Bangladesh Institute of Bank ManagementS e c t i o n - 2 , M i r p u r , D h a k a - 1 2 1 6

Eighteenth Nurul Matin Memorial Lecture on Ethics in Banking

(2019)

Too Connected to Fail: Politics, Public Policy and the Financial Sector

Junaid K. AhmadCountry Director

The World Bank, India

Biography of Late A. F. M. Nurul Matin

(1928-1978)

Mr. Nurul Matin was born in 1928. He joined the Research Department of the State Bank of

Pakistan in 1951 as an Officer Class I and, subsequently, his services were placed in the operational

departments of the Bank in 1963. During his long banking career, Mr. Matin occupied many senior

positions including Secretary to the Board of State Bank of Pakistan, Executive Director of Equity

Participation Fund, Managing Director and Chairman of Bangladesh Shilpa Bank and Deputy

Governor of Bangladesh Bank. He also worked as the Director of Bangladesh Institute of Bank

Management (BIBM). He was also one of the founders of BIBM.

Mr. Nurul Matin was a well-traveled person and represented Pakistan and Bangladesh in various

international conferences. He was not only acclaimed as a very efficient officer but was also

respected as a person of impeccable character. He also made significant contribution toward

rehabilitating the banking system after emergence of Bangladesh. His contribution to drafting of the

Bangladesh Bank Order 1972, Bangladesh Banks Nationalisation Order 1972 and his devoted and

dedicated work in the early '70s and thereafter for development of a sound banking system were

appreciated by the policymakers at the highest level. He died in 1978.

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Ethics in Banking

Too Connected to Fail: Politics, Public Policy and the

Financial Sector’

- Junaid K. Ahmad

Ladies and Gentlemen, Distinguished Guests, Honourable

Governor of Bangladesh Bank, Director General of BIBM,

and faculty members of BIBM:

I am very honored to deliver this year’s Nurul Matin Memorial

Lecture and grateful to Governor of Bangladesh Bank, Mr.

Fazle Kabir and Director General of Bangladesh Institute of

Bank Management, Mr. Md. Abdur Rahim for this

opportunity. But, at the same time, I recognize the deep

responsibility which comes along with your kind invitation.

Deputy Governor Md. Nurul Matin, whom we honour through

this lecture series, and Governor AKN Ahmed, who

introduced this lecture series, were nation builders. They were

the epitome of the first generation of policy makers who

moved the quest for our independence from the battle field to

building the institutions that would permanently secure our

nation. From areas like governance to banking, they were

Junaid K. Ahmad, a Bangladeshi national, is currently Country Director of the

World Bank in India. He was invited to deliver the 18th Nurul Matin Memorial

Lecture in his personal capacity. The views expressed in this paper do not

represent the official views of the World Bank, its Board, or Management.

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ethical leaders whose moral codes and values crafted the future

of a new country. To speak in their memory is a daunting

responsibility.

Many of the past speakers – Professor Nurul Islam, Professor

Muzaffer Ahmad, Professor Rehman Sobhan, and Professor

Wahiduddin Mahmud – either taught us directly or taught our

teachers. They have shaped my generation’s thinking and our

values. To speak in their footsteps is an honour and one I do

so with trepidation.

Other speakers, like Mr. Syeduzzaman, Governor

Farashuddin, and Dr. Akbar Ali Khan are friends and

colleagues of my father, Mr. Muslehuddin Ahmad. Many I

have had the privilege to call “Chacha”. To offer perspectives

and views on a topic covered by them feels like a bridge too

far to cross.

I must, therefore, in the best of our traditions first seek their

permission to share my views and, second, their indulgence,

indeed forgiveness, for any errors I may make.

I must also add, that I do not speak here today on behalf of the

World Bank and I hope my Board of Governors will also be

generous in giving me the latitude to express my personal

views. Instead, I speak as a citizen of Bangladesh, drawing on

my experience of working on international development and

public policy issues both in a multilateral context and from my

formative years in the Planning Commission of Bangladesh.

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1. What have the Past Speakers Suggested

I would do injustice to this lecture series and to the past

speakers if I did not start by reflecting on some of the messages

and insights of past presentations. In reading the previous

lectures, I came away with several conclusions which I will

elaborate on in my presentation. But, let me first summarize

some of these main messages.

Ethics, Operational Principles, and An Asymmetry

All speakers in the past accepted the importance of using ethics

as a lens to analyze the banking system. In reading their

speeches, I tried to assess whether a common definition of

ethical banking was adopted by the various speakers, or

whether the speakers converged around a set of organizational

principles to design and manage a banking or financial system

based on ethics. I did not see this consensus emerging in the

speeches. Indeed, I do not believe a consensus on how to base

banking systems on ethics exists.

