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Bangladesh Institute of Bank ManagementS e c t i o n - 2 , M i r p u r , D h a k a - 1 2 1 6
Eighteenth Nurul Matin Memorial Lecture on Ethics in Banking
(2019)
Too Connected to Fail: Politics, Public Policy and the Financial Sector
Junaid K. AhmadCountry Director
The World Bank, India
Biography of Late A. F. M. Nurul Matin
(1928-1978)
Mr. Nurul Matin was born in 1928. He joined the Research Department of the State Bank of
Pakistan in 1951 as an Officer Class I and, subsequently, his services were placed in the operational
departments of the Bank in 1963. During his long banking career, Mr. Matin occupied many senior
positions including Secretary to the Board of State Bank of Pakistan, Executive Director of Equity
Participation Fund, Managing Director and Chairman of Bangladesh Shilpa Bank and Deputy
Governor of Bangladesh Bank. He also worked as the Director of Bangladesh Institute of Bank
Management (BIBM). He was also one of the founders of BIBM.
Mr. Nurul Matin was a well-traveled person and represented Pakistan and Bangladesh in various
international conferences. He was not only acclaimed as a very efficient officer but was also
respected as a person of impeccable character. He also made significant contribution toward
rehabilitating the banking system after emergence of Bangladesh. His contribution to drafting of the
Bangladesh Bank Order 1972, Bangladesh Banks Nationalisation Order 1972 and his devoted and
dedicated work in the early '70s and thereafter for development of a sound banking system were
appreciated by the policymakers at the highest level. He died in 1978.
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Ethics in Banking
Too Connected to Fail: Politics, Public Policy and the
Financial Sector’
- Junaid K. Ahmad
Ladies and Gentlemen, Distinguished Guests, Honourable
Governor of Bangladesh Bank, Director General of BIBM,
and faculty members of BIBM:
I am very honored to deliver this year’s Nurul Matin Memorial
Lecture and grateful to Governor of Bangladesh Bank, Mr.
Fazle Kabir and Director General of Bangladesh Institute of
Bank Management, Mr. Md. Abdur Rahim for this
opportunity. But, at the same time, I recognize the deep
responsibility which comes along with your kind invitation.
Deputy Governor Md. Nurul Matin, whom we honour through
this lecture series, and Governor AKN Ahmed, who
introduced this lecture series, were nation builders. They were
the epitome of the first generation of policy makers who
moved the quest for our independence from the battle field to
building the institutions that would permanently secure our
nation. From areas like governance to banking, they were
Junaid K. Ahmad, a Bangladeshi national, is currently Country Director of the
World Bank in India. He was invited to deliver the 18th Nurul Matin Memorial
Lecture in his personal capacity. The views expressed in this paper do not
represent the official views of the World Bank, its Board, or Management.
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ethical leaders whose moral codes and values crafted the future
of a new country. To speak in their memory is a daunting
responsibility.
Many of the past speakers – Professor Nurul Islam, Professor
Muzaffer Ahmad, Professor Rehman Sobhan, and Professor
Wahiduddin Mahmud – either taught us directly or taught our
teachers. They have shaped my generation’s thinking and our
values. To speak in their footsteps is an honour and one I do
so with trepidation.
Other speakers, like Mr. Syeduzzaman, Governor
Farashuddin, and Dr. Akbar Ali Khan are friends and
colleagues of my father, Mr. Muslehuddin Ahmad. Many I
have had the privilege to call “Chacha”. To offer perspectives
and views on a topic covered by them feels like a bridge too
far to cross.
I must, therefore, in the best of our traditions first seek their
permission to share my views and, second, their indulgence,
indeed forgiveness, for any errors I may make.
I must also add, that I do not speak here today on behalf of the
World Bank and I hope my Board of Governors will also be
generous in giving me the latitude to express my personal
views. Instead, I speak as a citizen of Bangladesh, drawing on
my experience of working on international development and
public policy issues both in a multilateral context and from my
formative years in the Planning Commission of Bangladesh.
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1. What have the Past Speakers Suggested
I would do injustice to this lecture series and to the past
speakers if I did not start by reflecting on some of the messages
and insights of past presentations. In reading the previous
lectures, I came away with several conclusions which I will
elaborate on in my presentation. But, let me first summarize
some of these main messages.
Ethics, Operational Principles, and An Asymmetry
All speakers in the past accepted the importance of using ethics
as a lens to analyze the banking system. In reading their
speeches, I tried to assess whether a common definition of
ethical banking was adopted by the various speakers, or
whether the speakers converged around a set of organizational
principles to design and manage a banking or financial system
based on ethics. I did not see this consensus emerging in the
speeches. Indeed, I do not believe a consensus on how to base
banking systems on ethics exists.
