Aleqsandra Laliashvili Eka Qarosanidze
Global financial crisis prompted governments to strengthen regulation of financial field. Governments’ financial aid became necessary to recover banks and various financial organizations.
USA and Europe drew the conclusion that in order to avoid similar financial crisis and its deplorable results in the future, it is necessary to increase the regulation of financial sectors. Discussions have already been started in Georgia concerning National Bank’s institutional and functional strengthening.
However, before discussing current situation in Georgia, allow me to acquaint you with some tendencies in the world. Euro Commission offered to establish new organization which will control financial system of Council of Europe. European Commission wants to establish European Systemic Risk Council, ESRC. The head of the organization will be the president of European Central Bank. The main goal of the organization will be gathering and analysing of the information that is essential for financial stability of the member countries of Council of Europe.
European Commission reckons that establishing a council would be an adequate measure in the times of financial economic crisis. In addition, Euro Commission plans to establish European System of Financial Supervision. The representatives of the institutions that are observing the activities of the banks and insurance companies will join the system. European Central Bank will control general economic situation, instead of controlling separate credit organizations.
However, not every member country supports the strengthening of regulation. There is a difference of opinions concerning this matter. Great Britain already opposed plans of European Commission. Government of Foggy Albion fears that new financial regulators will be given too many authorities that contradicts with the interests of separate countries of Council of Europe. Head of European Commission Jose Manuel Barossa reckons that new regulators should start operating in 2010.
Secretary of US Treasury wants to establish new standards and is planning to prepare legislative act in the nearest future. Moreover, Barak Obama is supporting this idea either.
Whole world is hot-headedly taking decisions and follows the events step by step. I suppose it would be better to analyze everything calmly. However, one thing is obvious; era of big changes has come. Georgia keeps pace with the world. There have been talks about establishing new regulation standards long ago. One step is intention, another is taking measures and third is prognosis, evaluation of the influence that these changes might have on financial sector. We tried to answer these questions with Economic expert Davit Narmania.
National Bank of
Functional and institutional changes have been made in National Bank – declared president of National Bank, Giorgi Kadagidze. He noted that National Bank is working on legislative changes together with parliament. The aim of the changes is to strengthen National Bank functionally and institutionally. At this stage, representatives of National Bank are not making any further comments and note that details will become known pretty soon. By that time, the directions of the bank’s strengthening are not officially specified. However, some talks have been concerning unification of National Bank and service of financial supervision.
Economic expert Davit Narmania:
In due time, I made a conclusion concerning why the separation of Financial Supervision Agency and National Bank was a step backward. National Bank of any country is a strong financial institution independent from government. It has policy maker collegial body that defines the policy of National Bank. Bank should have plenipotentiary power and it should not be responsible only for macroeconomic stability. All the levers of monetary policy should be concentrated under one institution. For instance, if Bank will be responsible for regulating inflation processes, but at the same time it won’t have the function of supervising commercial banks, pretty soon this might bring to deplorable results. The same happened in Georgia. Despite its short-term practice, after separating Agency of financial supervision from National Bank, undesirable processes revealed themselves. Therefore, existing of strong National Bank became a main issue of agenda. Moreover, together with financial sector, increase of deregulation and regulation weakening policy brought undesirable results in many other fields also. At the time when separate Financial Supervision Agency was established, the case was not only in reforming National Bank of Georgia, but huge package of legislative amendments (so-called panacea amendments) was prepared according to which Georgia should have become not only regional, but the world’s financial centre also. Unfortunately, any concrete steps made or results received did not follow the mentioned financial package.
West talks about increase of regulation, while Georgia of decrease
Georgian government is working on simplifying regulation standards for banks. However, the details are not specified either in the government or in National Bank. The head of the board of Financial Supervision Agency Mr. Christiansen declared that one of the ways of bank stimulation is reduction of capital adequacy ratio that allows banks to reduce basic capital. Christiansen noted that banks are maintaining normal state in the current situation and none of them is facing significant difficulties. The problem has changed its shape, “Banks are issuing credits, but they have no clientele. I don’t think that the problem is the lack of the confidence, the case is that unemployment is widespread in the country” – said Mr. Christiansen. He noted that other regulation standards are to be simplified either. However, he also noticed that the stringency of the regulations is the warranty of the banks maintaining stability.
Difference of opinion is in the world and in Georgia concerning increase-decrease of regulation. European Bank for Reconstruction and Development (EBRD) doesn’t support simplifying standards of regulation for Georgian banking sector. The head of EBRD in Georgia Irakli Meqvabishvili doesn’t advise National Bank to simplify standards of regulation. He doesn’t support liberalization process either. He reckons that banking system stood the complicated situation due to strictness of the standards of the regulation. For instance, capital adequacy standard is quite severe in Georgia. However, the fact that banking system didn’t wreck during August events and financial crisis, is the merit of the mentioned severity. – said Meqvabishvili.
