The Banks with Huge Capital Reserves - Essay Example

?Finance in Mauritius Table of Contents Table of Contents 2 Chapter Introduction 3 1 Background 3 2 Impact on financial parameters of Mauritianbanks 4 1.3 Defining the Problem and Research Objectives- 9 1.4 Structure of study 9 Chapter 2- Literature Review 11 Reference 14 Bibliography 15 Chapter 1-Introduction The sub-prime mortgage crisis of US and the crash of the housing prices in some of the major industrialized economies sent ripples across the world. The recent financial crisis that had started showing signs towards the middle of 2007 and became full-fledged in 2008 was the result of the excessive and unsolicited credit lines granted to the individuals and companies to boost the prices in the housing market. The rising market volatility due to the growing speculation in the stock markets led to failure in payment of debt among the banks, insurances and mortgage companies. The gravity of the problem was such that even the banks with huge capital reserves could not evade the situation (Mohamudally-Boolaky & Ramlall, 2010). This led to the fall of the one of the four pillars of Wall Street Lehman Brothers while some of the once ‘unfathomable to fall banks’ were either taken over at very low valuations or had to be rescued by the government. 1.1 Background Chan Lau (2008), states that the credit turmoil sent the US economy into a jittery. Even the European economies could not escape from the crisis and it gradually spread across the emerging economies. Initially, it was believed that the impact of the financial fiasco would be least on the African countries due to their limited exposure to structured financial products. However, this proved to be false. Ramlall (2009) highlighted that the financial crisis increased the sensitivity of the stock market index of Mauritius to international markets (Mohamudally-Boolaky & Ramlall, 2010). There have been other emerging economies like China, India and Brazil that followed the developed economies into the period of recession during the recent crisis raising serious concerns about their resilience against external shocks. However most of these emerging economies have bounced back from the recent crisis towards the middle of 2009 and have successfully weathered the credit turmoil in a much better way as compared to the developed nations. The financial system of Mauritius is mainly bank-based with the banks representing 70 percent of the overall assets. In the “Financial Stability Report of the Bank of Mauritius” released in the year 2009 it has been stated that the recent credit fiasco did not have much impact on the indigenous banking sector. It is mainly because the banks in the country were not directly exposed to any toxic debt that affected the worldwide financial markets. The recent credit crisis has put forth the requirement to safeguard from vulnerabilities like rising foreign currency and credit risk, funding reliability and lending practices (Mohamudally-Boolaky & Ramlall, 2010). 1.2 Impact on financial parameters of Mauritian banks In a survey of Mauritian commercial banks and three important insurance companies it has been revealed that impact of the crisis was severe on the exports of the country with the mixed responses regarding the impact on the banks. As per this survey most of the banks witnessed a lag effect of the credit crisis mainly during the period 2009-10. Table 1- Impact of crisis on important banking ratios Source: (Mohamudally-Boolaky & Ramlall, 2010). The above table shows that the banking system in the country has emerged unscathed from the crisis. A rise in important financial parameters shows that the performance of the banks rose considerably. This implies that most of the banking activities are internal making it less risky as compared to those arising out of foreign operations (Mohamudally-Boolaky & Ramlall, 2010). The recent global financial crisis is reckoned as the worst credit crisis after the Great Depression. It initiated a number of policy actions by the central banks and governments across the world but still the most developed nations could not remain immune to the financial strains. As per the Global Financial Stability Report of IMF the crisis posed a serious threat to the financial stability (Bank of Mauritius, 2009). There is no clear-cut definition to the term ‘financial stability’. As per Oosterloo et al. (2006) financial stability can be referred to as the smooth and uninterrupted functioning of the various key elements comprising a financial system. Svensson (2003) states that a report on financial stability helps in maintaining the confidence among the various economic agents ensuring them that there is no significant risk to the financial system. There is a common belief among the academics and practitioners that any form of financial instability is induced by rising financial imbalances that eventually cause a severe