Bank capital insurance scheme is to save the Financial World?!

Maka Ghaniashvili

What might (might not) have happened in Georgia’s construction business if developers had taken care of construction projects’ insurance

Since when the banks, because of existing crisis in the world, have experienced numerous billion losses, started the selling of their actives and reduction of crediting, in order not to let the fall of their capital’s cost. According to several banks this was considered as a rational decision, but entirely for the banks this means a creation of a haunted circle: reduction of credit sources, which would be followed by decrease of economic growth and new losses caused by not repaying the debts. From this, it is not surprising that the managers of central banks, once having met the above mentioned unpleasant situation, are aspiring to increase demands towards Credit Organizations, in order their capital to be more protected. Experts consider that if banks are charged to have larger sized private capital, in this case boom would not come up to the stage of over warming, but the possibility of crisis will be reduced. Everything this sounds to be reasonable, but such kind of logic still may appear to be harmful. Forcing financial institutions to have a large sized private capital- ordinary, in the form of stocks- first of all contradicts the interests of shareholders, because this causes the reduction of income. Finally this has a negative influence on economic growth, because capital is cut off from such kind of projects, which were able to bring huge profit. Besides this, because of the above mentioned demand the credit becomes completely inaccessible for reliable debtors. And finally, everything this may be less effective because the chance is created for the banks to go on provocative games along with the system, which forms additional problems. Where is the way out?
On an annual economic conference that has been convoked by the Kansas City Federal Reserve Bank in the USA, the experts of Harvard and Chicago University have raised the question of capital insurance. According to it during a period of normal functioning Banks purchase insurance policies and in the moment of a crisis these policies become a source of additional income flow. The report had roused a great interest among the officials of Central Bank gathered on the conference, who now are extremely worried about the question how to act during the next economic cycle.
Till 1970s the echo of the great depression was still possible to hear: Banks put in a superior position their capital and not the development and its growth. This approach changed gradually, though, the carrying of accent on capital growth often excessively increased the credit expenses. Especially this was typical for the Latin America, where as a result they received frequent write offs and periodic financial crisis.
The reaction of regulators showed itself in 1988: Basel Agreement was adopted, according to which similar demands have been established for the Banks of the World in relation with the size of their capital. But Banks always found de tour roads of the above mentioned regulation. During the last decades the schemes of non balance liabilities have been widely spread, which gave the possibility of sequitised mortgage papers accumulation. The fact that such kind of papers needed very little or sometimes no capital at all presented a stimulus for this. Last year when creditors refused to refinance those short term papers that were inserted in this scheme, Banks were forced to take these papers on their balance, because of this the reduction of their capital sufficiency coefficient took place.” Hence it follows that Bank activity implies assumption and management of risks, any broad experiment to hamper the execution of risky operations will only cause these experiments to become less transparent”- mentioned Raghuram Rajan, one of the speaker of the conference.
The authors of the reports are making conclusion that it is extremely hard to force banks deny the credit support. According to economists the restriction of your own capital favors its high level management. Give banks too much capital and they will spend it on non effective projects. But place them in a kind of conditions when they are to rely on short term loans and will implement the crediting in a much more careful way, in order their money not to appear in the hands of suspicious borrowers.
More strict demands for capital’s size do not guarantee that banks are not to impede economic development in the periods of its growth’s slowdown. The American financial institutions are starting very operatively to stern credit condition then when their “First Level” capital (mainly is the capital of shareholders), which is estimated in the relation with risks’ level, falls on the point of 10.1%, as it has happened on June 30. Such kind of correlation sufficiently exceeds 6% norm, which is considered to be a good index of Bank capitalization. The manager of Italian Bank, Mario Dragi says- Banks start to increase their capital not because that the level of it has reduced on an established minimal limit, but because that they are worried by the fact that markets may punish those organizations, which might not have buffers in the form of capital.
Like other regulators Mr. Dragi is sure that the demands established for such kind of index as capital sufficiency index should be restricted- may be on a level that is adopted in the Spanish Bank System possessing a good reputation (here these demands grow during the credit boom and reduce during its fall), though a number of experts do not agree on this, pointing the fact that crisis seldom take place and in case of such attitude banks mostly would be overloaded by unused capital.
In exchange for the above mentioned issues they offer banks to make a choice between the strict capital demands and capital insurance cards purchase. The scheme of its regulation is the following- some pension or national insurance fund would have made a bonus on this, for example let’s say on 10 billion USD sum, in exchange for deposing the state obligations. In case of beforehand agreed situation’s existence these funds are supplied to banks.
In spite of the fact that this initiative sounds to be very interesting such proposal still raises a number of questions, among of which are the following: who defines the set of the x point time? Where it would be placed? Which countries and what kind of companies (except banks) would participate in the given system? Allan Blinder from Princeton University stated that crisis practically touches everyone and if a kind of insurer isn’t found which receives profit from this crisis, in this case insurance bonus would have to be very high, in order insurers manage to pay insurance sum directly during the crisis and with this action facilitate the search of way-out from crisis for other financial institutions (among them banks).