Governor YV Reddy in his speech stressed that trust and
confidence are the fundamentals of a banking system.1 The
origin of the word “credit” comes from Latin “credere” which
means to trust. I would add that building trust and confidence
is a work of a lifetime but one that can be lost overnight. While
the objectives of building and sustaining trust and confidence
in a banking system may offer some important implications for
managing a banking system – and certainly strongly suggest
1 Dr. Y.V. Reddy, 12th Nurul Matin Memorial Lecture on, “Trust in Banking”.
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that the integrity and professionalism of the bankers from
officials at the central bank to the teller in a commercial bank
matters – I find it harder to draw on ethics for designing a
banking system.
But, while ethics in my opinion may not offer practical design
options for a banking system, policy makers and politicians
involved in the financial sector ignore ethics at their own peril.
This asymmetry – ethics as not having practical design
implications, but in managing a banking system you cannot
ignore ethics – is the second conclusion I draw from the past
speeches.
A few examples may help make this point clear.
Take the US elections, for example. Two very different – and
unexpected – candidates emerged in the political scene during
the 2016 elections: Donald Trump and Bernie Sanders. Both
represented very different political and economic views, but
both were buoyed by a common factor: a strong belief that
elected representatives were captured by interest groups and
that the political system was unable to hold them accountable
for their decisions. In particular, there seemed to be a feeling
that both the Republican party under George W. Bush and,
subsequently, Barack Obama and the Democratic party failed
to hold the financial sector leaders accountable for the banking
crisis of 2007. This anger against the financial sector leaders
and what was perceived as their links with elected leaders may
have ultimately played an important role in the election of
Donald Trump and the rise of the powerful challenge Bernie
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Sanders mounted within the Democratic Party. Both were
perceived – correctly or incorrectly – as outsiders capable of
breaking the insider alliance between politicians and the
financial sector.
Governor Subbarao in his speech gave the example of micro
finance and ethics.2 The Governor referred to what is often
discussed as the ethics of charging interest to poor
communities, especially self-help groups. He used the
example of Andhra Pradesh in India, but this debate has
surfaced also in Bangladesh. I will refer to the Andhra example
in more detail, but at this stage I just wanted to flag the point
that looking at the microcredit industry without a transparent
discussion about charging interest rates to poor communities,
especially poor women, can boomerang on policy makers,
MFIs, and communities in unexpected ways.
Sean Hagen, IMF’s General Counsel, in leading a discussion
on Ethics and Finance at the IMF-World Bank Annual
Meetings referred to data from a 2013 survey conducted by the
Economic Intelligence Unit of the Economist.3 The results
further confirm the difficulty of ignoring ethics and the
financial sector. When respondents around the world were
asked to rank sectors in terms of trustworthiness, the financial
2 Dr. D. Subbarao, 16th Nurul Matin Memorial Lecture on, “Ethics in the
Financial Sector, An Oxymoron?”. 3 The references to Sean Hagen, Archbishop Justin Welby, and Philip Hildebrand
come from their comments at the roundtable on Ethics and Finance held at the
IMF-World Bank Annual Meetings, 2014. The video of the roundtable is
available on IMF website.
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sector was judged to be the least trustworthy to do the right
thing. The choice was between 18 different sectors from
industry to finance. More worrisome, of the 400 financial
services executives polled across the globe, over 50 percent
felt that their own career progression would be difficult
without being flexible with respect to ethical issues.
Banking Reform: How to Think about It
All speeches moved from a discussion about ethics and the
banking system to offering ideas about reforming a weak
financial system – whether characterized by high Non-
performing Loans (NPLs) – in India and Bangladesh it is over
10 percent and growing – fraud, corruption, or bailouts. These
discussions about banking reforms can be categorized around
what I would call “different schools of thoughts” in how they
diagnose the source of the problems and therefore the potential
solutions for reforming the banking system.
Many of the speakers have focused on management issues and
the challenges of reforming corporate governance. They have
addressed the banking problem by emphasizing reforms at the
firm or at the bank level. The focus is on how the board of
director functions in a financial institution, the separation of
powers between management and the board, the technical
issues of audits and so on. I call this the “management
approach” to banking reforms.
Others lay the blame of a weak financial sector on too much
reliance on markets and the failure of markets to address
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problems of information asymmetries and externalities, hence
allowing dysfunctional financial systems to emerge. There is
an emphasis on how markets sponsor short term focus on
profits which undervalues the future and results in financial
sector managers adopting a strategy that leads to a ‘race to the
bottom’. I call this approach the “blame it on the markets”
syndrome or “market failure”.
The third school of thought focuses on public policy and weak
or incomplete regulatory mechanisms. Poor regulatory design,
weak state capability to regulate, and regulatory capture define
this school of analysis and fits well into the definition of
“government failure”.
In assessing the ability of these three schools to explain the
source of the problem of a weak banking system and therefore,
offering a structural reform path, I would suggest that the
management approach is the weakest. Perhaps, I can use the
words of the Archbishop of Canterbury, Justin Welby, to best
summarize this point of view. In response to Queen
Elizabeth’s question about the financial crisis of 2007 – ‘what
went wrong?’ – the stakeholders of the financial sector in
England wrote a long letter which talked about mispricing of
risk, lending behavior, poor management supervision, and
other technical issues mostly internal to banks and the overall
banking system. Archbishop Justin opined that these answers
were akin to suggesting that the Titanic sank because of too
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much water!4 Somewhere in the discussion the story of the
iceberg had become the elephant in the room which everyone
seemed eager to ignore!