damage to the overall economy. As pointed out by Laeven and Valencia (2008) the damages caused by the crisis can impact other economies and even the ones not directly impacted cannot remain immune to it. This paper attempts to study the resilience shown by the Mauritian banking and financial sector in the wake of the recent financial crisis. Mauritius is an open economy integrated into the global markets and the small size of the economy makes it susceptible to any form of external shocks. In the last few years the country had to bear a sharp fall in the price of sugar exports and high oil and food prices. Despite these the Mauritian economy has shown high levels of resilience. Due to the recent financial crisis the growth rate of the economy witnessed a fall mainly on account of the slack performance of the tourism and textile industry. The global credit turmoil did not create a liquidity crisis in the indigenous financial market. The banks in Mauritius have to comply with the Basel II norms from the start of 2008. The banks in the country had adequate capitalization to withstand the crisis period and the adverse impact of the crisis in the financial system was felt mainly on the investment funds (African Development Bank, OECD, 2009, p.435-442). The elements that contributed to the resilient stand of the Mauritian economy in the recent credit crisis include its strong financial system and the string of reforms that enabled it to build up this resilience (Commonwealth Secretariat, 2010). The prevailing financial regulations in the country together with the conspicuous absence of structured derivative products signifies that the financial system of Mauritius remained unfettered from the financial contagion barring the occasional stock market corrections due to the panic-stricken investors across the globe. Despite all these there have been some marginal impacts as a country cannot remain absolutely immune to the after-effects of the worst crisis in the world in decades. In 2008 the Mauritian economy reported a growth of 5.3 percent which is close to its previous year’s growth of 5.4 percent. Of this growth nearly two-third was contributed by the service sector (Willem Te Velde, et al., 2010, p.32-34). The majority of the country’s FDI in the year 2008 has been from financial intermediation, tourism sector and real estate as per the data given by Bank of Mauritius. In sectors like tourism there has been a decline in FDI but the other sectors like financial services and real estate reported higher FDI flows in the first three months of 2009 as compared to the corresponding quarter in 2008. Due to the credit crisis, in the year 2008 the FDI flow remained at the level reported in 2007 (Willem Te Velde, et al., 2010, p.32-34). The financial stability report released by Bank of Mauritius highlights that the portfolio investments recorded were net cash outflows in 2008 as compared to the net cash inflows in 2007. The trend remained the same till the first three months of 2009. The banking sector withstood the recent financial crisis on account of the adequate capital backing of the private banks. The portfolio of the banks did not have any significant exposure to the toxic financial assets thereby reporting high and rising profits. The capital adequacy ratio commonly referred as CAR of the commercial banks increased from 15 percent to 17 percent during the period December 2008 to March 2009. This is well above the minimum requirement of 10 percent. The ratio of “nonperforming loans to gross loans” declined to 2.1 percent in 2008 but it increased to nearly 2.4 percent in the first quarter of 2009. The proportion of impaired loans to total loans disseminates stress in the tourism, construction and manufacturing sectors. The proportion of nonperforming loans owing to these sectors in the total nonperforming loans increased marginally between 2008 and 2009. The liquidity position of the banks has remained strong as apparent from the rise in the liquid assets of the bank from 36.1 percent in 2008 (December) to 40.4 percent in the end of the first quarter of 2009. The stock market in the country witnessed a sharp fall until Feb 2009 but it has recovered now. The total market capitalization dropped by 45 per cent in the year 2008, with the finance and tourism sectors bearing the brunt of the fall (Willem Te Velde, et al., 2010, p.32-34). The banking sector of Mauritius has by far withstood the global credit turmoil. This is to an extent owing to the fact that the portfolio of the indigenous banks remains uncontaminated from toxic assets and is partly due to the delayed effects of the credit crisis allowing the banks to adopt a more pro-active stand and introduce necessary measures. 