Governor YV Reddy in his speech stressed that trust and

confidence are the fundamentals of a banking system.1 The

origin of the word “credit” comes from Latin “credere” which

means to trust. I would add that building trust and confidence

is a work of a lifetime but one that can be lost overnight. While

the objectives of building and sustaining trust and confidence

in a banking system may offer some important implications for

managing a banking system – and certainly strongly suggest

1 Dr. Y.V. Reddy, 12th Nurul Matin Memorial Lecture on, “Trust in Banking”.

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that the integrity and professionalism of the bankers from

officials at the central bank to the teller in a commercial bank

matters – I find it harder to draw on ethics for designing a

banking system.

But, while ethics in my opinion may not offer practical design

options for a banking system, policy makers and politicians

involved in the financial sector ignore ethics at their own peril.

This asymmetry – ethics as not having practical design

implications, but in managing a banking system you cannot

ignore ethics – is the second conclusion I draw from the past

speeches.

A few examples may help make this point clear.

Take the US elections, for example. Two very different – and

unexpected – candidates emerged in the political scene during

the 2016 elections: Donald Trump and Bernie Sanders. Both

represented very different political and economic views, but

both were buoyed by a common factor: a strong belief that

elected representatives were captured by interest groups and

that the political system was unable to hold them accountable

for their decisions. In particular, there seemed to be a feeling

that both the Republican party under George W. Bush and,

subsequently, Barack Obama and the Democratic party failed

to hold the financial sector leaders accountable for the banking

crisis of 2007. This anger against the financial sector leaders

and what was perceived as their links with elected leaders may

have ultimately played an important role in the election of

Donald Trump and the rise of the powerful challenge Bernie

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Sanders mounted within the Democratic Party. Both were

perceived – correctly or incorrectly – as outsiders capable of

breaking the insider alliance between politicians and the

financial sector.

Governor Subbarao in his speech gave the example of micro

finance and ethics.2 The Governor referred to what is often

discussed as the ethics of charging interest to poor

communities, especially self-help groups. He used the

example of Andhra Pradesh in India, but this debate has

surfaced also in Bangladesh. I will refer to the Andhra example

in more detail, but at this stage I just wanted to flag the point

that looking at the microcredit industry without a transparent

discussion about charging interest rates to poor communities,

especially poor women, can boomerang on policy makers,

MFIs, and communities in unexpected ways.

Sean Hagen, IMF’s General Counsel, in leading a discussion

on Ethics and Finance at the IMF-World Bank Annual

Meetings referred to data from a 2013 survey conducted by the

Economic Intelligence Unit of the Economist.3 The results

further confirm the difficulty of ignoring ethics and the

financial sector. When respondents around the world were

asked to rank sectors in terms of trustworthiness, the financial

2 Dr. D. Subbarao, 16th Nurul Matin Memorial Lecture on, “Ethics in the

Financial Sector, An Oxymoron?”. 3 The references to Sean Hagen, Archbishop Justin Welby, and Philip Hildebrand

come from their comments at the roundtable on Ethics and Finance held at the

IMF-World Bank Annual Meetings, 2014. The video of the roundtable is

available on IMF website.

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sector was judged to be the least trustworthy to do the right

thing. The choice was between 18 different sectors from

industry to finance. More worrisome, of the 400 financial

services executives polled across the globe, over 50 percent

felt that their own career progression would be difficult

without being flexible with respect to ethical issues.

Banking Reform: How to Think about It

All speeches moved from a discussion about ethics and the

banking system to offering ideas about reforming a weak

financial system – whether characterized by high Non-

performing Loans (NPLs) – in India and Bangladesh it is over

10 percent and growing – fraud, corruption, or bailouts. These

discussions about banking reforms can be categorized around

what I would call “different schools of thoughts” in how they

diagnose the source of the problems and therefore the potential

solutions for reforming the banking system.

Many of the speakers have focused on management issues and

the challenges of reforming corporate governance. They have

addressed the banking problem by emphasizing reforms at the

firm or at the bank level. The focus is on how the board of

director functions in a financial institution, the separation of

powers between management and the board, the technical

issues of audits and so on. I call this the “management

approach” to banking reforms.

Others lay the blame of a weak financial sector on too much

reliance on markets and the failure of markets to address

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problems of information asymmetries and externalities, hence

allowing dysfunctional financial systems to emerge. There is

an emphasis on how markets sponsor short term focus on

profits which undervalues the future and results in financial

sector managers adopting a strategy that leads to a ‘race to the

bottom’. I call this approach the “blame it on the markets”

syndrome or “market failure”.

The third school of thought focuses on public policy and weak

or incomplete regulatory mechanisms. Poor regulatory design,

weak state capability to regulate, and regulatory capture define

this school of analysis and fits well into the definition of

“government failure”.

In assessing the ability of these three schools to explain the

source of the problem of a weak banking system and therefore,

offering a structural reform path, I would suggest that the

management approach is the weakest. Perhaps, I can use the

words of the Archbishop of Canterbury, Justin Welby, to best

summarize this point of view. In response to Queen

Elizabeth’s question about the financial crisis of 2007 – ‘what

went wrong?’ – the stakeholders of the financial sector in

England wrote a long letter which talked about mispricing of

risk, lending behavior, poor management supervision, and

other technical issues mostly internal to banks and the overall

banking system. Archbishop Justin opined that these answers

were akin to suggesting that the Titanic sank because of too

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much water!4 Somewhere in the discussion the story of the

iceberg had become the elephant in the room which everyone

seemed eager to ignore!

