines for provisioning purposes including off-balance sheet exposure;
  • To set out rules for what may be considered good security;
  • To restrict credit to single and group borrowers; and
  • To give the Central Bank - the Bank of Guyana - greater responsibility and authority over the operations of the commercial banks.

The principal objective of commercial banks’ regulation is of course the protection of depositors’ funds which is extremely important in the absence of any type of depositor protection like the FDIC in the United States. Another important objective is the reduction of the risk of bank failures which could have such a devastating impact on the rest of the economy. Perhaps it would not be overstating the case to add that in the context of increasing globalisation the developed countries wanted to ensure that the financial systems in the developing countries maintained some degree of stability and were able to meet their international obligations.

From the time the FIA was first mooted the bankers raised a number of concerns some of which were addressed in the legislation subsequently passed. However there was not much the authorities could do without significantly affecting the substance of the legislation. The flip side of the concern for the security of depositors’ funds is of course that those funds be securely invested. If they are not then the interest rates on loans to be charged would be prohibitive if the banks were still to make a profit and attract further depositors’ and investors’ funds. Banks had previously stretched their discretion as far as their auditors would accept and generally carried some loans and advances the repayment of which depended on the banks continuing to roll forward those facilities. The legislation took account of this and provided for a grace period of four years from June 1, 1997 in which banks could bring their provisioning into compliance with the Guideline issued under the Act.

The banks each adopted a policy that took account of its own circumstances. One of them indicated that it had adopted international norms for the classification of loans and advances and that in so doing it had already been in compliance with the FIA. Most others however felt that the implications for immediate provisioning would be disastrous for their financial statements and are utilising the entire four year period for compliance.

What has compounded the problems for the commercial banks however is the difficulties which the economy has been experiencing since 1997 when the country held general elections which have since seen social, political and economic repercussions. As if this was not enough bad weather is creating havoc in the crucial rice sector and gold, lumber and sugar, the other main pillars of the economy are all experiencing problems of varying degree. Indeed so serious has been the problems for the rice sector that the Bank of Guyana has twice waived the provisions of the FIA to facilitate refinancing of credit facilities in that sector.

Interestingly enough the Banks have not responded with great enthusiasm to this waiver, a recognition that the FIA gave them the opportunity to call in some of loans which they may have been too liberal in granting in the first place. Indeed the Banks are finding that the FIA is not of much use in those cases where security had not been perfected or they accepted projections which were too unrealistic to be true.

The banks now seem to be torn between their desire to show profit and the danger of restoring on their books loans which may yet prove difficult given the uncertainty of the economy in the immediate future. The banking sector is becoming extremely competitive and the desire to show profits is very strong but at the same time they also realise that paying corporation tax at the rate of forty-five percent (45%) on paper profits is not good business.

Has the FIA worked?

I surveyed by way of a short confidential questionnaire the views of the commercial banks in Guyana their views on the operation of the FIA. The consensus among the responses is that the FIA has forced the banks to adopt greater discipline in their evaluation of credit applications with emphasis placed on ability to repay, security and documentation.

Respondents agreed that generally the FIA has operated in the interest of the banks and that the strengthening of their balance sheet places them in a better position to withstand unexpected shocks. They noted that by extension their borrowers benefit as well since the banks must now impose and enforce discipline among those who seek to borrow from them. However it was felt that the Act discriminated against agriculture and specialised large scale manufacturing as a result of the assessment for security valuation purposes. The respondents consider that stricter financial discipline was unavoidable in the interest of development of the economy - that once the economy showed signs of slippage the chickens would come home to roost, as indeed they have.

On the other hand it was felt that some of the rules were inflexible and restricted banks’ ability to assist customers in unusual circumstances. Commenting on the provisioning requirements one banker noted that the 20% provision for accounts rated as sub-standard was unnecessarily stringent since those loans are, by FIA definition, well secured. One international operator commented that the Act does not give due regard to Branch banking.

It was also felt that the classification of accounts after 90 days past due is more stringent than in other countries and the strictures imposed thereby on borrowers do not allow the flexibility to withstand unexpected shocks. The limit of two to the number of times an account may be re-financed was commented on as similarly restrictive although this was not referred to by most of the respondents.

Despite the inflexibility in the legislation the supervising authority, the Bank of Guyana was rated as helpful and co-operative with the banks without compromising the intent and integrity of the FIA. One banker commented that the transitional period was too short and did not anticipate or cater for a slow down in the economy.

One respondent considered that the FIA as currently in place is insensitive and inappropriate to developing countries economic, legal and social conditions and that their strict enforcement could precipitate a collapse of the economy while trying to remedy deficiencies in the banking system. It was noted for example that there is no financial market and that commercial banks are performing the role of development/merchant banks: having to lend long while borrowing essentially short. Unlike developed countries jurisdictions such as Guyana have a wide range of critical deficiencies. The legal system is overloaded and does not accord a high priority to commercial matters while companies legislation does not allow distressed companies the type of Chapter 11 relief available in the United States of America. The accounting and tax system and culture are extremely deficient while as is becoming apparent in the press there is still prejudice against bankers seeking to enforce their security.

The lessons from the Guyana experience

As this article suggests while every financial system requires the existence and enforcement of strong regulatory mechanisms for the generation of confidence and stability, the successful operation of such a system assumes a compatible accounting, legal, social, cultural and political environment. Each country has to examine the constituent parts of its society and as far as possible ensure that banking regulations are not imposed in a vacuum. Guyana at the beginning of the nineties was coming out of a long period of political experimentation which had done great harm to the economy and the regulatory environment. For the four years up to the introduction of the FIA the economy had been coasting along smoothly and the transitional period of four years for full compliance might have been quite adequate had this trend continued.

On the other hand it is frightening to consider the consequences if the FIA had not introduced greater discipline in lending. Indeed one of the unintended consequences of the FIA is the creation of a reserve of debts against which provision had been made and from which recovery will therefore constitute profit.

For those countries in the Caribbean which are thinking of similar legislation the Guyana experience would be very useful as a case study. For those which already have such legislation this would still be useful. It is always a good policy to review the operation of major legislation after a few years. There could be no better case for such a review as the FIA and its operation in Guyana.

The contributor wishes to acknowledge the contribution of the commercial banks operating in Guyana by responding to our questionnaire.