BANK DISTRESS IN GAMBIA
The Gambia currently has four commercial banks and one Islamic bank with the former having branches in the rural areas. In addition to these banks, a number of non-bank financial institutions (NBFI) were established. The bulk of their operations are concentrated in the rural areas. The emergence and quick expansion of the NBFI made it prudent for the government to initiate a policy that would ensure that they are properly registered under savings and credit associations as finance companies.
The small size of the economy (population 1.2 million) and its activities means that there are a number of constraints against financial innovation and the creation of secondary money markets. In general, the financial system of the Gambia has evolved gradually within the last decades. Despite this slow pace, the economic policy practices have moved ahead of the law due to the liberalization of the financial and the exchange systems, where interest rates are freely determined. Direct controls that existed in the early 1980s have been repealed and the authorities have introduced an indirect system of monetary controls. Past events such as bank distress in the industry also made a compelling case for a reform of the laws. The financial Institution Act (FIA) 1992 and the Central Bank of Gambia (CBG) Act 1992 were promulgated, replacing the FIA 1974 and CBG Act 1971.
ISSUES IN BANKING SUPERVISION
The banking Supervision Department (BSD) which is supervisory arm of the Central Bank of Gambia was created in 1976 to concentrate on the regulation and supervision of financial institutions in line with the provisions of the Financial Institutions Act 1974. The act replaced the CBG Act 1971 and the Currency Act as the sources of authority for the supervision of banks. To ensure compliance, existing banks were instructed to apply for a license to operate under the new Act. The granting of the license became predicted on the acceptance by each bank to comply with the provision of the FIA 1974. The 1980s saw the emergence of four distressed banks, three of which went through liquidation. The privatization of the fourth bank in 1991 was adequate reminder that tougher laws were required and stringent supervision tools were necessary to combat the reoccurrence of failed banks. By the late eighties, the BDS had already begun the process of strengthening the staff both by number and qualification in relevant fields to enhance professionalism in the department’s work.
The department has metamorphosed from its humble beginnings in the middle of the seventies into a highly computerized and sophisticated surveillance unit. In the process, it fashioned a mission statement that put emphasis on regulation to ensure the maintenance of public confidence in the safety and soundness of the financial system. It expects to achieve this through the setting up of a supervisory framework that seeks to ensure each institution’s ability to meet all obligations as they fall due.
Following the liberalization of The Gambian financial and exchange system in the late 1980s, as well as the shift by the authorities to an indirect system of monetary control, it became apparent that some fundamental changes were required in the law to improve both the prudential and supervisory standards in the banking industry. This led to the promulgation of the new FIA 1992 and CBG Act 1992 which replaced the old ones.
The new standards set by the laws require financial institutions to conduct their activities in a safe and prudent manner. The CBG was further granted autonomy in most of its dealing with commercial banks. This has enabled it to prescribe new reporting guidelines for banks as well as establish a framework for the licensing of banks.
Three supervisory documents apart from the new FIA 1992 and CBG Act 1992 were introduced between 1992 and 1995, namely, the BSD Manual of Guidelines and Instructions in 1993; the Guidelines for Licensing of Banks in The Gambia in 1994; and the Guidelines for Branch Expansion by Banks in The Gambia in 1995.
FINANCIAL INSTITUTION ACT, 1992
The FIA 1992 is the main regulatory document for banks in the Gambia. It prescribes among other things, the procedure for the licensing of commercial and Islamic banks, the supervisory role of the CBG and the requirements for banks’ management in safeguarding depositors’ funds.
In the area of licensing, the law is further elaborated in a document called the Guidelines for Licensing of Banks. Unlike the old FIA 1974 where banks could be incorporated prior to the seeking of approval from the CBG, it is now mandatory that applicants must get CBG’s consent prior to incorporation. The CBG may in its discretion, allow for incorporation and issue a license authorizing the financial institutions to carry on the business of banking. Other criteria that the CBG takes into consideration are the competence of the management team (fit and proper persons’ test), a comprehensive feasibility study and whether the structure of the share ownership does not violate section 8 of the FIA 1992.
This section prevents any person or associated persons from controlling more than 10% of the total votes that could be cast on any resolution of the financial institution without the prior consent of the CBG. A distinct set of requirements also exist for the opening of new branches by financial institutions. Under the provisions of the Guidelines for Branch Expansion, a bank may open new branches only if it has been making profits over the years. Furthermore, its capital ratio must be adequate. Experience has shown that some banks had in the past attempted to use depositors’ funds to expand and this led to liquidity problems.
The emphasis in the old law regarding capital adequacy was the maintenance of minimum capital requirement based on the greater of D250,000 and 5% of the average liabilities to the public. There was no rationale for this approach as it failed to capture the risks inherent in the different asset components of the balance sheets of banks. Subsequently, the CBG adjusted its requirements to properly reflect the Bank for International Settlements (BIS) guidelines on capital adequacy, taking into consideration the need to adapt it to the local banking industry.