But, the market and regulatory failure explanations also have

their weakness. Analysis of market failure generally leads to

a call for regulation. Ironically, the assessment of government

failure also creates demand for more intensive government

regulation. In both cases, there is limited discussion of

government capability to regulate markets and therefore why

imperfect markets should necessarily lead to government

intervention or why government failure would lead to call for

greater government oversight.

Too Connected to Fail: It is about Politics – Essence of the

Nurul Matin Lecture Series

Others, however, suggest that financial markets fail because of

the political relations with government that underpin these

markets. In this context, the “too big to fail” story is generally

assumed to be the connection between the political system and

the financial institutions. The 2007 financial crisis is perhaps

a proof of this linkage. In its aftermath, governments used

bailouts, guarantees, and other tools to restore financial

stability. According to Philipp Hildebrand, former head of the

Swiss central bank, as much as 20% of GDP of the G-20

economies was leveraged to stabilize the markets after the

2007 crisis.

4 Ibid.

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I would argue that the ‘too big to fail’ explanation for bailouts

and sustaining of banking dysfunctions, including NPLs, must

be complemented by a ‘too connected to fail’ narrative.

The latter emerges out of the reality that the political system

in many countries creates a stake in financial institutions

which ignores the large conflict of interest that can shape this

relationship. Ethics in banking, in my view, lies not in how

ethics shapes the design and operation of the banking system

but more in how it governs the relationship between the

political system and the financial sector.

To Put it Bluntly, the Ethics of How a Parliament Governs

will Determine Whether the Banking System is Built on

Ethical Foundations

And this is where I believe the sharp foresight of Governor

AKN Ahmed is evident. He knew as a nation builder that the

protection of the financial system would ultimately lie in the

hands of the political system. In this context, Governor AKN

Ahmed may have surmised that the political relations

underpinning the country’s banking system would need to be

discussed and reviewed constantly and, particularly, through

the prism of ethics. Not because ethics would offer the

organizational principles to build a banking system but rather

ethics would help us understand the relationship between the

political system and the financial sector. Governor AKN

Ahmed may have felt that a process of constant public

discourse and debate would be one mechanism of protecting

the financial sector. In other words, putting the spotlight on

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where it is needed through discussions and debates.

This memorial lecture in honour of Deputy Governor Nurul

Matin has now become an important part of this broader public

debate on ethics and banking that Governor AKN Ahmed

launched.

An excellent review of G. N. Bajpai’s book A Game

Changer’s Memoir on the essentials of corporate governance

in India suggests “corporate governance is a sub-set of the

country’s overall governance culture and when the super-

structure is toxic (regardless of the party in power), then faith

in the sub-set is bound to be weak.” 5 This conclusion supports

the proposition that the focus on corporate governance is only

a partial framework for assessing the underlying governance

issues facing the financial sector. Importantly, the real story

lies in the relations between financial sector and the political

context of a country.

2. Politics and Public Policy

Let me offer you some stories that I hope will convince you of

the importance of approaching the story of ethics in banking

through the prism of the relations between politics, political

economy and public policy.

Three Principles

But, first let me share with you three principles which underlie

the three stories: First, there is a personal side to the stories.

5Lokeshwarri, SK “An Insider’s Tale Sebi at Work” , The Hindu, December 16,

2018.

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We are talking about ethics and if I cannot relate it to some

aspects of my own life, I would do injustice to a discussion on

ethics which has deep links to personal aspects of who we are.

In fact, after the global financial crisis of 2007, there has been

a renewed call for holding individuals responsible for their

actions, an important part of an ethical approach to public

policy – bringing accountability to the level of the individual

and the personal. But, I recognize that talking about ethics at a

personal level in a public forum makes one very vulnerable.

But, it is a risk one must take if we are to pay respect to giants

such as Deputy Governor Nurul Matin and Governor AKN

Ahmed.

Second, I would like to explain the underlying framework of

my analysis so that all of you understand the perspective I am

taking in analyzing ethics in banking. I was trained in neo-

classical economics. I use this framework as a mean to

understand the theory and reality of public choice -- why

governments make the choices they do in setting public policy.

Perfect markets are not my paradigm; principal agent

frameworks embedded in political markets and understanding

the accountability of institutions is how I approach public

policy

Third, each of the stories I will share with you I believe has

implications to help us understand the relationship between

public policy, political economy, and the banking sector. And,

each, I hope will offer insights on how to look at ethics in

banking.

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Story-1: Is It Ethical to Charge for Water?

There are many who would argue that water should not be

priced. Indeed, the tradition in South Asia – and I see this

regularly in my work in India – has resulted in tariffs barely

recovering 20 percent of operations and maintenance costs.

Capital costs are hardly part of tariff structures. Whether this

policy stance is a result of ethical objectives or not, it would

be important to assess the consequences of such an approach.