1.3 Defining the Problem and Research Objectives- This paper attempts at finding out the impact of the recent financial crisis on the banking and financial services sector of Mauritius. For this the impact on important financial parameters of the banks will be analysed for the pre-crisis and post-crisis period. Further the measures required to strengthen the position of the banks to withstand any external shocks will also be discussed. The research objectives are- To show the impact of the recent financial crisis on the key elements of the financial system of Mauritius. To perform a comparative financial analysis of the domestic banks. To identify the reforms initiated by the regulatory authorities and its impact on the banking sector. To identify any changes in the asset and liabilities pattern of the banks. An evaluation of the supervisory functions with respect to the changing scenario. Identifying solutions for strengthening the banking sector so that it can remain insulated from any external shocks. 1.4 Structure of study The paper is divided into five main sections- introduction, literature review, research methodology, analysis of results & discussion and recommendation & conclusion. The introduction gives an insight into the financial crisis, its impact and a highlight of the major factors that led to the crisis. The literature review section is divided into theoretical and empirical review. The former gives a general idea about the financial crisis and emphasises into the factors that led to the crisis, its impact on the economies in various stages of development, causes etc. The empirical review refers to the various theories developed on the financial crisis and talks about the impact of the crisis on the Mauritian economy. The methodology section will make use of the secondary sources of data and finally the results will be analysed in the analysis section. The conclusion and recommendation section will summarise the various aspects covered in the paper and a recommendation will be given to strengthen the financial and banking sector to avert such crisis in the future. Chapter 2- Literature Review The exogenous factors dismantle the stability of the economy and often the impact of these events is so severe that there is a ripple effect across the globe. This leads to a crisis situation destabilising the global financial system. In recent times there have been two major crises -the Asian financial crisis that spread across all the major Asian markets and the American subprime mortgage crisis that spread as a global contagion. The reason for the former was ‘currency devaluation’ and the housing bubble caused the recent sub-prime mortgage crisis. Financial crisis has become a persistent phenomenon throughout history. Reinhart & Rogoff (2008a, 2008b, 2009) are of the view that “systemic banking crises” are the aftermath of sustained periods of booms in credit market and bubbles in the asset prices. This has been true in the case of the recent credit turmoil as well, as it primarily originated due to the price bubble in the American housing market (Allen, et al., 2009). There are various views regarding the recent financial crisis. Patterson has highlighted the role played by “quants” in the financial services sector. Etzioni (2009) states that the regulators, supervisors and policymakers were somewhat ‘captured’ by the various market experts preventing these regulatory bodies from introducing sound regulations and policies. Akerlof & Schiller (2009) also bring attention to market psychology as the complex derivative products; inadequate governance structure etc played a key role in crisis (Roberge, 2010). The global credit turmoil has brought forth issues like financial stability in front of the policymakers. The crisis has highlighted the requirement of a strengthened set of financial norms to ensure financial stability. The situation in Mauritius was a bit different as compared to other countries. All the Mauritian banks have exhibited considerable resilience in respect of growth rate in balance sheet, capital adequacy, loan delinquencies and profitability. Overall the financial system in the country has not shown any severe liquidity crunch. On an average the banks in the country maintained a CAR of 15.8 percent towards the end of 2008 against the minimum requirement of 10 percent (Bank of Mauritius, 2009). As per IMF Executive Board the policy response of the Mauritian authorities was both prompt as well as comprehensive. This included a fiscal stimulus aid of nearly 5 percent of the GDP during the period 2009 to 2010. The uncertain global outlook prompted the government to have contingent stimulus measures. Based on factors like conservative practices, robust starting balance sheets and the approach of giving relief to the firms on temporary basis have helped in keeping the financial system in good stead. The authorities of Mauritius have been appreciated for temporary and well targeted fiscal stimulus incentives besides the monetary easing offered by the authorities was well in line with the extent of the external shock (IMF, 2010). Sunil Benimadhu (2010) in