The minium capital requirement was dropped from the FIA 1992 and replaced by the new requirement that all banks must maintain their unimpaired capital at or above 8% of their total assets. A major weakness of this method is its failure to recognize the fact that some assets are riskier than others and as a result, the capital ratio must reflect such risk. The BSD is currently reviewing the requirements with a view to adopting the risk weighted method of capital adequacy computation.
MANUAL OF GUIDLES AND INSTRUCTIONS
This document complements the FIA 1992. It provides a detailed interpretation of the provisions of the law. The manual was launched in December, 1993 and it is divided into two main parts. The first part which contains the guidelines delineates the accounting and other standards while the second part contains information on how to complete statutory returns for subsequent delivery to the CBG. Data collected from these returns provide the BSD with adequate information for quarterly analysis of each ban. The quarterly analysis is a sophisticated off-site examination system which was computerized in 1994 and enables the use of ratios and calculation of yields or returns on earning assets automatically. CBG management always consider findings from such analysis seriously and take action when necessary.
The policy tools in place as part of the indirect system of monetary control (following the liberalization of the financial and exchange systems) have brought about a stable banking system in the country. The following are among the key supervisory tools.
Just as was the case in the old regime, banks in the Gambia are required to maintain reserves of which 80% must be kept with the CBG, while the remaining 20% is held as cash in hand. A financial penalty (civil money) is levied against a bank on any day it defaults against these requirements.
Liquid Assets Ratio
Banks are also required to maintain 30% of their liabilities to the public as liquid assets. This also attracts a financial penalty (civil money) any day a deficiency occurs. Both the required reserves and the liquid assets ratios are early warning signals that often alert the monetary authorities on the financial viability of the supervised banks.
Loans and Advances
Although the cases of bank distress in The Gambia were induced by a number of factors, weak management and poor loan schemes have emerged as the most crucial factors. Without doubt, loans and advances are the most risky assets in a bank’s balance sheet.
To redress the situation, new disclosure requirements were instituted against all banks in the BSD manual. In addition to the implementation of effective loan policies, banks must now comply with the standards set in the manual of guidelines and instruction particularly in the following areas:
Interest income on non-performing loans must be suspended and can only be recognized in the income statement on cash basis, when payments are made by customers, by a third party or through disposal of security.
Provisions for non-performing loans must be made as follows:-
Newly classified loans 20 per cent
Aged 6 months 50 per cent
Aged 6 months to one year 100 per cent
General provision 1 per cent
The classification of nonperforming loans comes under scrutiny in each on-site examination and banks are required to constantly update such information. These and other details related to non-performing loans are supplied to the CBG on a monthly and quarterly basis. They have has enhanced the off-site analysis greatly.
The law also provides heavy credit concentration (vide section 17 of the FIA 1992). As a result, banks cannot lend in aggregate to one person or associated persons beyond 20 per cent of their unimpaired capital. Furthermore, there was an average capital adequacy ratio of 8.1 per cent in the banking industry as a December, 1996. This ratio is equivalent to 15.45 per cent if one goes by the risk weighted method.
III BANK DISTRESS IN THE GAMBIA
The FIA 1992 came at a time when the industry had witnessed the experience of four distressed banks, which subsequently let to either their closure or privatization.
Most of the provisions of the FIA 1992 were aimed at strengthening the BSD in its regulation of the banks and mandated the CBG to act swiftly when banks started to exhibit signs of distress. A bank is considered to be in distress when its capital is either impaired, when it has recurring liquidity problems and/ or losses, or when its management is weak and this has affected its optimal use of resources leading to any one of the above conditions. Although the term “bank distress” was not in common usage, several banks have exhibited the signs listed above to warrant its use.
The first distressed bank in The Gambia was the General Merchant Financial institution (GMFI) which was foreign owned. This bank started to operate in 1980 but eventually closed two years later in 1982. It faced considerable organizational problems at the very beginning and was unable to attract substantial deposits from the public to gainfully engage in banking business. During its existence, it failed to send returns to the CBG for a long period of time. to ensure that the banking industry was not compromised by this non-compliance, coupled with the need to ascertain from the records the bank’s actual operation, it was seized by the CBG in 1982. Liquidation proceedings were instituted against it when its banking activities were found to be unsatisfactory.
The international bank of West Africa, otherwise known as BIAO, a Senegalese branch, opened its doors to the public in 1982 to capitalize on the new opportunities in The Gambia and Senegal in what was to be the ill-fated Senegambia Confederation of 1981. The bank became entangled in feasibility nightmares in the trade discussions which fizzled out due to disagreements between two countries. Its operations in the Gambia lasted for less than one year before it voluntarily closed down.
The Agricultural Development Bank (ADB) was government-owned and was established to provide credit to small-scale farmers in the country. it experienced managerial and loan recovery problems and this greatly affected its viability. Consequently, the bank was initially under a “cease and desist” order for a year. However, when the order was discontinued and the bank was allowed to operate on its own, it soon ran into problems again and was seized in 1985. Government decided to close down the bank and appointed the CBG to manage the liquidation process in 1986.