But, the market and regulatory failure explanations also have
their weakness. Analysis of market failure generally leads to
a call for regulation. Ironically, the assessment of government
failure also creates demand for more intensive government
regulation. In both cases, there is limited discussion of
government capability to regulate markets and therefore why
imperfect markets should necessarily lead to government
intervention or why government failure would lead to call for
greater government oversight.
Too Connected to Fail: It is about Politics – Essence of the
Nurul Matin Lecture Series
Others, however, suggest that financial markets fail because of
the political relations with government that underpin these
markets. In this context, the “too big to fail” story is generally
assumed to be the connection between the political system and
the financial institutions. The 2007 financial crisis is perhaps
a proof of this linkage. In its aftermath, governments used
bailouts, guarantees, and other tools to restore financial
stability. According to Philipp Hildebrand, former head of the
Swiss central bank, as much as 20% of GDP of the G-20
economies was leveraged to stabilize the markets after the
2007 crisis.
4 Ibid.
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I would argue that the ‘too big to fail’ explanation for bailouts
and sustaining of banking dysfunctions, including NPLs, must
be complemented by a ‘too connected to fail’ narrative.
The latter emerges out of the reality that the political system
in many countries creates a stake in financial institutions
which ignores the large conflict of interest that can shape this
relationship. Ethics in banking, in my view, lies not in how
ethics shapes the design and operation of the banking system
but more in how it governs the relationship between the
political system and the financial sector.
To Put it Bluntly, the Ethics of How a Parliament Governs
will Determine Whether the Banking System is Built on
Ethical Foundations
And this is where I believe the sharp foresight of Governor
AKN Ahmed is evident. He knew as a nation builder that the
protection of the financial system would ultimately lie in the
hands of the political system. In this context, Governor AKN
Ahmed may have surmised that the political relations
underpinning the country’s banking system would need to be
discussed and reviewed constantly and, particularly, through
the prism of ethics. Not because ethics would offer the
organizational principles to build a banking system but rather
ethics would help us understand the relationship between the
political system and the financial sector. Governor AKN
Ahmed may have felt that a process of constant public
discourse and debate would be one mechanism of protecting
the financial sector. In other words, putting the spotlight on
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where it is needed through discussions and debates.
This memorial lecture in honour of Deputy Governor Nurul
Matin has now become an important part of this broader public
debate on ethics and banking that Governor AKN Ahmed
launched.
An excellent review of G. N. Bajpai’s book A Game
Changer’s Memoir on the essentials of corporate governance
in India suggests “corporate governance is a sub-set of the
country’s overall governance culture and when the super-
structure is toxic (regardless of the party in power), then faith
in the sub-set is bound to be weak.” 5 This conclusion supports
the proposition that the focus on corporate governance is only
a partial framework for assessing the underlying governance
issues facing the financial sector. Importantly, the real story
lies in the relations between financial sector and the political
context of a country.
2. Politics and Public Policy
Let me offer you some stories that I hope will convince you of
the importance of approaching the story of ethics in banking
through the prism of the relations between politics, political
economy and public policy.
Three Principles
But, first let me share with you three principles which underlie
the three stories: First, there is a personal side to the stories.
5Lokeshwarri, SK “An Insider’s Tale Sebi at Work” , The Hindu, December 16,
2018.
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We are talking about ethics and if I cannot relate it to some
aspects of my own life, I would do injustice to a discussion on
ethics which has deep links to personal aspects of who we are.
In fact, after the global financial crisis of 2007, there has been
a renewed call for holding individuals responsible for their
actions, an important part of an ethical approach to public
policy – bringing accountability to the level of the individual
and the personal. But, I recognize that talking about ethics at a
personal level in a public forum makes one very vulnerable.
But, it is a risk one must take if we are to pay respect to giants
such as Deputy Governor Nurul Matin and Governor AKN
Ahmed.
Second, I would like to explain the underlying framework of
my analysis so that all of you understand the perspective I am
taking in analyzing ethics in banking. I was trained in neo-
classical economics. I use this framework as a mean to
understand the theory and reality of public choice -- why
governments make the choices they do in setting public policy.
Perfect markets are not my paradigm; principal agent
frameworks embedded in political markets and understanding
the accountability of institutions is how I approach public
policy
Third, each of the stories I will share with you I believe has
implications to help us understand the relationship between
public policy, political economy, and the banking sector. And,
each, I hope will offer insights on how to look at ethics in
banking.
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Story-1: Is It Ethical to Charge for Water?
There are many who would argue that water should not be
priced. Indeed, the tradition in South Asia – and I see this
regularly in my work in India – has resulted in tariffs barely
recovering 20 percent of operations and maintenance costs.
Capital costs are hardly part of tariff structures. Whether this
policy stance is a result of ethical objectives or not, it would
be important to assess the consequences of such an approach.
