By Idris Mukhtar, PhD.
This write-up seeks the correct the perception of some people about the Commercial Banks’ operations and the Central Banks’ regulations.
A banking operation is a business like any other business. They collect money from those that have a surplus and channel it to those that are in deficit with the sole aim of making positive returns. In this sense, the business has to respect the law of demand and supply, which basically determines the prices. Human beings are rational in nature; thus, they try to avoid anything that could bring them dissatisfaction in favour of the things that could bring them satisfaction.
Basically, peoples are the owners of commercial banks. They invest their personal net worth in banks with the sole aim of making profits and avoiding disasters. However, because of the high-risk nature of the banking operations (i.e., dealing with money, complicated mode of operation, and the important roles these institutions play in economic development), the government, through Central Banks and other regulatory agencies, makes certain regulations with the aims to make their operations smoothly and to safeguard the investors’ money. The government regulates the banking system by setting a minimum Liquidity Requirement, Minimum Capital Requirements, Non-Performing Loans threshold, Maximum Expense vs Revenue (efficiency ratio) Requirement, Concentration Ratio, etc.
Based on the above, to ensure fairness to all (developed or underdeveloped) within a given jurisdiction, these regulations must be made equal among the banks in a particular category (i.e., International banks, National banks, Microfinance banks, etc.) by considering several factors.
For example, regulators set the minimum Capital requirements for international banks differently from national banks or microfinance banks just to make sure fairness is achieved uniformly within the country. No particular region, segment, or people will be given preferential treatment over the other. In setting these regulations, due to the nature of banking operations, any preferential treatment because of the underdevelopment of the region will set that region or people preferred in the disadvantage stage because investors will definitely not find it easy to risk their capital in a high-risk region that did not have stringent regulations that could safeguard their money.
Because of the rationality of the consumers who are the capital providers to the banks, if the regulations are enforced in a particular region due to the so-called reason that the region is not advanced and the economic life is difficult in such a way that will temper with investors interest (i.e. attaining a positive return and avoiding negativity) to protect their personal wealth invested, they will run away from that region in favour of the region that has an adequate regulation to safeguard their hard-earned money.
No one will stay in the region, which will cause them to lose money unless few. (even these few could only stay if they believed they could get a higher profit/interest rates by charging high markup on loans and advances to cover the high risk they took by staying in an area in which there is a high risk of defaults). This will cause economic hardship, a high rate of crime, terrorism, and continued deterioration of the conditions in such a region.
If we look all over the world, due to the loan default expectation, any region that proves to be economically more prosperous enjoys the teaming number of investors trooping to such a region for investment even though the gain is lower because of the competition. That is why the profit/interest rate on loans charged to borrowers in developed nations is much lower compared to what is charged in developing or underdeveloped nations that have lower ratings or high credit risk (this is basic as per as risk management is concerned), i.e., in Nigeria commercial banks charges between 20%-25% on loans while in the US or the UK the rate is lower than 5% per annum. What explains this scenario is simply, in comparison to US or UK, Nigeria is a high-risk country disturbed by a high rate of corruption, insecurity, terrorism, etc. which scare any rational investor away unless he could be compensated by charging a high-interest rate that will worsen the economic situations of the borrowers.
To me, the way forward for a less economically developed region to compete with another region is to continue educating its younger ones gradually. Research shows a positive correlation between education, low corruption, terrorism, and improvement of economic conditions. With a good and quality education, businesses will thrive, people will prosper, income will improve, and well-to-do members of the region or investors from outside will invest their surplus funds in such a region because of the expectation of positive gains on their investments and good business models that will ensure non-default in the loans.
Any enforcement by the regulators on the people’s right to the investment of their personal wealth (i.e., calling for the government to enforce peoples invest their wealth in a region with a high risk of default in such a way that they will incur losses just because the government wants help that region or the region is less developed) is an illusion and will do more harm to the region than good in future. In the end, instead of that region prospering because of that policy, it will end up deteriorating.
Dr Idris Mukhtar wrote from Jeddah, Saudi Arabia, via email@example.com.