Bank Failures: Will the BoT’s Intervention on Insider Transactions Help?

New regulations comes with three main objectives first to promote and maintain public confidence in banks and financial institutions and establish standards for corporate governance processes and structures as well as providing guidance to directors for the proper discharge of their fiduciary responsibilities. 
Emmanuel K. Mwesiga7 December 20217 min

On October 29, 2021, the Bank of Tanzania (BOT) released The Banking and Financial Institutions (Corporate Governance) Regulations, 2021. These regulations were made with three main objectives: promote and maintain public confidence in banks and financial institutions; establish standards for corporate governance processes and structures; and guide directors for the proper discharge of their fiduciary responsibilities. 

While some have praised the move, others were and still are disenchanted by a sudden move from the Bank of Tanzania (BoT). Our friends in question were miffed by the fact that the Bank encroaches on business arrangements where people are free to transact and honor their contractual obligations.

Well, it dates back to the 2007-8’s financial crises where many financial institutions suffered severely from their bad Corporate Governance practices. Studies show several banks and financial institutions’ failures and bankruptcies were attributed to predatory lending, insider transactions, and other unregulated practices by the executives and managers. 

These practices in turn enriched the executives massively at the expense of shareholders by approving loans that turned out to be bad or non-performing loans simply because most of them were benefiting from commissions and “kickbacks.” This was a reason behind the collapse of Integrity Bank USA and many others from the UK, Germany, Canada, and Zimbabwe.

Addressing Non-Performing Loans (NPLs)

Years after the said global financial crisis in 2007/8, it is presumed, though might not be the case, that BoT detected that a similar situation was going or is likely to happen in Tanzania if not immediately intervened. 

One area that the new regulation was going to tackle is on curbing non-performing loans (NPLs). On November 7, 2021, Tanzania’s central bank issued a statement on measures to address NPLs which specifically targeted insiders, that is, the employees. 

It is reported that in March 2020 NPLs stood at 9.36 percent of total loans, nearly twice the recommended threshold of 5 percent. And the proportion of bad loans stood at 10.50 percent, according to the Ministry of Finance.

By definition, a non-performing loan is a loan in which the borrower has failed to repay the principal amount of monies borrowed and its interest as agreed with a bank or a financial institution for a specified period. Non-performing loans occur when borrowers run out of money to make repayments or get into situations that make it difficult for them to continue making repayments towards the loan.

According to BoT’s investigations, NPLs are caused by employees of some banks and financial institutions directly engaging in issuing or taking loans without following procedures, but also fraud, corruption and other practices that are “tantamount to lack of integrity” attributed massively to NPLs. 

In Tanzania, bad loans and ghost borrowers have hugely contributed to instability in the financial sectors for the past five years or so which is why several banks and financial institutions found themselves financially unstable and failed to meet capital adequacy requirements as specified by the Bot, a problem known as “undercapitalization.”

Minimum core capital for banks

Tanzanian laws have provided for a minimum core capital which banking and financial institutions have to meet. The minimum core capital for Fully-fledged Banks like commercial banks and cooperative banks (with a nationwide network) is Sh15 billion. 

For limited scope banks like Microfinance Banks, the capital is Sh5 billion. Community Banks: Sh2 billion and Cooperative Banks (Regional) Sh5 billion For Specialized Institutions like Development Finance Institutions the minimum core capital is Sh50 billion, Finance Lease Companies, Sh1 billion, Housing Finance Companies, Sh15 billion, Tanzania Mortgage Refinance Company (TMRC) Sh6 billion, Merchant Banks Sh25 billion, and Islamic Banks Sh15 billion.

According to reports, some banks and financial institutions were closed because they could not meet the stated threshold. For example, in 2018, BoT revoked licenses of Covenant Bank, Efatha Bank, Njombe Community Bank, Kagera Farmers’ Cooperative Bank, and Meru Community Bank on account of their undercapitalization.

However, closing down of banks and revocation of licenses was not the only measure taken to address the problem of undercapitalization. Corporate Mergers and Takeovers were taken as recourse in the year 2016 to help banks and financial institutions boost their financial capacity. 