In my work I have discovered that the most expensive water
for poor people is free water. Why? Globally, subsidies tend
to accrue to the middle class – the politically connected. In an
urban setting, water utilities often draw their incremental
revenues not from tariffs and charges but from budgetary
transfers which are under the control of the bureaucracy and
the political apparatus. The managers of utilities are more
geared to responding to the signals from above – their
paymasters – than responding to and being accountable to
customers – rich and poor. Left out of access to formal water
utilities, the poor land up paying for water from informal
vendors or middle men who tap illegally into water sources
and charge a premium to their customers. And, even more
unfairly, family members – mostly women and girls – spend
hours in lines for collecting water from common wells and
sources. This is the gender impact of free water.
At the core of this problem is the governance framework of
water utilities – indeed most services provided as public
services. There is little separation of roles between the policy
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maker, provider of services, and regulator. Without the checks
and balance which is inherent in such a system of separation
of roles, the result is a political capture of the delivery system.
On this issue of separation of roles, pricing acts as an important
bridge and mechanism of accountability. Customers who pay
and service providers who charge enter into a relationship
which is a necessary first step towards creating accountability
in a system of service delivery. By providing free services
funded through the general budget, politicians and policy
makers break this relationship between customer and provider.
Whether we discuss water, electricity, transport or other
services, price manipulation is one of the most powerful
mechanism of building political patronage often justified using
the ethical argument that services should be given free. The
promise of free water is, thus, a promise never fulfilled. No
wonder that the visionary Akthar Hameed Khan – the father of
the community delivery systems in South Asia – has talked
about the debilitating power of the promise of free services by
government.
Let me be clear that universal access to services – no one being
left behind – as the ethical outcome to be achieved is an
important policy objective. But, such an ethical stance needs
to be matched by an understanding of how to organize service
delivery to achieve the objective of universal access. Universal
access as the ethical outcome – or objectives of social justice,
as many would suggest – can be achieved in various ways to
support low income households. But, in practice such an
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objective is often used to create a pricing and regulatory
framework that places service delivery in a political economy
context where the poor are left out of the formal service net,
resulting in a service delivery system that is often
dysfunctional. The initial intervention may not have been
motivated with this outcome in mind, but if the policy process
is not protected from capture or itself based on ethical
standards, ethics as an objective in designing service provision
or the goal of social justice through universal access can be
subverted. This is an important lesson for linking ethics and
banking.
Story-2: North South University6
My father, Mr. Muslehuddin Ahmad, thought of the idea of
North South, he designed North South, and he brought
together a coalition of academics, business groups, and
professionals to establish North South as the first private
university in Bangladesh. He coined the name North South as
a past member of Chairman Willy Brandt’s North South
Dialogue and as a firm believer that the dialogue about
international development was the most important global issue
facing our generation. He personally drew the logo of NSU.
I remember that soon after his retirement from thirty-three
years of service in Government, including as Ambassador and
Secretary, he dedicated himself to making North South a
6 Ahmad, Muslehuddin (2004), The Tale of the First Private University of
Bangladesh: North South University, Academic Press and Publishers Ltd.
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reality. The respect he earned as a dedicated official with a
reputation of establishing an ethical standard in how he
managed his work was an important reason why government
officials were quick to endorse his idea for establishing a
private university. But, as a believer of parliamentary
processes and the rule of law, my father politely declined the
individual permission to establish North South and actively
lobbied for an act to be passed by parliament for opening the
role of private sector in higher education. My father even tried
to have the bill jointly sponsored by Government and
Opposition. He believed an act of parliament would ensure
that private participation in higher education would be secured
and supported as an arm of nation building and, importantly,
establish the appropriate public oversight. It was his
conviction that an act of parliament would ensure that private
universities would not be a monopoly of a few. He and a few
other like-minded individuals had a hand in establishing many
of the principles behind the bill.
My father started his efforts to establish North South in 1988;
the university opened in 1992-93; and the ethical crisis
happened in 1998, several years after he had become Vice-
Chancellor. One morning when he arrived at the university he
found the door of his office secured with a padlock; he was
locked out of his office; and to add insult to injury, he was
escorted by security guards out of the university he had built.
In a flash of a moment, my father lost at least ten years of his
life. Today, my father’s name is not mentioned as the founder
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of North South – check some of the university’s you-tube
movies and you will see what I am alluding to.
What I am sharing is at one level a personal story. True. But,
I share it because I believe it is one that raises important issues
for public policy and offers insights about ethics in banking
from the world of education. To make this connection between
the education sector and banking, I will draw partially on a
framework used to analyze the 2007 financial crisis by Philipp
Hildebrand, Black Rock Vice Chair and former head of Swiss
Central Bank.7
If we start by looking at the crisis at the firm level – i.e. at the
level of the individual organization or a university in this case
– the first question could well be whether it was a result of
management failure. Perhaps my father was a poor manager
and, as often prescribed in these circumstances, maybe he
should have invested in training to address his shortcomings.
