Do bailouts incentivise risks?

Bam! Bailoooooout! We need more money to fix the challenges in the banking sector. Bailouts have been associated with banking crisis for many years. A bailout can either be given to a bank to save it from becoming insolvent or used to safeguard the entire financial system from the rippling effects of those banks (financial institutions) which had collapsed.

A case in point is the US banking sector which has received bailouts for each crisis since 1970 from the Federal Reserve and through an Act- the $700 billion bailouts for the Troubled Asset Relief Program (TARP) was authorised by the legislature to support banks during the 2008 financial crisis.

Financial institutions such as Morgan Stanley and Goldman Sachs which occupy a pride of place in the US economy have benefitted from bailout packages at certain times in their operations. The two banks are in the league of lenders considered as ‘too big to fail’ and always supported with bailouts. In most instances, the bailouts to institutions during financial crises are not free and normally paid back with interest.

In Ghana, matters relating to bailouts have been very topical in recent times. It is a matter of public knowledge that the Bank of Ghana offered liquidity supports to the tune of Gh¢ 860 million to UT Bank and Gh¢620 million to the Capital Bank. The Sovereign Bank received Gh¢21 million while the uniBank, on the other hand, received over Gh¢ 2.2 billion. These bailouts (liquidity supports) were then offered to the defunct banks to sustain their operations, but unable to keep their heads above water, hence liquidated. The extent of recovery of these funds will depend on the receivers’ (PricewaterhouseCoopers and KPMG) actions as defined by law.

Aside from the banks, the Bank of Ghana recently made public its intention to liquidate the savings and loans companies and the microfinance companies it has identified as insolvent and too weak to stand in the banking sector. Sequel to the impending liquidation, Monday 29, 2018 edition of the Business & Financial Times reported that government with the financial support from the World Bank will spend about Gh¢10 billion as additional funds on the exercise. This is will take place against the backdrop of the Gh¢7.6 billion bond issued earlier by the Government of Ghana to cover the seven erstwhile banks’ selected assets and liabilities.

Really, the reason for extra funds is obvious and rightly so; to ensure comprehensive overhaul and reforms in the financial sector that needs strong and well-capitalised banks or deposit-taking institutions to support the country’s economic growth and development. This can be achieved when the banking sector operates smoothly and protects depositors, hence, the extra spending efforts.

Reminiscence

From hindsight, we can identify the problems which pushed the institutions to the brink of collapse or collapsed them, hence, necessitating the bailouts. These are poor corporate governance practices, poor credit administration which gives rise to the alarming non-performing loans, excessive risk-taking where some deposit-taking institutions (savings and loans companies/microfinance companies) ventured into non-permissible activities or long-term projects which lock up depositors’ funds. The problem has also been attributed to the intense competition among the deposit-taking institutions to give customers alternative choices but unmatched with the required strong supervision. Unlike the situation when deposits with the universal banks are secure even on revocation of the insolvent ones’ licences, deposits with other financial intermediaries (the savings and loans/microfinance companies) are not insured.

As a result, it becomes a nightmare for depositors with any of these companies in insolvency to withdraw their funds. They tend to lose confidence and trust in the financial system which should not have been the case. Early this year, Alpha Capital Savings and Loans and the Accent Financial Services were considered by the public as insolvent and unable to pay their customers. The companies’ operations are now lulled with their branches under lock and key. In effect, the fate of their customers’ investments or ordinary savings hangs in the balance. These cases come in handy to appreciate the issue under consideration in much detail.

When the companies collapse, and the unpaid customers lose their savings, the owners of the companies later profit from the supposed risks investments they had made in different businesses at the regulators’ blindside. It is believed that those owners come back later with the same moral hazards by using other people to front for them in the banking business.

Divergent Opinions

With inferences from the foregoing experiences, a school of thought strongly oppose the bailout program and consider it as an incentive to entrench a culture that encourages lenders especially the owner-managed ones to ride on the so-called entrepreneurial risks to repeat and profit from their past mistakes.

In order not to reward gratuitous and excessive risk-taking disposition, people, therefore suggested that the bailouts should be directed towards development projects such as roads, schools, hospitals etc. They want regulation to be tightened to prevent the recurrence. That said, people also want any plan to punish the owners for the financial impropriety through the courts to go beyond the usual rhetoric. What do you say? Do you share in this sentiment or have a dissenting opinion?

In a contrary view, others reiterate the fact that the financial system is the lifeblood for the survival of the economy and cannot be allowed to suffer a haemorrhage. Hence, the bailouts should be used as part of the reforms to build a resilient banking sector that will always protect depositors’ funds and customers’ interest. Dear reader, where do you stand in this stimulating discussion concerning the bailouts?