In my work I have discovered that the most expensive water

for poor people is free water. Why? Globally, subsidies tend

to accrue to the middle class – the politically connected. In an

urban setting, water utilities often draw their incremental

revenues not from tariffs and charges but from budgetary

transfers which are under the control of the bureaucracy and

the political apparatus. The managers of utilities are more

geared to responding to the signals from above – their

paymasters – than responding to and being accountable to

customers – rich and poor. Left out of access to formal water

utilities, the poor land up paying for water from informal

vendors or middle men who tap illegally into water sources

and charge a premium to their customers. And, even more

unfairly, family members – mostly women and girls – spend

hours in lines for collecting water from common wells and

sources. This is the gender impact of free water.

At the core of this problem is the governance framework of

water utilities – indeed most services provided as public

services. There is little separation of roles between the policy

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maker, provider of services, and regulator. Without the checks

and balance which is inherent in such a system of separation

of roles, the result is a political capture of the delivery system.

On this issue of separation of roles, pricing acts as an important

bridge and mechanism of accountability. Customers who pay

and service providers who charge enter into a relationship

which is a necessary first step towards creating accountability

in a system of service delivery. By providing free services

funded through the general budget, politicians and policy

makers break this relationship between customer and provider.

Whether we discuss water, electricity, transport or other

services, price manipulation is one of the most powerful

mechanism of building political patronage often justified using

the ethical argument that services should be given free. The

promise of free water is, thus, a promise never fulfilled. No

wonder that the visionary Akthar Hameed Khan – the father of

the community delivery systems in South Asia – has talked

about the debilitating power of the promise of free services by

government.

Let me be clear that universal access to services – no one being

left behind – as the ethical outcome to be achieved is an

important policy objective. But, such an ethical stance needs

to be matched by an understanding of how to organize service

delivery to achieve the objective of universal access. Universal

access as the ethical outcome – or objectives of social justice,

as many would suggest – can be achieved in various ways to

support low income households. But, in practice such an

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objective is often used to create a pricing and regulatory

framework that places service delivery in a political economy

context where the poor are left out of the formal service net,

resulting in a service delivery system that is often

dysfunctional. The initial intervention may not have been

motivated with this outcome in mind, but if the policy process

is not protected from capture or itself based on ethical

standards, ethics as an objective in designing service provision

or the goal of social justice through universal access can be

subverted. This is an important lesson for linking ethics and

banking.

Story-2: North South University6

My father, Mr. Muslehuddin Ahmad, thought of the idea of

North South, he designed North South, and he brought

together a coalition of academics, business groups, and

professionals to establish North South as the first private

university in Bangladesh. He coined the name North South as

a past member of Chairman Willy Brandt’s North South

Dialogue and as a firm believer that the dialogue about

international development was the most important global issue

facing our generation. He personally drew the logo of NSU.

I remember that soon after his retirement from thirty-three

years of service in Government, including as Ambassador and

Secretary, he dedicated himself to making North South a

6 Ahmad, Muslehuddin (2004), The Tale of the First Private University of

Bangladesh: North South University, Academic Press and Publishers Ltd.

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reality. The respect he earned as a dedicated official with a

reputation of establishing an ethical standard in how he

managed his work was an important reason why government

officials were quick to endorse his idea for establishing a

private university. But, as a believer of parliamentary

processes and the rule of law, my father politely declined the

individual permission to establish North South and actively

lobbied for an act to be passed by parliament for opening the

role of private sector in higher education. My father even tried

to have the bill jointly sponsored by Government and

Opposition. He believed an act of parliament would ensure

that private participation in higher education would be secured

and supported as an arm of nation building and, importantly,

establish the appropriate public oversight. It was his

conviction that an act of parliament would ensure that private

universities would not be a monopoly of a few. He and a few

other like-minded individuals had a hand in establishing many

of the principles behind the bill.

My father started his efforts to establish North South in 1988;

the university opened in 1992-93; and the ethical crisis

happened in 1998, several years after he had become Vice-

Chancellor. One morning when he arrived at the university he

found the door of his office secured with a padlock; he was

locked out of his office; and to add insult to injury, he was

escorted by security guards out of the university he had built.

In a flash of a moment, my father lost at least ten years of his

life. Today, my father’s name is not mentioned as the founder

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of North South – check some of the university’s you-tube

movies and you will see what I am alluding to.

What I am sharing is at one level a personal story. True. But,

I share it because I believe it is one that raises important issues

for public policy and offers insights about ethics in banking

from the world of education. To make this connection between

the education sector and banking, I will draw partially on a

framework used to analyze the 2007 financial crisis by Philipp

Hildebrand, Black Rock Vice Chair and former head of Swiss

Central Bank.7

If we start by looking at the crisis at the firm level – i.e. at the

level of the individual organization or a university in this case

– the first question could well be whether it was a result of

management failure. Perhaps my father was a poor manager

and, as often prescribed in these circumstances, maybe he

should have invested in training to address his shortcomings.

