One key outcome from the Basel Capital Accords which started in 1998 was the imposition of capital requirements on banks to ensure stability of banks and the financial system. The 1988 Capital Accords calls for relative capital requirement (i.e. capital must cover at least 8% of bank risk assets. BSP embraced the relative capital requirements and made it more stringent (10% instead of 8%), but also retained the minimum absolute capital requirements. Along the way, the thinking in BSP is that bigness is good, and that consolidation and mergers must be encouraged. The predilection for bigness was mirrored in ever growing minimum capital requirement despite the parallel relative Capital Adequacy Ratio (CAR) of 10%.
Is bigness always desirable? Does
size of capital make a bank immune from risk and the banking system safe from
instability. History tells us this is not the case. Baring Bank, a 233-year big
English Bank, collapsed due to operational risk failures. Banks big and small
suffered during the Asian Financial Crisis. The US Sub-prime Crisis which
morphed in the Global Financial Crisis was started by sophisticated big banks.
Silicon Valley Bank and Signature Bank were mid-sized American banks.
Can small be beautiful? If a
Philippine rural bank with small capital remains profitable and compliant with
relative CAR requirements, and extends credit in rural areas even if loan purpose
has moved away from agriculture to consumer lending, should it be closed simply
because it failed to meet an absolute capital amount? Lending to rural folk is
still financial inclusion, which remains an important objective of the central
bank. Shutting such bank reduces economic value added and welfare in the rural
community it serves. Does its shut off significantly reduces systemic risk? Not necessarily;
it may even make it worse.
If a productive, profitable and
CAR-compliant rural bank wants to stay small, is there anything wrong with
that? Most economies are built on swarms of small and medium enterprises. I personally know of a second-generation rural banker who simply decided
to stop the business because he grew tired of the increasing BSP requirements
on rural banks. BSP write in policies that its treatment of banks vary with the size and level of sophistication, and yet in reality there is tendency to
impose on smaller banks practices that are done in commercial banks. Examples
of this will be expectation of having full-time compliance officer and chief risk
officer which may not be necessarily needed full-time in rural banks with
simpler business models. The expectation of similar practices eventually push
the rural banks to hire more people and hike cost, or leave the business altogether.
BSP’s concern for rural bank stability
and contagion to the bigger financial system is valid, moreso in the light of
irresponsible rural bankers who left their depositors hanging by engaging in
unsound banking practices. But maybe it is time to abandon the absolute capital
requirement in favor of the global requirement of capital relative to risk
assets.
Small can be beautiful. Big is
not always desirable.