Or, perhaps the culture of corporate governance was missing
and the Board of governors and management, their roles, and
separation of powers needed to be better implemented. May be
the training would need to be targeted more broadly at those
involved in corporate governance. This focus on the
management level and emphasis on training and reviewing the
roles of individual managers and boards has been very much
prominent in the discussions of the banking crisis. Perhaps
7 Ibid. 4
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Archbishop Welby’s Titanic analogy was even more relevant
in the situation confronted by my father.
Extending the framework offered by Hildebrand we could also
ask a more fundamental question. Did we, to begin with, adopt
a wrong management model of corporate governance or wrong
business model for private universities? Perhaps, the western
corporate governance model is not applicable in our context. I
wonder if we should have kept this as a family business? Or,
we should have investigated other forms of governance,
perhaps a society or foundation management model. Mark
Carney, Governor of Bank of England,8 speaks of the incentive
in the management model of banks that placed excessive focus
on share prices and current profits at the expense of
undervaluing the future. In many ways, the management
models may have led to what the survey of financial services
executives said were pressures to be flexible about ethical
standards. Perhaps our private university board members and
managers face similar incentives.
We could also ask whether the events would be best ascribed
to market failure? Too many private universities leading to a
race to the bottom where the markets were not appropriately
signaling the possible unethical corporate behavior and
decision making. Perhaps that is what may lead some
universities to admit students without meeting the entrance
requirements, or seeking illegal payments for admissions, or
8 Ibid. 4
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having weak audits, or allowing for huge expenses that cannot
be accounted for, or payment to individuals for just for
attending board meetings that would be difficult to justify.
But, any discussion of market failure must be followed by the
question about who is regulating the private universities?
University Grants Commission (UGC)? What is its capacity,
its legal mandate, and, ultimately, its clout to regulate? Who is
giving licenses to open new private universities and is that
process robust or is it influenced by political dimensions? And
if the latter, is the process leading to “too many” universities
and “too much competition” and hence contributing to the
“race to the bottom” better described as state failure?
Furthermore, the fact that we do not have a level playing field
between public and private universities adds complexity to the
issue of regulatory and market failure and makes it difficult to
disentangle the impact of each on the functioning of the
university sector overall.
The parallel with the banking sector is clear. The issue of the
capacity and mandate of the central bank in regulating and
supervising the banks, the nature of the independence of the
central bank, the rules that govern public and private banks,
and how markets respond to the management of individuals
banks are very similar to issues I have raised in the context of
higher education.
How did the courts respond to my father’s situation? Watching
my father navigate the legal process revealed many insights
into Bangladesh, the reality of the rule of law in our country,
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and the contradictions potentially inherent in ethics, justice,
and law. It became very clear that if basics of corporate
governance and contracts do not find protection in the legal
system, how can we expect sanctity of contracts to be
preserved in any specific sector, education or banking, and, in
this context, how can principles of ethics in the functioning of
banks be expected. The rule of law and the capacity and
independence of the legal system must work hand in hand with
the capacity and independence of the central bank to ensure
that the banking system is efficient and responds to society’s
needs.
You can see the linkages I am drawing with the banking sector.
The parallels are very evident: corporate governance issues at
the bank or organizational level; efficiency of markets and
whether there is a level playing field between public and
private banks; the strength of the regulatory framework; and
the role of public institutions including the central bank and
the legal system. But, this broader context of public policy is
set by the political class given responsibility for safeguarding
the nation. To ring fence and focus on the breakdown of
corporate governance inside any individual bank – or
university – without an understanding of how the broader
system of policy and laws set the incentives that guide the
delivery of public services would be to miss that ethics in
public services must ultimately be linked to the ethics of those
who set policies and laws.
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I must hasten to add that individual leadership failure or
fraudulent behaviour by any individual overseeing the banking
system or by any employee in a bank cannot be excused just
because the overall governance of the system is weak.
Individuals must be held to account as it sends important
signals in a system especially in a financial sector built on trust
and confidence. My point is that by focusing solely at the
individual level – no matter its importance and need – would
only address the symptom of the problem.
Hildebrand adds a final component to his framework by
introducing the notion of “societal failure” or the collective
responsibility of society. Referring to the global financial
crisis, Hildebrand points out that prior to the 2007 events he
was at social engagements where it was quite visible how
much the financial sector executives were sought after and in
effect recognized as leaders of the society. It reminded me of
dinners and weddings in Dhaka where my father was present
along with those who had created the crisis at his expense. The
events were well known – the informal word was out amongst
the elites of society – but there was absolutely no societal
sanction being applied. I would agree with Hildebrand that in
such context societal norms may set the boundaries of what
will be acceptable ethical behavior and, therefore, result in the
collective societal responsibility for breakdown in ethics. To
discuss about ethics in banking without an understanding of
the broader societal setting is to miss out the deeper story of
ethics and public policy.
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Story-3: Micro Credit
Governor Subbarao speaking in this lecture series referred to
the challenge of capping or even fixing interest rates for
microcredit borrowers. He faced an interesting dilemma –
regulating specific interest rates in an era where liberalizing
markets, prices, including the price of credit was increasingly
the policy direction of an India committed to market reforms.