For instance, Twiga Bancorp Limited was put under Statutory Management of the Bank of Tanzania with effect from October 28, 2016, same as Tanzania Women Bank following their undercapitalization status. The two banks with the addition of TIB Corporate Ltd were forced to merge with TPB Bank Plc. in 2020. This made TPB Bank’s assets base rise by 48 percent to the tune of Sh1 trillion, exceeding the minimum capital adequacy required.

Apart from the state-run institutions above, some private banks and financial institutions did the same thing to avoid being axed out of the market by the regulator. Many analysts, translate the new regulation as the Central Bank move to avoid closure and unending mergers and takeovers

Corporate governance deficiencies 

Experts in the banking industry agree that most bank failures are caused by corporate governance deficiencies, hence the need for sound corporate governance rules is not far-fetched. As a way of micro-prudential supervision, BoT issued these regulations. 

The regulations define “corporate governance” as a set of relationships between a company’s management, its Board, its shareholders, and other stakeholders, which provide the structure through which the objectives of the company are set, and the means of attaining those objectives among other things.

Generally, the regulations, among others, seek to monitor boards of directors of banks and financial institutions by providing for their qualifications and office tenures. 

Furthermore, issues like conflicts of interests are put into check. Also, members of the National Assembly or House of Representatives or councilors of the local government authority are restricted to being appointed as a director of banks or financial institutions.

According to these regulations, the Board of Directors is obliged to establish, implement and regularly review policies that guide transactions with insiders and their related parties and ensure that such transactions are conducted on arm’s length terms, thus on terms not more favorable than would be available to other customers. Also, ensure corporate or business resources of the bank or financial institution are not misappropriated or misapplied.

Historically, insider transactions and “corporate incest” have led to many bank failures and a good example was the failure of Renaissance Merchant Bank Limited in Zimbabwe in 2011. It is reported that this bank failed due to NPLs insider loans and related party exposure. One was the $9.8 million loan to its former CEO only. The CEO borrowed to finance personal businesses. The failure of this bank was caused by insolvent with a negative capital of $16.7 million.

One might argue that some of these cases informed the writing of the BoT regulation above as it strictly prohibits a bank or financial institution to directly or indirectly grant any credit accommodation to an insider unless the credit accommodation is approved by all members of the Board. And where a bank or financial institution grants a credit accommodation to an insider above, it has to notify the BoT within seven days from the date it grants the credit accommodation.

The regulation further provides that the total amount of credit accommodation which any bank or financial institution may grant, directly or indirectly, to an insider shall not exceed ten percent of the core capital of the bank or financial institution. These limits apply regardless of the type and value of the security held.

Regarding loans to employees, a bank or financial institution is restricted to grant salary advances to any of its officers or employees which exceed the annual remuneration of the borrowing officer or employee. However, the “annual remuneration” of an officer or employee means the basic salary plus fixed allowances paid in cash to the officer or employee on a regular and periodic basis as part of his compensation for services rendered to the bank or financial institution. 

And, in case of commercial loans and advances to officers and employees of a bank or financial institution they have to be in the regular course of business and on terms not more favorable than would be available to other borrowers.

Will this rescue banks from failures?

Technically, it is too early to answer that question given the circumstances that measures in place were suggested as a pre-crisis recourse after 2008/9. 

Though there is a huge need to keep constant monitoring of these banks and financial institutions to protect the economy, depositors, and shareholders from the aftermath of corporate mismanagement i.e. bank run and credit crunch. 

It is argued that the regulation is too strict to some extent as it restricts the rules of freedom of contract flexibility envisaged in laissez-faire economics.

Emmanuel is experienced in commercial and corporate law transactions and advisory. He can be reached through e.mwesiga@yahoo.com or follow him on Twitter at @EsquireMK. These are the writer’s own opinions and do not necessarily reflect the viewpoints of The Chanzo Initiative. Want to publish in this space? Contact our editors at editor@thechanzo.com for further inquiries.

  

 

 

 

Emmanuel K. Mwesiga

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