Or, perhaps the culture of corporate governance was missing

and the Board of governors and management, their roles, and

separation of powers needed to be better implemented. May be

the training would need to be targeted more broadly at those

involved in corporate governance. This focus on the

management level and emphasis on training and reviewing the

roles of individual managers and boards has been very much

prominent in the discussions of the banking crisis. Perhaps

7 Ibid. 4

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Archbishop Welby’s Titanic analogy was even more relevant

in the situation confronted by my father.

Extending the framework offered by Hildebrand we could also

ask a more fundamental question. Did we, to begin with, adopt

a wrong management model of corporate governance or wrong

business model for private universities? Perhaps, the western

corporate governance model is not applicable in our context. I

wonder if we should have kept this as a family business? Or,

we should have investigated other forms of governance,

perhaps a society or foundation management model. Mark

Carney, Governor of Bank of England,8 speaks of the incentive

in the management model of banks that placed excessive focus

on share prices and current profits at the expense of

undervaluing the future. In many ways, the management

models may have led to what the survey of financial services

executives said were pressures to be flexible about ethical

standards. Perhaps our private university board members and

managers face similar incentives.

We could also ask whether the events would be best ascribed

to market failure? Too many private universities leading to a

race to the bottom where the markets were not appropriately

signaling the possible unethical corporate behavior and

decision making. Perhaps that is what may lead some

universities to admit students without meeting the entrance

requirements, or seeking illegal payments for admissions, or

8 Ibid. 4

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having weak audits, or allowing for huge expenses that cannot

be accounted for, or payment to individuals for just for

attending board meetings that would be difficult to justify.

But, any discussion of market failure must be followed by the

question about who is regulating the private universities?

University Grants Commission (UGC)? What is its capacity,

its legal mandate, and, ultimately, its clout to regulate? Who is

giving licenses to open new private universities and is that

process robust or is it influenced by political dimensions? And

if the latter, is the process leading to “too many” universities

and “too much competition” and hence contributing to the

“race to the bottom” better described as state failure?

Furthermore, the fact that we do not have a level playing field

between public and private universities adds complexity to the

issue of regulatory and market failure and makes it difficult to

disentangle the impact of each on the functioning of the

university sector overall.

The parallel with the banking sector is clear. The issue of the

capacity and mandate of the central bank in regulating and

supervising the banks, the nature of the independence of the

central bank, the rules that govern public and private banks,

and how markets respond to the management of individuals

banks are very similar to issues I have raised in the context of

higher education.

How did the courts respond to my father’s situation? Watching

my father navigate the legal process revealed many insights

into Bangladesh, the reality of the rule of law in our country,

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and the contradictions potentially inherent in ethics, justice,

and law. It became very clear that if basics of corporate

governance and contracts do not find protection in the legal

system, how can we expect sanctity of contracts to be

preserved in any specific sector, education or banking, and, in

this context, how can principles of ethics in the functioning of

banks be expected. The rule of law and the capacity and

independence of the legal system must work hand in hand with

the capacity and independence of the central bank to ensure

that the banking system is efficient and responds to society’s

needs.

You can see the linkages I am drawing with the banking sector.

The parallels are very evident: corporate governance issues at

the bank or organizational level; efficiency of markets and

whether there is a level playing field between public and

private banks; the strength of the regulatory framework; and

the role of public institutions including the central bank and

the legal system. But, this broader context of public policy is

set by the political class given responsibility for safeguarding

the nation. To ring fence and focus on the breakdown of

corporate governance inside any individual bank – or

university – without an understanding of how the broader

system of policy and laws set the incentives that guide the

delivery of public services would be to miss that ethics in

public services must ultimately be linked to the ethics of those

who set policies and laws.

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I must hasten to add that individual leadership failure or

fraudulent behaviour by any individual overseeing the banking

system or by any employee in a bank cannot be excused just

because the overall governance of the system is weak.

Individuals must be held to account as it sends important

signals in a system especially in a financial sector built on trust

and confidence. My point is that by focusing solely at the

individual level – no matter its importance and need – would

only address the symptom of the problem.

Hildebrand adds a final component to his framework by

introducing the notion of “societal failure” or the collective

responsibility of society. Referring to the global financial

crisis, Hildebrand points out that prior to the 2007 events he

was at social engagements where it was quite visible how

much the financial sector executives were sought after and in

effect recognized as leaders of the society. It reminded me of

dinners and weddings in Dhaka where my father was present

along with those who had created the crisis at his expense. The

events were well known – the informal word was out amongst

the elites of society – but there was absolutely no societal

sanction being applied. I would agree with Hildebrand that in

such context societal norms may set the boundaries of what

will be acceptable ethical behavior and, therefore, result in the

collective societal responsibility for breakdown in ethics. To

discuss about ethics in banking without an understanding of

the broader societal setting is to miss out the deeper story of

ethics and public policy.

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Story-3: Micro Credit

Governor Subbarao speaking in this lecture series referred to

the challenge of capping or even fixing interest rates for

microcredit borrowers. He faced an interesting dilemma –

regulating specific interest rates in an era where liberalizing

markets, prices, including the price of credit was increasingly

the policy direction of an India committed to market reforms.