Davit Narmania: I fully agree with EBRD’s attitude. One cannot name political and economic crisis as the reason to everything and say that due to crisis the form of regulating something in financial sector should be reduced. There are many important things to do in financial system that will be more beneficial than diminishing this standard.
E.G. – What can you offer as an alternative?
D.N. – For instance, to analyse the approved practice of the world beginning from October of last year. What has been done for stability of financial sector? We can take some few interesting elements of it that will encourage stability of our financial system.
E.G. – It appears that we are moving in opposite direction. Because the processes in either Europe or USA are moving to strengthening standards of regulation.
D.N. – Yes, of course. In the times of severe crisis, government of any country is interested in stability. Additional levers of regulation are always needed in the times of mass destabilization and frequent changes. Responsibility is distributed between the state and business, state is taking responsibility for regulation and maintaining of stability. On its part, business is taking some risks either. Government of any normal country is interested in stability of business. Stable business feeds the state with more income, while the last means that government will successfully fulfil own obligations. Every normal country has recently elaborated actual anti crisis plans. Georgia should have designed such plan soon after August events, but even after ten months anti crisis plan hasn’t been worked out yet. It is still not clear what is government going to do tomorrow. Some information is spread everyday but there are no results followed.
How far establishing of banking deposit insurance program
is justified in Georgia?
Since the banks suffered millions of losses due to world financial crisis, Central Banks decided to increase requirements toward credit institutions. Experts reckon that if the banks would be obliged to have bigger equity capital and reserves, the boom will not reach the overheating stage and the chances of crisis will be reduced. However, these demands might damage economy, as the projects with high profitability will suffer the lack of funds. So, where is the way out?
Economic experts offered a capital insurance system at the conference held by Federal Reserve Bank of Kansas City in USA. Insurance system offered by experts implies purchasing of insurance policies by the banks in the times of their normal functioning that becomes additional source of the capital in the crisis period.
The work plan is the following: some Pension Fund or National Welfare Fund would establish insurance premium for instance in amount of $10 billion. Under preliminary agreed conditions these funds will be supplied to banks.
International Monetary Fund advises Georgian government to establish Banking deposit insurance system. Official representative of the fund in Georgia Edward Gardner declares that one of the ways to restore confidence in the banks is deposit insurance system. “We discussed this issue with government and advised them to implement this system. However, it is necessary to be careful as in case of mistakes this might be followed by negative consequences.” – declared Mr. Gardner.
It’s interesting, whether deposit insurance system is as effective as it is told and what would be the situation in Georgian banking system if the mentioned system were functioning today.
Nowadays, degree of confidence in banks is quite low in Georgia. The proof of this is that level of money turnover outside the banks is very high, while most of the banking operations are in foreign currency.
Main aim of deposit insurance system is rising of population’s degree of confidence in commercial banks that is directly connected with increase of their resource potential. The last one also concerns reduction of interest rates and consequently, is a necessary precondition for ensuring economy with financial resources.
Special insurance fund should be established that ensures full or partial remuneration of the client’s deposits in case of commercial bank’s bankruptcy.
There is no such institution in Georgia yet that has negative impact on increase of number of deposits in commercial banks.
Obviously, banks’ involvement in deposit insurance fund after paying definite interest rate aggravates their situation even more. This might even bring to bankruptcy.
In order to solve the mentioned problem, at the initial stage it is necessary to involve state backing, as this will help banks to restore confidence of the depositors. State’s co-participation in the financing at the initial stage of establishing fund is a world-wide practice. For instance, initial instalment of Latvian government in the fund made up $8.6 million, in Lithuania the sum amounted $1.8 million.
National Bank of Georgia is guided by monetary and credit policy resolution adopted by Georgian parliament at the end of each year. Deposit insurance issue was mentioned in 2004, 2006 and 2007 resolutions. However, there is no state insurance system and law in Georgia yet. Georgia is the only country in former soviet space that doesn’t have such deposit insurance system.
It is worth of noting that such scheme is connected with moral risk in some degree. In case if deposits are insured, banks might have no fear to take risk and thus place depositors’ interests in danger. The same can be said of depositors as they might deposit in unreliable bank that offers high interest rate to clients. Client takes comfort in that if the bank is bankrupted the deposit insurance system will compensate the money.
Population started taking deposits out of the banks in last summer, after the August war events. They lost confidence in banks. Approximately deposits of $300 million flew from the banks. The funds of the banks gained from the cheapest local markets significantly decreased. Banks have many bad loans that are a serious pain in liquidity and financial stability issues.
