20 Per Cent Capital Adequacy For Banks Favoured

The World Bank has said that the Basel committee recommendation of 8 per cent capital adequacy for the banking sector, which is followed in India and some other countries, is not enough. It should be raised to at least 20 per cent, said the World Development Report.

The report says there should be a sufficient number of supervisors, not only skilled enough to do their job but also politically independent enough to do it impartially. It is not enough to rely exclusively on prudential regulation and supervision to undergrid the banking sector without having these perquisites in place.

The report recommends putting tough restrictions on entry of new players by raising the franchise value of the banking licence for incumbents and strengthening the incentive to stay in business.

 

It has also suggested imposition of a ceiling on interest rate on deposits, not only to keep banks in business but also to create powerful incentives for banks to extend branch networks, so as to boost total deposits and accelerate financial deepening.

Governments should also impose punitive contingent liability on bank owners, directors and managers in the event of bank failure. The case for regulating banking is as compelling as ever despite the near-universal trend to move away from controls over the structure of financial markets and their allocation of finance, and embark on a process of liberalisation. Unlike other companies, banks can be hopelessly insolvent without running into a liquidity crisis. It is possible for banks to disguise their internal weaknesses and continue to attract fresh deposits, the report warned.

Failing banks often engage in even more reckless gambles to salvage their position, throwing good deposits after bad, and driving up their losses before the inevitable crash.

Agreeing with systems for formal supervision of banks in certain countries like India, the report says: Well-designed regulation, monitored and enforced by competent supervisory authorities can overcome information asymmetries inherent in banking, and detect at least contain potentially ruinous banking crisis.

The report has listed key elements of a system of supervision as:

* Minimum capital requirement to ensure that owners have something to loose in the event of bank failure. Authorities should also consider qualifications and track record of proposed owners and managers.

* Restrictions on lending to bank insiders can also cut down on fraudulent loans. Many countries also limit a banks lending to a single client, usually to 15-25 per cent of bank capital, making it difficult for banks to make unsound loans.

* Requiring that banks classify the quality and risks of their loan portfolio according to specific criteria and define and identify non-performing assets can provide early warning of problems.

* Minimum auditing standards and disclosure requirements can make reliable and timely information available to bank depositors, investors and creditors.