Governor Subbarao hints that not enough work had been done

to understand whether the micro-credit markets were

competitive, what more could be done to increase the level of

competition to reduce the interest rates, and while recognizing

that borrowers in this segment did not have access to formal

commercial banks, the extent to which they were accessing an

alternative to the high rates offered by informal money-

lenders. In other words, there seemed to be quite a bit of scope

to improve the functioning of micro credit markets without

necessarily resorting to interest rate controls.

While the policy challenge the Governor was facing is an

interesting one, in my opinion the more relevant implication

for our discussion on ethics and banking emerges from the

story of how the situation in rural Andhra Pradesh led to the

recommendation of an interest rate cap.

The GoAP promulgated an Ordinance on October 15, 2010.

Among other provisions, it prescribed that MFIs had to

register with GoAP in each district separately and seek GoAP

approval before lending to SHG members, thus effectively

preventing them from further lending. More importantly, the

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Ordinance also prohibited MFI staff from visiting the

residence or workplace of a borrower asking for repayment of

their existing loans. This was a deathblow to MFIs in AP.

December 2010, the RBI appointed a Board sub-committee

under Mr. Malegam’s9 chairmanship and held many hearings

including in Hyderabad. The Malegam Report was quite even-

handed in the sense that it recognized the need for MFIs to

charge interest rates even high ones, but also suggested

regulatory solutions to curb the malpractices by some MFIs.

The report concluded by saying that if those changes were

made by the RBI, then there would be no need for the AP MFI

Act. The RBI also later gave significant relief in provisioning

to the AP loan portfolio of all MFIs. But the interest rate cap

was replaced with a margin cap of 10 per cent for MFIs with

loans over Rs. 100 crore and 12 per cent for those below.

Neither was viable when banks were charging MFIs upwards

of 15 per cent per annum; and so, there was need for more

advocacy with the RBI.

The MFI sector in India today is a healthy one and growing.

But, the AP incident suggests several lessons that I have tried

to capture in my presentation so far. Ignoring ethics in banking

can come back and hit policy makers in a harsh way. In AP,

9 Yezdi Hirji Malegam is an Indian chartered accountant who was the president

of Institute of Chartered Accountants of India from 1979 to 1980. He was the

chairman of National Advisory Committee on Accounting Standards. Since 27

November, 2000, he has been a board member of Reserve Bank of India. Yezdi

Hirji Malegam, 80, has a rare honour of being the longest-serving member of the

Reserve Bank of India (RBI) board.

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the process started by the decision, some would say

interference, of district collectors in the rural areas – the

bottom of the civil administration – to control the MFI sector

as they felt the need to respond to concerns of indebtedness

and suicide of farmers. In this case, ethical issues led to

directed credit – a political response. Whether motivated

initially as such, there is always a possibility that reference to

ethics may well be used as a backdoor way of controlling

financial markets and directing credit according to political

objectives. On the other hand, a constant policy focus on

ensuring a well- functioning market using the traditional tools

of information, sector liberalization, and pragmatic regulation

may achieve the results that ethical principles would suggest

we achieve without direct controls of markets and their

possible political economy implications.

3. Lessons

What, finally, are the lessons that I take away from these three

stories and the conclusions I draw from my reading of the past

lectures? I share these lessons with you not as a set of policy

recommendations for the banking sector in Bangladesh.

Rather, these are presented as a set of principles that I believe

are pertinent to the issue of ethics in banking. Whether they

apply in the context of Bangladesh and to the discussions

about banking reforms in our country, I leave it for you to

decide. Unlike many of the previous speakers in this series, I

have no special knowledge or expertise of Bangladesh’s

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financial sector and, even I felt I did, this forum would not be

the right place to engage on specific policy reforms.

Too Connected to Fail: Navigating the Links between Ethics,

Politics, and Public Policy

A context where the political economy, public policy, and the

financial sector are linked creates what I have called a “too

connected to fail” banking system. To be sure, this is not a

developing country story only. Kevin Villani reminds us that

early American banking was often unethical. “It was

characterized by lending to insiders and politically directed to

“public infrastructure” where crony corruption was pervasive,

and it led to widespread bank failure.” 10

Taking only a technocratic perspective to manage the banking

system where the political system and the financial sector are

not appropriately and sufficiently separated will not offer us a

credible platform to engage in banking reforms. Using

principles of ethics to organize the banking system may also

not be practical and, may in fact be co-opted to deepen the

connection between the political system and the financial

sector. Instead, the lens of ethics may be more usefully

leveraged to assess and evaluate the connection between

political economy, public policy, and the banking system. For

this to happen, however, we must be ready to ask the critical

questions of how ethics can be embedded into the functioning

10 Kevin, Villani (2009), Dangers of Ethical Banking, Foundation for Economic

Education, March.