If there were deposit insurance system, banking sector would avoid going of liquid assets in such amounts. Deposit insurance system is one of the mechanisms of protection for banking system in such panic situations.
E.G. – Will the deposit insurance system be effective in the existing situation in Georgia?
D.N. – International practice shows that deposit insurance system is essential for the stability of financial system. Insurance companies have additional income from this. Moreover, physical and legal bodies that have deposits in the banks will be more confident and thus they will be ready to pay definite premium for this confidence. Therefore, late or soon this system will be implemented in Georgia. However, I reckon that this should have been done before the influence of financial crisis on Georgia would become more active. In terms of current reality and financial crisis, implementation of such system would be unprofitable and not popular. It would be wrong if we say that state should elaborate everything alone. Banking institutions and insurance companies should gradually become interested in this matter and come to the conclusion that existing of such product in the market is necessary and essential.
Despite the opinion that crisis won’t affect Georgia heavily, the facts show different. In times when there is a staff reduction in banks, no credits are issued; accounting year is completed with losses, it is impossible to believe that crisis is far away from Georgia. Crisis is near and it affected Georgian banking system so that it continues existing at the expense of commission charges. Frightened banks stopped issuing loans. Investment in private sector became risky as the population is left without income and consequently the risk of default is quite high.
Banking system is a foundation stone of a country. Therefore, governments of various countries are elaborating plans for helping commercial banks that are in grave condition.
$800 billion bail-out was issued for the banks by the initiative of President Barak Obama. $700 billion bail-out was assigned by ex-president Bush.
We have paradoxical situation in Georgia. By the time when world’s giant states assign funds for supporting banking system, our government deprives banks of money. (It is actually acting so, when it plans to issue Exchequer Stock).
Government is quite optimistic. Treasury obligations will develop Georgia’s equity market on the one hand, and encourage diversification of commercial banks’ portfolio. – Declared Minister of Finances Kakha Baindurashvili.
E.G. – What were the reasons of the government’s new initiative? Is their aim to help financial system that is in grave situation?
D.N. – Suppose that’s true. Let’s see how state might help the banks in this case. Exchequer Stock allows banks to invest at comparatively low risk level, while investments in private sector are connected with huge risks. Of course, this is positive fact, but not in case of Georgia. Financial condition of our country is not stable; budget is running a deficit instead of surplus. In case if there are no funds in state budget, government might postpone stocks and it even might have difficulties in paying interest. Fact whether banks become interested in this project is under question. Interest rate offered by the government is of big importance in this case. In terms of budgeted deficit, it is unlikely that offered interest rate would be high. Practice shows that Exchequer Stock is characterized with low interest, as they are connected with low risks. Thus, investing in private sector would be more profitable for banks.
E.G. – Maybe, government’s initiative aims to recover economy?
D.N. – As the government representatives declare the funds received from the mentioned project will be spent on recovering of infrastructure. It’s true that this will create temporary working places but this doesn’t imply economic growth in long-term perspective. Treasury obligations are the same internal debt that becomes a burden for the population. This step might be justified only in one case – if the mentioned sum will be converted into capital expenses, if government tries to increase demand with these funds, instead of financing cultural or health care projects. Of course, health care projects and strong defense are necessary for the country, but if the money taken from the banks by the government will be spent on such projects, business activity will be reduced and thus tax revenues also.
At the same time, credit market is shrinking even more. This initiative decreases banks’ Edgewarth Box by 260 millions that finally brings us to reduction of budget and economy in whole. By taking funds from the banks the state is playing the role of rival for private investors. This will even more decrease already reduced business-credits.
The question remains unanswered. What are the aims of the government’s initiative, if this doesn’t help either banks or private sector?
One of the ways of financing state budget is taking internal or foreign debt. From the entire above-mentioned one can conclude that the aim is one – financing of budgeted deficit. Formulating as if this helps banking and private sectors and thus packing final goal.
Let’s face it! Today, banks’ main problem is bad loans. Their market is significantly decreased, as approximately 200 thousand people are blacklisted. If government really wants to help banking sector it should take care of restructuring problem loans as such amount of bad credit histories will have negative impact on the market of bank services. In this case, state intervention is truly necessary. Government should work out complex program of economic recovery and it should stand as warrant of restructuring.
Economic expert Davit Narmania: Georgia has some experience of issuing treasury obligations. However, the reason of issuing them now is of main importance. Nowadays, government is masking grave economic situation in the country. It assures that its aim is to encourage financial sector and enable commercial banks to give credit to the state and take interest of it. However, if the banks are really possessing such resources, they freely can issue loans to private sector. In many cases, banks are not crediting because there is a very heavy political situation in the country and thus they find it difficult to take risky decisions. Therefore, for some banks it might be attractive to deal with one debtor – state, instead of dealing with diversified risks. If we take into consideration grave financial conditions of the country, to my mind this is the main precondition of government’s decision and not that commercial banks are in hard situation and state wants to encourage them.