Governor Subbarao hints that not enough work had been done
to understand whether the micro-credit markets were
competitive, what more could be done to increase the level of
competition to reduce the interest rates, and while recognizing
that borrowers in this segment did not have access to formal
commercial banks, the extent to which they were accessing an
alternative to the high rates offered by informal money-
lenders. In other words, there seemed to be quite a bit of scope
to improve the functioning of micro credit markets without
necessarily resorting to interest rate controls.
While the policy challenge the Governor was facing is an
interesting one, in my opinion the more relevant implication
for our discussion on ethics and banking emerges from the
story of how the situation in rural Andhra Pradesh led to the
recommendation of an interest rate cap.
The GoAP promulgated an Ordinance on October 15, 2010.
Among other provisions, it prescribed that MFIs had to
register with GoAP in each district separately and seek GoAP
approval before lending to SHG members, thus effectively
preventing them from further lending. More importantly, the
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Ordinance also prohibited MFI staff from visiting the
residence or workplace of a borrower asking for repayment of
their existing loans. This was a deathblow to MFIs in AP.
December 2010, the RBI appointed a Board sub-committee
under Mr. Malegam’s9 chairmanship and held many hearings
including in Hyderabad. The Malegam Report was quite even-
handed in the sense that it recognized the need for MFIs to
charge interest rates even high ones, but also suggested
regulatory solutions to curb the malpractices by some MFIs.
The report concluded by saying that if those changes were
made by the RBI, then there would be no need for the AP MFI
Act. The RBI also later gave significant relief in provisioning
to the AP loan portfolio of all MFIs. But the interest rate cap
was replaced with a margin cap of 10 per cent for MFIs with
loans over Rs. 100 crore and 12 per cent for those below.
Neither was viable when banks were charging MFIs upwards
of 15 per cent per annum; and so, there was need for more
advocacy with the RBI.
The MFI sector in India today is a healthy one and growing.
But, the AP incident suggests several lessons that I have tried
to capture in my presentation so far. Ignoring ethics in banking
can come back and hit policy makers in a harsh way. In AP,
9 Yezdi Hirji Malegam is an Indian chartered accountant who was the president
of Institute of Chartered Accountants of India from 1979 to 1980. He was the
chairman of National Advisory Committee on Accounting Standards. Since 27
November, 2000, he has been a board member of Reserve Bank of India. Yezdi
Hirji Malegam, 80, has a rare honour of being the longest-serving member of the
Reserve Bank of India (RBI) board.
23
the process started by the decision, some would say
interference, of district collectors in the rural areas – the
bottom of the civil administration – to control the MFI sector
as they felt the need to respond to concerns of indebtedness
and suicide of farmers. In this case, ethical issues led to
directed credit – a political response. Whether motivated
initially as such, there is always a possibility that reference to
ethics may well be used as a backdoor way of controlling
financial markets and directing credit according to political
objectives. On the other hand, a constant policy focus on
ensuring a well- functioning market using the traditional tools
of information, sector liberalization, and pragmatic regulation
may achieve the results that ethical principles would suggest
we achieve without direct controls of markets and their
possible political economy implications.
3. Lessons
What, finally, are the lessons that I take away from these three
stories and the conclusions I draw from my reading of the past
lectures? I share these lessons with you not as a set of policy
recommendations for the banking sector in Bangladesh.
Rather, these are presented as a set of principles that I believe
are pertinent to the issue of ethics in banking. Whether they
apply in the context of Bangladesh and to the discussions
about banking reforms in our country, I leave it for you to
decide. Unlike many of the previous speakers in this series, I
have no special knowledge or expertise of Bangladesh’s
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financial sector and, even I felt I did, this forum would not be
the right place to engage on specific policy reforms.
Too Connected to Fail: Navigating the Links between Ethics,
Politics, and Public Policy
A context where the political economy, public policy, and the
financial sector are linked creates what I have called a “too
connected to fail” banking system. To be sure, this is not a
developing country story only. Kevin Villani reminds us that
early American banking was often unethical. “It was
characterized by lending to insiders and politically directed to
“public infrastructure” where crony corruption was pervasive,
and it led to widespread bank failure.” 10
Taking only a technocratic perspective to manage the banking
system where the political system and the financial sector are
not appropriately and sufficiently separated will not offer us a
credible platform to engage in banking reforms. Using
principles of ethics to organize the banking system may also
not be practical and, may in fact be co-opted to deepen the
connection between the political system and the financial
sector. Instead, the lens of ethics may be more usefully
leveraged to assess and evaluate the connection between
political economy, public policy, and the banking system. For
this to happen, however, we must be ready to ask the critical
questions of how ethics can be embedded into the functioning
10 Kevin, Villani (2009), Dangers of Ethical Banking, Foundation for Economic
Education, March.
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of the political system, the decision-making of politicians and
political parties, and in the case of countries like ours, the
parliament. Ensuring, for example, that the parliamentary
committee on banking and finance follows ethical principles
to protect the citizens and ensures a transparent and
competitive financial sector and a banking system is what
citizens should expect and demand from their political system.