By 1990, the Gambia Commercial and Development Banks (GCDB) was in distress. This bank was created by an Act of Parliament in 1972 “… in order to fulfill a pressing need in the country, for an institution which will provide both agricultural credit and development finance and at the same time promote Gambian entrepreneurship by giving the Gambian nationals appropriate access to the much needed bank credit”. By 1991, the bank was considered insolvent and was sold in a privatization scheme. GCDB’s problems had all the hallmarks of a classic bank failure. It grew very rapidly within a decade of operations by expanding its branch network in the country. By 1980, it had more branches than the other two long-standing banks. Its strategy was to mobilise savings country-wide and this was rewarded when it increased its share of the deposit market to 55.1% within four years of operations.
However, by the middle of the eighties, its capital was impaired; it had negative reserves that eroded capital more than 40%. Its loans and advances were several times more than its total deposits. This phenomenon came about by large borrowing from the CBG over extended periods of time. Collection of loans generally proved difficult amidst increasing operational costs and this led to serious liquidity problems. These factors compelled the government to restructure the bank in the late 1980s.
During this period, the management of the bank frequently failed to comply with supervisory directives. Returns were sent to the CBG several months after their prescribed submission date. Furthermore, the management of the bank did not possess the vital experience required to manage an ever increasing bank operation. Its investment in fixed assets were too high in relation to its capital. Lack of adequate and trained staff arose and complicated matters for the branch net-work.
In summary, GCDB’S distress can be attributed to the following conditions existing in the bank:
Weak internal controls
Management failed to satisfactorily perform this vital function of its responsibilities. Record keeping was poor. Staff were largely not qualified, had very little banking experience, hardly any on-the-job training, and no formal structured local training existed to develop staff potential.
Inadequate lending policies
The bank had a credit committee but its attention was mainly misdirected. Insider credit was very high signifying non-optimal use of funds.
Inadequate capital to sustain branch expansion and reserves to absorb losses
The bank lacked experienced and proactive management team to ensure adaptability particularly in the distress period, hence it failed to downsize bank’s operations, cut costs and establish a scheme of cost control; and focus on the bank’s strength and eliminate or minimize its weaknesses.
Inadequate accounting policies
Low levels of reserves were maintained for non-performing loans.
External factors that existed during the GCDB distress period were:
The establishment of the bank by an Act of Parliament somehow gave it a perceived special status. The government had on occasions sought funds from the bank for project financing. This placed the supervisory authorities in a precarious situation particularly, when the bank failed to restrict lending in line with the credit ceiling directive that was in place. The bank achieved its credit expansion scheme through manipulations of this situation.
The political connection proved fatal to the bank’s strategy of opening branches very rapidly in line with the terms/conditions of its establishment. Although it was competitively positioned to market its products, it attempted to do this with limited capital funds.
Limitation of examinations
The BSD conducted on-site examinations of the GCDB once every three years during its existence. Most of the criticisms directed at the bank were valid ones, but did not result in any meaningful redress of the situation. Off-site examination, on the other hand, had not developed into a system of surveillance as a monitoring tool that would detect serious problems in the future operations of the bank.
Insufficient material for reference purposes
The BSD had few materials to assist in the work required. Up to 1988, the main CBG library primarily meant for the Economic Research Department was devoid of any meaningful reference materials for banking supervision purposes. Most of the new developments in the supervision field, therefore, were unknown to the department.
Within a decade, from 1981 to 1991, the supervisory authorities witnessed three bank distresses. Most of the problems that affected these banks arose in the 1980s. They exhibited an inability to adapt to the financial and economic realities and the strategies each embarked upon subsequently created bottlenecks in their operations. However, depositors’ funds during closures of the BIAO and ADB were fully paid and in the case of the GCDB they were successfully transferred to the new bank that took over its operations. Depositors of the GMFI, on the other hand, were paid pro-rata from proceeds of the sale of assets. The supervisory process in the early 1980s was limited but in the later years, it has begun to remodel itself to suit the changing and exact focus of the supervisory concerns.
The early part of the 1990s saw the reform of the legislation governing banking and the new FIA 1992 brought in new tools of regulations, the test of “fit and proper persons”, and saw the CBG use its authority to develop frameworks within which the banking industry is expected to operate, to ensure a sound banking system.
The development of the framework of guidelines and instructions in 1993 has enabled the BSD to have a greater insight into the operations of each bank. New supervisory techniques demand accurate determination of the condition of each bank and communication is frequently used as a tool in directing each bank’s attention to supervisory concerns requiring redress.
Nowadays, the senior management of the CBG frequently demand information on the supervision of banks placed under closer scrutiny due to any distress factors, be it liquidity problems, capital inadequacy, inadequate provisions of credit losses, etc an aspect of the supervisory approach which has paid dividends is the constant communications through meetings between supervisory agents and commercial bank officials, on matters ranging from operational performance to treatment of accounting of specific transactions.
The provision of detailed data on each bank’s operation has proved useful in providing vital information to the supervisory authorities in The Gambia. This has enabled the CBG to actively pursue its regulatory and supervisory objectives. The FIA 1992 has now been in operation for nearly five years without any bank failure or any serious distress.
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