There is a heavy economic situation in the country during last two years – continues Davit Narmania – there are many hardships and undesirable processes. Financial crisis, August war, consecutive and façade policy brought to deplorable results like minimal tax revenues. As a result, government started to actively use international aid and credits for covering current liabilities, paying salaries, pensions and financing various social programs. Country has quite a number of liabilities and very scarce tax revenues. International grants and credits are not enough to fully cover these expenses. Country is in need of financial resources, while it is actually impossible to receive them from international sources as there is a raging financial crisis. Moreover, we are receiving international aid in 2009-2010 and we do not posses resources of taking even more at this stage. The only thing government has left to do is to take credits from internal sources. Another aspect is that credit is not a gift and it is necessary to pay in. Treasury obligations increase internal debt. Due date and interest rate haven’t become known yet. In any case, this debt is to be paid with interest after some period. As the banks are commercial organizations, they are interested in deriving as much profit as possible. I reckon that issuing treasury obligations is dictated by very hard situation, especially when we say that budget must be increased by 315 millions. In such situation, it is simply illogical to take internal debt from commercial banks.
National Bank makes interventions by currency auctions
Another important novelty in Georgian banking-financial field is connected with GEL exchange rate. After twelve years of functioning, Tbilisi interbank monetary exchange gives arena to monetary auctions. JS company “Interbank monetary exchange” was founded by National Bank of Georgia together with twelve commercial banks, in September of 1992. Starting from 25 May of 2009, National Bank of Georgia will make interventions at monetary exchange only by currency auctions. President of National Bank of Georgia officially declared this. Giorgi Kadagidze declared that this step doesn’t consider any changes in exchange rate policy; it just implies modification of operational framework of monetary market. Official exchange rate will be defined by taking into account the deals registered at Blumberg trade system. “Planned changes do not consider any changes in exchange rate policy. National Bank continues to function in the regime of controllable floating exchange rate. Exchange rate will be defined by means of market mechanisms. From time to time National Bank will make interventions by means of auctions, in order to avoid short-term fluctuations of exchange rate” – said Giorgi Kadagidze.
According to the results of monetary auctions and deals concluded at interbank market of Blumberg trade system, National Bank will calculate average weighted rate of a day that will be the official exchange rate of the next day.
Demand on Monetary Exchange will consequently decrease, but it continues to exist.
E.G. – Mr. Davit, why National Bank decided to replace exchange with auction?
D.N. – Exchange had no properly operating mechanism. I reckon that auction is more flexible mechanism for macroeconomic stability and for defining GEL exchange rate. I suppose that this were not the only reasons of National Bank. I am not familiar with this subject and it is difficult for me to make other comment.
– It should be noted that interbank monetary exchange was a joint stock company. Its main field of activities was connected with entrepreneurs, in accordance with Georgian legislation. Both commercial banks and National Bank were making monetary operations at the exchange. Monetary auction is rather new, but approved mechanism in whole world. The main feature characterizing both mechanisms is that National Bank is not limited in interventions and it may participate in any trading. National Bank will make interventions on monetary auction, just like it was acting in case of interbank monetary exchange. Mechanisms of administering and trading are different. National Bank issued instructions for participants of the caution so that trading rules and regulations were clearly defined. Both National Bank and commercial banks should follow the instructions.
E.G. – Is monetary exchange still functioning?
D.N. – Yes, monetary exchange still exists. One cannot abrogate or close it. This is a joint stock company and if commercial banks will want to exchange currencies with each other and make financial operations, in this case they can participate in interbank monetary exchange. However, monetary exchange will have to change its status as it is left without its main function of mediator in monetary deals. Monetary exchange, as a financial institution might participate in other mediator operations. For instance, it may contact foreign financial institutions and find sources there and afterwards it might credit these funds to commercial banks and receive profit of it. Commercial banks might find benefit of this either as international resources are unavailable for them. Monetary exchange may help them in finding foreign resources. Commercial banks that are founded with local capital and doesn’t represent some foreign bank, cannot find necessary financial resources independently on international market. JS may help them in this and both of them will benefit of this.
E.G. – Some of the experts note that Monetary Auction may increase risk of speculative deals. What are the reasons of such point of view?
D.N. – To be honest I haven’t observed the results of conducted auctions and I cannot tell whether the chances of speculative dealing might increase. However, these were not excluded at monetary exchange either. So, if Financial Supervision Agency joins National Bank the main function of it might be avoidance of such manipulations. Supervision of the processes at monetary auction by relevant services is of big importance.