Central Bank, Consumer Organizations, and Self-
regulation: Ensuring A Transparent System
In this context by keeping ethics central to the discussion of
how a country’s political process is functioning, policy-
makers can then focus on the mechanism to create a
competitive and transparent banking and financial sector
overall. Central to this objective is the need to have well
defined roles for the various players that influence the banking
sector.
To being with, a point stressed by academics and policy
makers world wide – the importance of ensuring a strong and
independent central bank. The ability of central banks to
supervise and oversee the banking sector and to do so with
independence is central to the growth of a healthy banking
system. Developing the framework and culture for such
independence is not automatic. It requires several components
of a good governance system, including a transparent process
for the appointment of the head of central bank, developing a
system where the head of the central bank – a very powerful
position in an independent institution -- is held accountable,
26
establishing the rules that determine the interface between
parliament and the central bank governor, and other important
factors. The literature on this issue is vast and the experience
from other countries readily available. There is little that I can
add here.
But a strong central bank is only one component of the overall
regulatory framework. It offers a top down approach to
supervising the banking sector – what the regulatory literature
would call a “police patrol” method. Equally important would
be to complement it with a bottom-up approach through
consumer protection organizations capable of monitoring the
banking system – what I would call citizen’s watch or citizen’s
ombudsmen. Such a system would offer “alarm bells” that
citizens or organizations representing them can “pull” to signal
that something is wrong in the relationship between the
political system and banks. These pro-citizen groups must also
keep a watch on how courts and parliaments are addressing
bank failures to play their role effectively.
An additional level of oversight is through “self-regulation”
by the industry and for the industry itself to set up a transparent
process of upholding banking standards. Here, I would refer
again to the important point made by Hildebrand that if the
industry ignores ethical issues there may be a risk that the
public – and hence governments – will demand greater and
more intrusive regulation of the sector. Ironically, the latter
intervention may well further deepen the syndrome of “too
connected to fail.” But, bringing together the industry to agree
27
on a set of common standards, taking necessary steps to abide
by these standards, and reporting the outcomes regularly to the
public is not an easy process. To protect the private
universities, my father created EQAF – Education Quality
Assurance Foundation – by bringing together several top
universities in Bangladesh to develop a self-regulatory
process. He invited NEASC (New England Association of
Schools and Colleges) – as an independent third party –to help
the private universities develop a benchmark against which
they could measure their own performances over time.
NEASC provided capacity support to the group to engage in
such an exercise. The objective was to create a ‘race to the top’
and assure the public of the commitment that the universities
were making to preserve the quality of education. It was also
aimed at protecting the universities from political interference
by creating a standard, abiding by it, and reporting regularly
and transparently to the public on how well the universities
were achieving their self-stated goals. EQAF needed the
universities to own and invest in the process of self-regulation;
having started the process under my father’s leadership, after
his death the process of self-regulation did not persist.
Ultimately – and this is a point that is increasingly being
articulated by global leaders from the financial sector – a
system that relies excessively on a top down regulatory
architecture, is essentially “bankrupt.” The voice of consumers
and self-regulation – which is a signal that financial leaders are
accepting their responsibility to be, borrowing Governor
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Carney’s words, “custodians of their institutions” – as a
complement to the traditional state regulation is more akin to
a system that is ethically robust.
Overburdening the Banking Sector
Public policy is expected to address many important issues
facing citizens. These include creating jobs - small and
medium enterprises are expected to play a major role in this
effort; protecting our environment and managing the
challenges of climate change; and ensuring universal access to
services including financial services. These objectives are not
only important from an economic perspective but in many
cases the “right thing to do” from a social indeed an ethical
perspective. The challenge for policy makers is to find the
right set of policy instruments to achieve these objectives.
Often the approach is to achieve these policy goals through the
financial sector and overburdening the banking sector with
what in effect can become directed credit. A preferable
approach would be to ensure a transparent and well-
functioning banking sector to play its role of intermediation in
finance. Social and ethical objectives should in turn be debated
and acted upon by parliament and the government through its
budget allocation. This would link public policy transparently
to fiscal policies, creating a separation between fiscal
objectives and financial systems.
In this context, as Kevin Villani correctly points out, socially-
progressive investment funds and non-bank lenders are a more
29
efficient and transparent way of addressing the important
ethical goals embedded in various public objectives. Leaving
BRAC bank to competitively grow in its field of comparative
advantage – small and medium enterprises – while using PKSF
as a wholesaler to support MFIs is an excellent example of this
separation. Interestingly, competition may well lead other
banks such as HDFC to expand and enter the small and
medium enterprise sector.