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of the political system, the decision-making of politicians and

political parties, and in the case of countries like ours, the

parliament. Ensuring, for example, that the parliamentary

committee on banking and finance follows ethical principles

to protect the citizens and ensures a transparent and

competitive financial sector and a banking system is what

citizens should expect and demand from their political system.

Central Bank, Consumer Organizations, and Self-

regulation: Ensuring A Transparent System

In this context by keeping ethics central to the discussion of

how a country’s political process is functioning, policy-

makers can then focus on the mechanism to create a

competitive and transparent banking and financial sector

overall. Central to this objective is the need to have well

defined roles for the various players that influence the banking

sector.

To being with, a point stressed by academics and policy

makers world wide – the importance of ensuring a strong and

independent central bank. The ability of central banks to

supervise and oversee the banking sector and to do so with

independence is central to the growth of a healthy banking

system. Developing the framework and culture for such

independence is not automatic. It requires several components

of a good governance system, including a transparent process

for the appointment of the head of central bank, developing a

system where the head of the central bank – a very powerful

position in an independent institution -- is held accountable,

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establishing the rules that determine the interface between

parliament and the central bank governor, and other important

factors. The literature on this issue is vast and the experience

from other countries readily available. There is little that I can

add here.

But a strong central bank is only one component of the overall

regulatory framework. It offers a top down approach to

supervising the banking sector – what the regulatory literature

would call a “police patrol” method. Equally important would

be to complement it with a bottom-up approach through

consumer protection organizations capable of monitoring the

banking system – what I would call citizen’s watch or citizen’s

ombudsmen. Such a system would offer “alarm bells” that

citizens or organizations representing them can “pull” to signal

that something is wrong in the relationship between the

political system and banks. These pro-citizen groups must also

keep a watch on how courts and parliaments are addressing

bank failures to play their role effectively.

An additional level of oversight is through “self-regulation”

by the industry and for the industry itself to set up a transparent

process of upholding banking standards. Here, I would refer

again to the important point made by Hildebrand that if the

industry ignores ethical issues there may be a risk that the

public – and hence governments – will demand greater and

more intrusive regulation of the sector. Ironically, the latter

intervention may well further deepen the syndrome of “too

connected to fail.” But, bringing together the industry to agree

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on a set of common standards, taking necessary steps to abide

by these standards, and reporting the outcomes regularly to the

public is not an easy process. To protect the private

universities, my father created EQAF – Education Quality

Assurance Foundation – by bringing together several top

universities in Bangladesh to develop a self-regulatory

process. He invited NEASC (New England Association of

Schools and Colleges) – as an independent third party –to help

the private universities develop a benchmark against which

they could measure their own performances over time.

NEASC provided capacity support to the group to engage in

such an exercise. The objective was to create a ‘race to the top’

and assure the public of the commitment that the universities

were making to preserve the quality of education. It was also

aimed at protecting the universities from political interference

by creating a standard, abiding by it, and reporting regularly

and transparently to the public on how well the universities

were achieving their self-stated goals. EQAF needed the

universities to own and invest in the process of self-regulation;

having started the process under my father’s leadership, after

his death the process of self-regulation did not persist.

Ultimately – and this is a point that is increasingly being

articulated by global leaders from the financial sector – a

system that relies excessively on a top down regulatory

architecture, is essentially “bankrupt.” The voice of consumers

and self-regulation – which is a signal that financial leaders are

accepting their responsibility to be, borrowing Governor

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Carney’s words, “custodians of their institutions” – as a

complement to the traditional state regulation is more akin to

a system that is ethically robust.

Overburdening the Banking Sector

Public policy is expected to address many important issues

facing citizens. These include creating jobs - small and

medium enterprises are expected to play a major role in this

effort; protecting our environment and managing the

challenges of climate change; and ensuring universal access to

services including financial services. These objectives are not

only important from an economic perspective but in many

cases the “right thing to do” from a social indeed an ethical

perspective. The challenge for policy makers is to find the

right set of policy instruments to achieve these objectives.

Often the approach is to achieve these policy goals through the

financial sector and overburdening the banking sector with

what in effect can become directed credit. A preferable

approach would be to ensure a transparent and well-

functioning banking sector to play its role of intermediation in

finance. Social and ethical objectives should in turn be debated

and acted upon by parliament and the government through its

budget allocation. This would link public policy transparently

to fiscal policies, creating a separation between fiscal

objectives and financial systems.

In this context, as Kevin Villani correctly points out, socially-

progressive investment funds and non-bank lenders are a more

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efficient and transparent way of addressing the important

ethical goals embedded in various public objectives. Leaving

BRAC bank to competitively grow in its field of comparative

advantage – small and medium enterprises – while using PKSF

as a wholesaler to support MFIs is an excellent example of this

separation. Interestingly, competition may well lead other

banks such as HDFC to expand and enter the small and

medium enterprise sector.