his work “Global Financial Crisis and Policy Response in Mauritius: Key Lessons” has highlighted about the growing progress achieved by Mauritius over the last few decades. The global slowdown impacted some of the key economic sectors. The textile industry fell by 4 percent in 2009 after reporting a growth of 8.5 percent in 2007. This trend was similar in the case of tourism sectors which fell by 5.3 percent in 2009 after reaching a growth of 14 percent in 2007. In fact all the principal sectors in the economy witnessed a deceleration. However, Benimadhu (2010) states that the overall performance of the Mauritian economy did not cave in. The growth rate in GDP has been in the range of 3 percent to 5 percent during the crisis years of 2008 and 2009. Given the acuteness of the recent financial crisis the figures are fairly strong. Benimadhu states that resilience shown by the economy of Mauritius was not created in a day rather it has been the result of series of reforms announced by the authorities over the decades (Benimadhu, 2010). Bheenick (2010), the Governor of the Bank of Mauritius, has attributed the commendable resilience of the Mauritian banking sector to the prudent supervisory and regulatory framework. Although the growth rate in the total assets failed to match with highs of the previous year it is still a robust figure considering the appalling state of the banking sector in the other major economies. Buoyed by the efforts of the Monetary Policy Committee (MPC) the central bank of the country managed to maintain stability in the prices. Together with this the conservative attitude of the banks helped in managing the country’s foreign currency reserves. To alleviate the impact of the crisis the central banks lowered their interest rates on deposits thereby affecting their profitability but this helped in the greater good for the economy. The central bank in the country emphasised on ‘financial stability’ as it became the key agenda at all the meeting with the Governors’. The Financial Stability Unit set up three years ago helped in identifying the financial vulnerabilities so as to develop policies and tools to bring in financial stability. Thus, the Mauritian economy has been able to present a strong face, based on the flexible and prompt response of the regulatory authorities, proving its mettle against the backdrop of the world’s worst credit fiasco (Bheenick, 2010). Reference African Development Bank. OECD. (2009). African Economic Outlook 2009: Country Notes: Volumes 1 and 2. OECD Publishing. Allen, F. Babus, A. Carletti, E. (2009). Introduction. Financial Crises: Theory and Evidence. . [Accessed on March 29, 2011]. Bank of Mauritius. (2009). RELEASE OF THE SECOND ISSUE OF THE BANK OF MAURITIUS FINANCIAL STABILITY REPORT. . [Accessed on March 29, 2011]. Benimadhu, S. (2010). Global Financial Crisis and Policy Response in Mauritius: Key Lessons. . [Accessed on March 29, 2011]. Bheenick, R. (2010). Surfing the second wave of the crisis and major developments in the banking and financial landscape of Mauritius. BIS Review 150/2010. < http://www.bis.org/review/r101117c.pdf?frames=0>. [Accessed on March 29, 2011]. Commonwealth Secretariat. (2010). Recent reforms help Mauritius dodge global crisis. News.. [Accessed on March 29, 2011]. IMF. (2010). IMF Executive Board Concludes 2009 Article IV Consultation with Mauritius. News. < http://www.imf.org/external/np/sec/pn/2010/pn1013.htm>. [Accessed on March 29, 2011]. Mohamudally-Boolaky, A. Ramlall, I. (2010. The Impact of the Global Financial Crisis on the Mauritian Financial Services Sector. International Research Symposium in Service Management. . [Accessed on March 29, 2011]. Roberge, I. (2010). Explaining Canadian Resilience to the Global Financial Crisis: The Role of Policy Networks. < http://regulation.upf.edu/dublin-10-papers/2A4.pdf>. [Accessed on March 29, 2011]. Willem Te Velde, D. Cal, M. Massa, I. (2010). Supporting Investment and Private Sector Development in Times of Crisis: Strategies for Small States. London: Commonwealth Secretariat. Bibliography Bank for International Settlements. (2009). Bank for International Settlements. Basel Committee on Banking Supervision. < http://www.bis.org/publ/bcbs164.pdf>. Cecchetti, G.S. Financial system and macroeconomic resilience: revisited. Bank for International Settlements. . Gourinchas, O.P. Obstfeld, M. (2011). Stories of the Twentieth Century for the Twenty-First. University of California Regents. < http://elsa.berkeley.edu/~obstfeld/stories.pdf>. Prasad, S.E. (2010). Financial Sector Regulation and Reforms in Emerging Markets: An Overview. The Brookings Institution. . Ramlall, I. (2009). Modelling the Impact of the US Subprime Crisis onto the Mauritian Financial System Via the Stock Market Channel. International Research Journal of Finance and Economics - Issue 34 (2009). . Zafar, A. (2011). Mauritius: An Economic Success Story. World Bank. . Read More