Corporate Governance
In this broader context that I have described -- of placing ethics
more in the domain of the political process, ensuring and
clarifying the roles of the various players in the financial
sector, and keeping the development goals of the banking
sector simple and transparent – corporate governance plays an
important role. In many parts of the world, the financial crisis
of 2007 has placed greater focus on what goes on “inside the
banks” at the level of boards, management, and staff. For
example, we are seeing a shift to compensation linked to
specific types of performances and payment – e.g. more
through stocks – to shift the management focus to the long run
rather than the immediate returns. Others have instituted
mechanisms to claw-back and cancel bonuses. Almost
everywhere, there is greater emphasis on accountability at the
individual level – whether in management or at the level of
board members – through various mechanisms including
direct personal liability and legal measures.
30
Importantly, as Hildebrand reminded us, Basel-1 may have
triggered a decoupling between the level of risk that financial
institution could take and the amount of capital that was kept
aside as security. There is now greater emphasis at the
individual bank level to ensure that risk taking is
commensurate with the level of capital put aside to cushion
any negative fall-out. Interestingly, in this context of
emphasizing management responsibility, Islamic banking
deserves an important mention. In Islamic banking it is
expected that lending in economic activities is, in effect,
through the principle of equity participation and sharing of
profits and losses. In addition, in Islamic banking, charging
interest is seen as unethical. Dr. Akbar Ali was perhaps the
only speaker in the past to have seriously looked at the Islamic
banking in the context of ethics in banking. Surprisingly,
others have not, and I place myself squarely in this group.
Bangladesh Institute of Bank Management (BIBM):
Training, Dialogues, and Voice of Citizens
What is the role of BIBM in this broader debate about ethics
in Banking? If my assumption that Governor AKN Ahmed
introduced this lecture series as a specific mechanism to have
all of us debate on the role of politics and finance and their
implications for how to protect the banking system from
becoming politicized, then BIBM has several roles to play.
First, in the arena of training, which BIBM is already
effectively undertaking, the organization’s focus on corporate
governance is of great import. BIBM offers the appropriate
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setting to take forward training for corporate executives and
banking boards around corporate governance.
But, training by itself would not suffice for addressing the
challenges around ethics in banking and banking reform more
generally. Rather, and this is my second point, BIBM would
need to invest in proactive dialogues focusing on
parliamentarians, policy makers, bank executives and board
members, and representatives of civil society. Some of these
dialogues should be within peer groups and in other cases, the
dialogues will need to be across peer groups. The outcomes of
these dialogues could be shared with the public, but some may
have to follow the Chatam House rules.
Proactively keeping the public informed and hence involved
in public policy would be an essential role BIBM could play.
Training for the public on financial sector issues and public
outreach and campaigns to inform the citizens are essential
mechanisms of outreach. Similarly, using its network of
connections with think tanks and universities and engaging in
developing the knowledge base around banking and public
policy which could inform public debate and curriculum of
schools and universities is another approach. Ultimately, a
well-informed public is critical for creating a broader social
compact around public policy. The banking sector is not an
exception to this rule.
Let me add that there is a difference between setting up
training programs and engaging in a process of stimulating
policy dialogues across stake holders. The latter requires a
32
different and dedicated set of skills and professionals distinct
from those involved in training programs. Indeed, it requires a
carefully thought strategy and tactics to influence policy
making.
Conclusion
Linking ethics to governance of nations and embedding it in
the formulation of public policy will secure a banking system
that supports such an ethical development path. But to achieve
this outcome, while ethics can inform broad principles, the
operational design of the banking system would need to be
designed from a careful mix of regulation, market competition,
informed citizens, and voices that represent consumer rights.
The invitation is to keep the structure of the banking system
simple and transparent and focused on the goals of linking
savers and borrowers and of transforming maturity. Let the
debate and decisions about ethics in development be placed on
the shoulders of our parliament and their political decision
making. Hiding it behind financial price manipulation rather
than transparently through budgetary and fiscal decisions will
be a sure path towards “a too-connected to fail” banking
system.
I hope that Deputy Governor Nurul Matin would have given
me his endorsement for this perspective.
Biography of Dr. Junaid K. Ahmad
Dr. Junaid K. Ahmad, a Bangladeshi national, is
currently the World Bank Country Director for
India. Prior to this assignment, he was the Chief
of Staff, Office of the President.
Dr. Ahmad joined the Bank as a Young
Professional in 1991, working as an Economist
in Africa and Eastern Europe before joining the
Africa Infrastructure Unit. Mr. Ahmad spent 10
years in the field, first as the Deputy Resident
Representative and Principal Economist in Johannesburg, and then as Regional Team Leader of the
Water and Sanitation Program in New Delhi. In 2004, he was a team member of the World
Development Report (WDR): Making Services Work for Poor People. From 2004-2008, he was the
Sector Manager for Social Development in South Asia Region and subsequently for Urban, Water
& Sanitation before taking on the latter responsibility for the Africa Region in 2010. He was also the
Director for Sustainable Development in the Middle East and North Africa Region, a position he
held from 2012-2014.
He holds a PhD in Applied Economics from Stanford University, an MPA from Harvard University,
and a BA in Economics from Brown University.
Bangladesh Institute of Bank ManagementS e c t i o n - 2 , M i r p u r , D h a k a - 1 2 1 6