Also one circumstance is worth to mention, in spite of the fact that current system is still far from perfection, as the number of experts consider, the complete disintegration of it is not at all necessary. It really helps to receive risks and short term loans and during such kind of regulation banks are not always able to place their resources effectively or reasonably. Despite this how hard the existed situation should be, till today none of banks have been bankrupted, mainly because that regulator organizations force credit organizations to have sufficient private capital. Moreover, banks managed to bring such sized significant capital, which nearly equals the 2/3 of till today existed copied off capital. But the realization of this becomes more and more complicated.
Of course crisis is still far from its final end. Though, on the above mentioned conference participants expressed fear that the worth is still to come and despite of the fact that it is already one year the financial crisis is going on, it still has not been fully reflected on the real economy. May be it is too early to discuss the working system, but changes are unavoidable, so every concept of future development deserves a careful investigation. One of them is, as we have already mentioned, Bank Capital Insurance Scheme.
Bank Capital Insurance is one of the subjects, which we will touch while discussing Georgia’s Insurance Market. What is happening on Georgia’s Insurance Market? How often do Georgian Banks use insurance schemes and do they offer it to their customers? On these issues we spoke with Eter Modebadze- Account Manager of “Aldagi BCI”, one of the leader companies of Georgia’s Insurance Market.
_After the events of August problems appeared nearly in every sphere, what has changed on Insurance Market?
_Like any other business problems touched insurance subject too. For example, several projects connected with the foreign investments that we used to have and were to be implemented soon are stopped now. But we are still waiting for the implementation of these projects. There were some problems connected with these projects, but our company has not experienced any kind of significant loss. This by all means was conditioned by the fact that after the war huge projects have entered and being implemented from the side of international organizations (e.g. European Commission). Insurance sector and our company are actively engaged in the implementation of these programs. It means that now our company has more work to do.
As for financial side our liquidity hasn’t been interrupted and today “Aldagi” keeps working operatively. If I say that we have experienced some kind of serious financial problems after the events of August won’t be true.
_ Does the Bank Insurance Scheme operates in Georgia?
_Similar service exists in our country, but reality is that Banks seldom apply to the scheme of capital insurance. May be it is because that insurance business is very young in our country, just 18-20 years old. Hence from that it is developing with time along and gradually such complex products and insurance like: bank capital insurance, etc will gain foothold. I repeat once more that nowadays it exists on Georgia’s insurance market and directly Banks are to possess the very culture and interest to purchase this product and make use of it. Though for nowadays it is even regulated by the legislation. Here are obligatory varieties of specific insurance, though most parts are free willed and the management of the company determines their necessity.
_One more actual c subject connected with insurance business is the Insurance of Construction sphere. What is happening towards this direction? Mostly this sphere has experienced serious problems during last period.
_This occurred because only few number of construction companies purchased such kind of insurance, so those problems they are facing now have to be taken by them. Factually on Georgia’s construction market only few projects have been and are insured. I hope that this crisis will manage to show to construction companies the necessity of defense from similar financial threats.
_Do you think that the lack of insurance culture is one of the reasons that problems are created in construction business? If the projects of developers had been insured could they have managed to overcome this crisis with little losses?
_ Of course they could. When there is a war or a kind of collapsing situation, this is the basic stipulating reason of existing crisis, but the fact that insurance mechanism isn’t created and regulated oppresses the problem more. There are companies on Georgia’s construction market that are considered to be quite prestigious and popular, but they do not apply for insurance. But insurance market can not develop if there is no interest towards it. But it is a fact that this culture is forming step by step in Georgia.
_If the most number of construction projects had been insured would not have it caused serious financial problems to you?
_This is a unique issue. I do not others but our company will reinsure all its risks, in other words this financial risk is not only assumed by us , behind us stand such financial institutions (international reinsures) such as: SWISS RE, MUNICH RE, LLOYOS OF LONDON and so on. It means that insurance risks are distributed and it is easier to manage them. The fact that serious international reinsures stand behind our company is an additional guarantee for our customers.
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The same is proclaimed by the representatives of other companies. For example, according to the representatives of “IRAO”, in Georgia insurance phenomenon is less known in the Society. The vivid example of it is that often seriously ill people apply for insurance, but as it is known insurance implies the regulation of risks that still have not taken place.
Medical Insurance is one more actual subject in Georgia nowadays. On above mentioned insurance the prices of products doubled in comparison with the last year. The main reason of it is that inflation rate in the country has increased, besides this medical service becomes more expensive and the inflation level in this sphere is significantly high than the average inflation index.
The tariffs of medical insurance are determined by the prices of drugs and medical service.
The expenses of drugs and medical service have increased with 50-60% in comparison with the last year. Dental service increased too and correspondingly raised the prices of those insurance products that foresee partial or full compensation of dental service.
According to specialists appearance of this product on insurance market, was stipulated by the cheapness of medical service in Georgia, also by rather lower prices of dental service and by highly competitive environment. After the price rise of medical service and drugs took place the cheap insurance of this sphere lost actuality for companies. Experts suppose that this tendency may continue in the future. If we take into consideration the very circumstance that in the conditions of possible inflation prices will increase more correspondingly the chances of potential customer will lower.
As we can see the prices of medical insurance is growing more and more, but the income of customer becomes unproductive in the conditions of inflation. If such tendency continues on the market the index of customer will decrease. At this stage this is the leading product in insurance portfolio. The sum total of bonus gathered by the 13 insurance companies operating on Georgian territory, in the period of six months in 2008, composed 132,765 billion GEL. 78,407 million GEL directly comes on medical insurance.