Business Page August 12th, 2001

Globe Trust - Testing the FIA



The problems at Globe Trust and Investment Company Ltd. have understandably dominated press and national attention over the past several weeks. Strictly speaking Globe Trust is a not a bank but is an authorised deposit taking financial institution under the Financial Institutions Act 1995 and comes under the supervision of the Bank of Guyana. The BOG, following an inspection of the company, had requested it to attend a hearing to show cause why its operations should not be taken over, or as the Act says, be taken possession of. The company did not go to the meeting but rather sought the Court's intervention in the matter raising a number of technical and constitutional points, the determination of which will help to resolve some of the issues which new legislation inevitably raises.

For Guyana, this is new territory. Both small and more sophisticated depositors who have always naively assumed that their money was safe now face the prospect of substantial unprotected losses. Questions will inevitably be asked whether the regulator should have acted earlier but precipitate action could in fact have exacerbated a difficult situation. For the Bank of Guyana, with its own absence of relevant experience, it was no doubt a hard decision. Sections of the press and some key political players had their say, perhaps with a little bit too enthusiasm. We cannot underestimate the vulnerability of the financial system. The wider public interest requires extreme caution in reporting or commenting on matters relating to specific financial institutions. The accounting profession will have to explain to the public why the danger of failure had not been raised by the auditors, the directors ought to explain their stewardship while the government will have to assure the nation that the damage can and is being contained.

The Fallout

The problem is that once trust and confidence is lost, it will take more than a little talking to restore the faith. Already - and despite statements from the highest levels of Government, the BOG, no less an authority than the IMF itself, and the assurances from some of the financial institutions - there is considerable unease among depositors, fearing the domino effect in the absence of any deposit insurance or other form of protection. It would be wrong for the Guyana Association of Bankers to maintain silence merely because Globe Trust is not a member of that organisation. The GAB should be meeting and making arrangements to support each other both privately and publicly in the event of a run on any of them.

There have been two principal responses to the developments at Globe Trust. One is the anger demonstrated by President Jagdeo, and the other the prediction that since Globe Trust is "a relatively small non-bank licenced depository financial institution with assets of approximately 1% of the financial system, and that the rest of the system is sound with adequate capital and liquidity, there would be no significant impact on the soundness of the financial system".

Self-fulfilling Fears

While the statistics may be true, and immediate concerns about any bank(s) may be entirely unjustified, the failure of even a small entity such as Globe Trust has to be considered far more widely than by reference to market share. Such failures cause losses to depositors and creditors, create problems for longstanding clients and spill over into other institutions with considerably more significant impact. Globe Trust was initiated with a distinct market focus and a number of small savers will have lost 100% of their savings. There is a saying in business generally but in banking in particular 'too big to fail', which offers some form of insurance to uninsured depositors. Unfortunately, small institutions are not seen as substantial enough players to justify any form of Government intervention. President Jagdeo has already ruled out a "bailout" but has committed Government support to small depositors of up to $10,000 and the press has suggested that these might account for over 50% of the deposit holders in Globe Trust.

While that will offer some political comfort, it means that there are a number of other depositors whose monies at best would be frozen for some considerable time while the assets of the company are being liquidated. This could have a substantial effect on national consumption as well as the psychological fear that the financial system- at the same time the foundation and the mirror of the economy - is in trouble. This can be a self-fulfilling fear since no bank or other financial institution is structured to meet large and largely simultaneous demands from the bulk of its depositors.

Demise Exaggerated

The press reports and the alarm bells that were sounded appeared to have assumed that the company was as good as dead and talks were either about bailing out or that the demise of the organisation would have no significant impact on the financial system, a position taken by no less an authority than the IMF itself. The options for the regulator are extremely difficult particularly given the political realities in this country. The regulator is of course aware of its role as guardian against failures in financial institutions even as others may want to accuse it of allowing the situation to have reached crisis stage. Whatever action the Bank of Guyana takes must have as its objective the reduction of losses to depositors, minimisation of negative consequences for other financial institutions and the economy, and the restoration of confidence.

Fortunately the Act allows the Bank of Guyana reasonable time to consider the state of the company while the political temperature cools off and letter writers have their say. The FIA sets out the conditions under which the Bank of Guyana can take possession of a financial institution and its options during possession. Among the conditions for the taking of possession are exhaustion of capital, dissipation of assets or earnings as a result of unsafe banking practices and insufficiency of assets to meet depositors, creditors and other liabilities.

Regulator's Options

The three options at its disposal are the closure of the operations and an application to the Court for an order for a compulsory liquidation if it considers that there is no reasonable prospect for the institution's return to financial soundness through re-organisation or otherwise; commencement of re-organisation if it considers that there are reasonable prospects of restoring the institution to financial soundness. In this case, it must submit to the Court a plan for approval; and finally, it may terminate the seizure if it determines that the grounds for the seizure no longer exist. The extreme remedy of liquidation is not the ultimate decision of the Bank of Guyana but that of the Court which can only make such a decree upon petition by the Bank or if it, that is the Court, rejects a re-organisation plan submitted to it.

When the Bank takes possession of a licenced financial institution, the Bank or any person it appoints as an administrator has exclusive powers of management and control including the discontinuation of operations, the payment of debts, employment, and taking action in its name on matters in which the financial institution may be a party.

Time to Reflect

The whole saga has brought into sharp focus the authority and operational capacity of the Bank of Guyana and the Financial Institutions Act which in the past has been criticised for its strict provisioning requirements. There were those who felt that the grace period of four years for bringing provision against doubtful debts in line with the Act was too short and that the Act must be flexible enough to accommodate any difficulties which borrowers face. The essence of the FIA is the principle of prudential banking and the essence of prudential banking is the protection of depositors' funds. It is not about enabling the financial institution to report continuous profits or to allow borrowers to repay whenever they can.

The purpose of the FIA is to protect the integrity of the financial system and to reduce the possibility of the sort of difficulties in which Globe Trust eventually found itself. No doubt in the wake of these difficulties there will be some review of the FIA but it is likely that Bank of Guyana will be much more vigilant in supervising and enforcing compliance with the Act. Financial business is no easy business and perhaps there is no greater need than that of good governance. Section 26 of the Act deals with the qualification of directors and officers and provides the very general condition that no one can be appointed a director or officer is he is not a "fit and proper person". One expects that greater attention will be placed on this requirement to improve the quality of governance in financial institutions.

There is clearly a need for some form of deposit insurance which is common in most financial systems. Deposits in GNCB are guaranteed on the Consolidated Fund and it must be a measure of the country's confidence in the banking system that depositors do not flock to place their money at the GNCB. The Globe Trust issue should make depositors more cautious and they may now have to reconsider whether loyalty is a substitute for discipline. The law does not allow them access to meetings of the institutions although it does require the publication of audited financial statements. Perhaps the governance system should provide for depositors -clearly a major stakeholder- to have some role in the organisation in which they are the largest contributor of funds.