If one buys a damaged car or shares in an unprofitable company, one tends to blame oneself and one’s imprudence. One does not demand that the state repair the car or pay dividends from budget resources. Then why do people shrink from individual responsibility when, hoping to make profit, they entrust-of their own will-their money to a bank?
There is a deep-rooted belief that there exist completely safe forms of saving and investing, and that government is responsible for banks and therefore will cover all losses incurred in case of bank failure. This opinion is being imperceptibly promoted by this very government by encouraging people with its decisions and actions to demand unjustifiable compensations.
Governmental promises to cover individual losses may be justified only by the fact that the authorities failed to perform their duty, thus adding to the occurrence of losses. Government could have chosen one of the two alternatives-either a perspective one, which consists of eliminating the origins of problems, or a retrospective one, that is, covering up of the consequences, compensations, and governmental custody.
The first path is much more challenging, but also more valuable. Government must establish clear relationships with banks, shareholders, and depositors. It should also provide conditions necessary for the three “whales” on which commercial banking rests to strengthen. These are:
· laws and rules;
· corporate governance traditions; and
· effective external supervision, whatever-private or public-it may be.
1. Government and banks
It is no secret that all market participants-banks among them-operate according to the rules established by government. Regrettably, one cannot improve or choose among these rules. One must simply obey them. Yet, rules determine a lot, and the results of banking activities are no exception.
Until late 1994 banking rules had not required banks to form loan-loss provisions, nor had they recognised losses. In the eyes of the public and authorities commercial banks had been geese that laid golden eggs.
When one reproaches banks for fabulous dividends, one somehow forgets that the same astronomic-though illusionary-profits were subject to a 29% corporate tax. I would not think that provisioning for loan losses had been deliberately held up for the magnanimous purpose of budget formation. While shareholders and depositors kept receiving distorted signals about banks’ activities, the allegedly thriving and credible banks tempted and misled. In fact, however, the risks as perceived by the public did not measure up to the reality.
The conditions changed in late 1994 when banks were instructed to form provisions for the whole period of their existence. Moreover, in late 1995 provisions exceeding profits were recognised as real losses. If losses exceeded 75% of share capital, banks were to reduce the share capital-private, inviolable property-by the amount of the losses. The government made a mistake by failing to introduce at the right time world-wide accepted rules of banking accounting. The penalty for this mistake plus the burden of rectifying it was imposed on shareholders.
There was another way of putting right this mistake, that is, by establishing back in late 1994 a bad loans management company whose purpose would have been very similar to that of loan-loss provisioning. The company would have helped the banks to straighten out the situation triggered by the authorities’-not banks’-inertness. Banks would have formed provisions only for newly extended bad loans, exchanging the old ones at their nominal value for equity in the said company. The forms of repurchasing shares could have been very diverse. They could have been repurchased by the company or repaid over several years by a given bank from the latter’s profits, provided that this portion of profits were tax-exempted and treated as special loss-provisioning. Losses incurred in case of failure to raise provisions for problem loans would have been dispersed over coming years. As a result, shareholders would not have been deprived of their property, or banks of their shareholders.
Regrettably, it was not until recently that the idea of a bad loans (or, asset management) company was contemplated, and what’s more, in an entirely different context. The newly founded bad loans company-in the form of the joint-stock company Property Bank (Turto Bankas)-will function like a “loan water closet”. If you are clever enough, you can palm off onto it anything you wish, for there is no sign of objective criteria of loan repayment. If the company took over only those nonperforming loans which had been extended prior to loan-loss provisioning-that is, the so-called “political” loans-the Property Bank would eventually cease to exist, thereby failing to bolster the traditions of inadequate management. In the present circumstances, however, the state is programming its tolerance of bad loans into the future by creating a simple governmental mechanism-the Property Bank-to get rid of them. One can hardly call it a farsighted decision.
2. Government and shareholders
A lack of corporate governance traditions in Lithuania determined that most of the Lithuanian banks are administered by their boards of directors. Everything would be all right but for the fact that these boards frequently hold down the shareholders. In most cases shareholders’ influence is only nominal. They gather together once a year to raise hands in favour of decisions advanced by the board and to approve a factual profit and loss account. Excessive confidence in banks’ boards allows them to administer expenses at their own discretion, expenses that may fail to safeguard shareholders’ interests.
The western banking “democracy” does not always work in Lithuania. Raised in the spirit of traditions of private property, western shareholders are real professionals. Their management is real and effective. Although Lithuanian laws state that the meeting of shareholders is the supreme management body, there is no mechanism to enforce this norm. Moreover, sometimes shareholders cannot exercise even their nominal rights, primarily because the only source of information is the board. Even audit conclusions, which are required by law to be disclosed to shareholders, are prepared selectively, specially for them. Conclusions intended for “official use” remain in the boards’ drawers, for it is allowed by law to conceal information whose “disclosure may do material harm to the company”. So what that these audits are financed by shareholders? The customer is the board ….
Shareholders’ eyes are tied with a double black band. They cannot ferret out information about the bank’s activity from the board; neither can they extract it from the banking supervisory authority, the Bank of Lithuania. In such circumstances today’s remarks about shareholders’ full liability are out of place. Creation of corporate governance traditions will take time. Meanwhile, the government should provide conditions necessary for shareholders to exercise their rights and identify reliable forms of banking supervision.
3. Government and depositors
All of us in Lithuania know that it is too perilous to rely on the traditional external banking supervision conducted by the central bank. Are there any other, more effective mechanisms of external supervision? The new Law on Individuals’ Deposit Insurance claims to become an additional guarantee for depositors. Yet, the “compensation mania” syndrome is still there.
The aforesaid law states that compulsory insurance is provided for all deposits in litas and foreign currency not in excess of five thousand litas. Insurance premiums are paid by the banks, although their level is not related to the degree of risk of a given bank’s activity, nor is it based on any other criteria of banking activity. The system of deposit insurance operates on the principle of budget crediting, the budget which is this very treasury that will compensate for depositors’ losses.
Respectful of private property and depositors’ right to decide by themselves, the government should have at least offered a voluntary deposit insurance system under which each depositor would decide by him- or herself whether or not to insure his or her deposit (without any limits being imposed on its size) and would pay insurance premiums.
This model would help government to avoid the responsibility for deposit safety in private banks, the responsibility that is both imposed on and willingly undertaken by government. Even if secured deposits were compensated for from the state budget, such a system would prevent from violating taxpayers’ rights, as is frequently the case when “private” losses are covered with “public” resources.
Going back to the choices mentioned earlier in the article-that is, perspective and retrospective-it should be said that the authorities opted for the latter by adopting a whole range of banking laws and legislative amendments. Each governmental step forward was merely two steps away from a society based on individual freedom, choice and responsibility.
