HomeOpinion & AnalysisColumnistsFive principles of financial regulation for stability in 2012

Five principles of financial regulation for stability in 2012


Speaking at the recent Confederation of Zimbabwe Industries (CZI) economic seminar described as agenda-setting, Reserve Bank of Zimbabwe (RBZ) governor Gideon Gono assured stakeholders that the domestic financial sector was safe and sound despite the myriad challenges it faces, not the least of which are the twin challenges of a gloomy liquidity outlook and undercapitalisation, now ably aided and abetted by rising credit default risk.

The focus of his presentation the creation of a stable financial market in 2012 got me thinking about the kind of regulation that will be required to achieve that objective.

It also reminded me of insights I recently came across from one Usha Thorat, director of the Centre for Advanced Financial Research and Learning in Mumbai and a former deputy governor of the Reserve Bank of India.

He proposes what he calls the five principles of financial regulation for the post-crisis world. In this article, I project his principles onto the local regulatory landscape, though I feel weird talking about a post-crisis world when the global financial system is evidently not yet out of the woods and it sometimes even feels as if the crisis is actually about to begin.

The Golden Mean
Thorats first principle The Golden Mean is about regulation being able to restrain excesses such as excessive leverage, excessive reliance on self-regulation, excessive innovation, excessive growth of the financial sector in relation to the real sector, excessive remuneration, but also excessive controls and caution.

With a loan-to-deposit ratio of 89% as at December 2011, the issue of leverage is obviously something the RBZ needs to keep an eye on, against the ugly background of liquidity constraints.

Warren Buffet talks about the banking business not being a particular favourite of his because when assets are twenty times equity a common ratio in this industry mistakes that involve only a small portion of assets can destroy a major portion of equity.

With the rate at which bank and non-bank players are innovating in the mobile banking space, the regulatory authorities will need to be on their toes in 2012 in order to keep up with both increased transactional activity and speed outside the traditional banking space.

The regulatory authorities should also have reason to worry about the current situation characterised by what pessimists (and a good number of optimists too) might pass off as excessive growth of the financial sector in relation to the real sector. In 2012, the finance and insurance sector is expected to contribute 23% to GDP growth compared to 15,8% for mining, 13,7% for tourism, 11,6% for agriculture and 6% for manufacturing.

Regulatory courage
In 2012 and beyond, regulatory authorities will need to have the nerve to take appropriate measures even when there is pressure from powerful stakeholder groups not to do so.

None more so than in the case of ReNaissance Merchant Bank did the regulatory authorities have the opportunity to exercise their harsher regulatory instincts and show some tough love.

It wasnt long after declaring that the RBZ had no appetite for curatorship that Gono swallowed his words and put the bank right under the dreaded shadow of a curator by all means a hard decision requiring him to muster significant courage.

The RBZ has also been known to exhibit acts of regulatory courage by sticking up resolutely for banks in the context of the indigenisation onslaught.

Need to encourage financial biodiversity
The third principle is about encouraging the presence of heterogenous institutions and market participants having differing business models and risk appetites, thus leading to better diversification of systemic risk.

The Zimbabwean financial sector is currently made up of a diverse range of institutions namely commercial banks, merchant banks, building societies, asset management companies, micro- finance institutions and bureaux de change, all with different regulatory capital requirements.

On that score, Zimbabwe appears to be doing quite well, sometimes to the point of being considered overbanked.

Thorat argues regulators need to enjoy public confidence and public understanding of their actions without diluting regulation, for which they need to communicate effectively. The CZI seminar was in itself a now rare opportunity for Gono to achieve this objective.

The governor no doubt relished the opportunity to present at the seminar, coming as it did before the forthcoming Monetary Policy Statement, for which it might be considered a prelude.

Of course, GG and his team may never again achieve the levels of visibility and omnipresence they enjoyed during the heydays (or heady days, if you will) of Sunrise 1 & 2 and Zero-To-Hero projects, but the market still expects the apex bank to be more proactive about communicating the relevance of the central bank, especially in the current context of its otherwise diminished influence caused by loss of control of the levers of monetary policy such as the printing press.

Co-ordination and co-operation
Co-ordination and co-operation are no doubt important elements of the regulatory framework. For optimum results, they should be at both national and global levels, involving the government, the central bank and other regulators.

We should be mindful of the global implications of national policies before we implement them, and conversely be aware of the implications of global developments on national policies.

The markets expect the regulators, working hand-in-glove with the government, to play a leading role in striking this fine balance.

While it is tempting to gloat over the stress in the eurozone and US markets, our primary focus should be to pre-empt how the meltdown can affect us, an effort which the financial regulators should be at the forefront of.

In closing, I quote Professor Njuguna Ndunguu, Governor of the Central Bank of Kenya, on what sort of regulation can ensure stability in 2012 without stifling economic activity.

We should not think of more regulation, but better regulation. What does better regulation entail? It entails a regulatory regime that can readily identify weaknesses and emerging vulnerabilities; is capable of analysing risks and adequately price risks; provide appropriate incentives (penalties) to induce prudent behaviour in the marketplace and encourage innovations and strong institutions to develop.
Weigh in with your insights on omen.muza@gmail.com.

Omen N Muza writes in his personal capacity.
He is a banker and Managing Director of TFC Capital (Zimbabwe) (Pvt) Ltd, a Harare based financial advisory company with interests in banking and agriculture as well as the convergence area between them.

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