A banking disaster averted but was a lesson learned

On November 10, 2006, Nepal witnessed the first-ever run on deposits. Following the media reports of the shaky financial situation of Nepal Bangladesh (NB) Bank, anxious depositors rushed to its branches to withdraw their money. Long lines formed. I had seen photographs of such events in history books. With advances in central bank oversight and deposit insurance systems (explicit or implicit), such an arcane thing is not supposed to happen in modern banking. But, here it was, live, right in front of my eyes! Fortunately, by the next business day, Nepal Rastra Bank (NRB), the central bank of Nepal, had intervened and the panic did not spread.

All organizations, including governments and central banks, make mistakes and face crises. Those things just happen from time to time. Even the most competent organizations cannot avoid all mistakes. They certainly cannot prevent or even anticipate all external shocks. Good leaders and managers know that. The key is to respond to them effectively. So, the run on deposit did happen in Nepal. Did NRB respond effectively? It did take over management of the NB Bank rapidly and assured the depositors that their money was safe. The run on deposits stopped. A major banking disaster was prevented. NRB deserves a big pat on its back. Or does it?

I say it deserves half a pat at this point. Why only half? Because the response has not been complete. When a crisis strikes an organization, it must do two things. First, it must deal with the immediate problem. Second, it must learn from the experience so that perhaps the crisis can be prevented next time, and even if it cannot be prevented, its impact can be minimized. NRB has done the first part well, but it has not done the second.

From those who are knowledgeable about the banking sector, I have heard many troubling things about the NB Bank episode. They may not be all accurate, but they do not seem groundless, either.
For instance, I have heard that an NRB official who had responsibilities to regulate or supervise the NB Bank had a close relative working at one of the NB Group banks (the NB Group owns NB Bank, NCC Bank, and two finance companies). There were speculations that this has led to some leniency in the way the NB Bank was treated.

The NRB Act of 2002 prohibits NRB officials from taking a job with a financial institution under NRB supervision within one year of retirement. Yet, I have heard one senior retiree was immediately hired by the NB Bank as an advisor. Perhaps an adviser is exempted from the rules, but I would think a paid job would be at least against the spirit of the rules. It naturally raises suspicions that the NB Bank may have received some regulatory forbearance in return for a promise of a job later.

The most troubling is the report that some Board members may have close kinship or social ties with some of the promoters of the NB Bank (as well as others) or major bank defaulters. If this is true, it seems highly problematic, for their decisions as the Board members may be influenced by their personal interests. In fact, I have heard that some Board members had often questioned tough actions against the NB Group or big defaulters. Because of the custom of seeking consensus at the NRB Board, they de facto have a veto power.

None of these things may be true. Even if they are true, it is possible that the NRB officials and the BRB Board members concerned are so honest and capable of separating their personal interests and their public responsibilities that it did not make any difference in the conduct of their official duties. Maybe. But, central banks around the world set up stringent rules to avoid putting their officials in such a position of conflict of interest in the first place. It removes any temptation to be swayed by personal interests. It also eliminates any public suspicion that their decisions may be tainted. It is just a sensible thing to do.

I know that the banking specialists at IMF and the World Bank had been aware of the serious problems at the NB Group, including the NB Bank, for a few years. They recommended strong actions to prevent just the kind of crisis that finally happened recently. Many officials inside NRB agreed and they proposed appropriate measures to force the NB Bank to comply with sound banking practices. Yet, for some reason, such actions were not taken. This is why I cannot dismiss lightly the many stories of conflicts of interest. I am not suggesting that any particular individuals were at fault, though some may have been. More important is the overall pattern. It seems quite conceivable that the web of personal interests blunted the ability of NRB to respond to the growing signs of financial and managerial problems at the NB Bank with the sharpness and alacrity the situation demanded. Maybe the reasons for slow reaction were different. But, if many technical experts at NRB knew about the problem at the NB Bank and yet as a system NRB failed to take appropriate actions, does that not suggest there were some serious flaws in the process? In all likelihood, the NB Bank crisis was preventable. That is why I think NRB should now focus on learning from this experience, so that another crisis will not happen so easily.Of course the review of the NB Bank crisis must be done by an independent team of experts from outside. No doubt NRB itself has competent professionals who can conduct such a review; however, let us remember that avoiding conflict of interest is a critical first step in making a process like this truly professional. And, NRB should not wait. I hear there may be other banks in similar problems. Mistakes do happen at any organization. Allowing the same mistake to happen twice without any reform, however, is not a hallmark of a good organization.

I should note that one part of the oversight system did work well: the media. Some journalists understood the seriousness of the problems brewing at the NB Bank. Their report forced much needed regulatory action by NRB. What the IMF and the World Bank together could not do, they did it with their informative reporting. This is why free and responsible media is so critical to the functioning of market systems. Hats off to those journalists!

(Ken Ohashi is the World Bank Country Director for Nepal. This article is picked from Nepalbiznews.com.)