Corporate Governance

In this broader context that I have described -- of placing ethics

more in the domain of the political process, ensuring and

clarifying the roles of the various players in the financial

sector, and keeping the development goals of the banking

sector simple and transparent – corporate governance plays an

important role. In many parts of the world, the financial crisis

of 2007 has placed greater focus on what goes on “inside the

banks” at the level of boards, management, and staff. For

example, we are seeing a shift to compensation linked to

specific types of performances and payment – e.g. more

through stocks – to shift the management focus to the long run

rather than the immediate returns. Others have instituted

mechanisms to claw-back and cancel bonuses. Almost

everywhere, there is greater emphasis on accountability at the

individual level – whether in management or at the level of

board members – through various mechanisms including

direct personal liability and legal measures.

30

Importantly, as Hildebrand reminded us, Basel-1 may have

triggered a decoupling between the level of risk that financial

institution could take and the amount of capital that was kept

aside as security. There is now greater emphasis at the

individual bank level to ensure that risk taking is

commensurate with the level of capital put aside to cushion

any negative fall-out. Interestingly, in this context of

emphasizing management responsibility, Islamic banking

deserves an important mention. In Islamic banking it is

expected that lending in economic activities is, in effect,

through the principle of equity participation and sharing of

profits and losses. In addition, in Islamic banking, charging

interest is seen as unethical. Dr. Akbar Ali was perhaps the

only speaker in the past to have seriously looked at the Islamic

banking in the context of ethics in banking. Surprisingly,

others have not, and I place myself squarely in this group.

Bangladesh Institute of Bank Management (BIBM):

Training, Dialogues, and Voice of Citizens

What is the role of BIBM in this broader debate about ethics

in Banking? If my assumption that Governor AKN Ahmed

introduced this lecture series as a specific mechanism to have

all of us debate on the role of politics and finance and their

implications for how to protect the banking system from

becoming politicized, then BIBM has several roles to play.

First, in the arena of training, which BIBM is already

effectively undertaking, the organization’s focus on corporate

governance is of great import. BIBM offers the appropriate

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setting to take forward training for corporate executives and

banking boards around corporate governance.

But, training by itself would not suffice for addressing the

challenges around ethics in banking and banking reform more

generally. Rather, and this is my second point, BIBM would

need to invest in proactive dialogues focusing on

parliamentarians, policy makers, bank executives and board

members, and representatives of civil society. Some of these

dialogues should be within peer groups and in other cases, the

dialogues will need to be across peer groups. The outcomes of

these dialogues could be shared with the public, but some may

have to follow the Chatam House rules.

Proactively keeping the public informed and hence involved

in public policy would be an essential role BIBM could play.

Training for the public on financial sector issues and public

outreach and campaigns to inform the citizens are essential

mechanisms of outreach. Similarly, using its network of

connections with think tanks and universities and engaging in

developing the knowledge base around banking and public

policy which could inform public debate and curriculum of

schools and universities is another approach. Ultimately, a

well-informed public is critical for creating a broader social

compact around public policy. The banking sector is not an

exception to this rule.

Let me add that there is a difference between setting up

training programs and engaging in a process of stimulating

policy dialogues across stake holders. The latter requires a

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different and dedicated set of skills and professionals distinct

from those involved in training programs. Indeed, it requires a

carefully thought strategy and tactics to influence policy

making.

Conclusion

Linking ethics to governance of nations and embedding it in

the formulation of public policy will secure a banking system

that supports such an ethical development path. But to achieve

this outcome, while ethics can inform broad principles, the

operational design of the banking system would need to be

designed from a careful mix of regulation, market competition,

informed citizens, and voices that represent consumer rights.

The invitation is to keep the structure of the banking system

simple and transparent and focused on the goals of linking

savers and borrowers and of transforming maturity. Let the

debate and decisions about ethics in development be placed on

the shoulders of our parliament and their political decision

making. Hiding it behind financial price manipulation rather

than transparently through budgetary and fiscal decisions will

be a sure path towards “a too-connected to fail” banking

system.

I hope that Deputy Governor Nurul Matin would have given

me his endorsement for this perspective.

Biography of Dr. Junaid K. Ahmad

Dr. Junaid K. Ahmad, a Bangladeshi national, is

currently the World Bank Country Director for

India. Prior to this assignment, he was the Chief

of Staff, Office of the President.

Dr. Ahmad joined the Bank as a Young

Professional in 1991, working as an Economist

in Africa and Eastern Europe before joining the

Africa Infrastructure Unit. Mr. Ahmad spent 10

years in the field, first as the Deputy Resident

Representative and Principal Economist in Johannesburg, and then as Regional Team Leader of the

Water and Sanitation Program in New Delhi. In 2004, he was a team member of the World

Development Report (WDR): Making Services Work for Poor People. From 2004-2008, he was the

Sector Manager for Social Development in South Asia Region and subsequently for Urban, Water

& Sanitation before taking on the latter responsibility for the Africa Region in 2010. He was also the

Director for Sustainable Development in the Middle East and North Africa Region, a position he

held from 2012-2014.

He holds a PhD in Applied Economics from Stanford University, an MPA from Harvard University,

and a BA in Economics from Brown University.

Bangladesh Institute of Bank ManagementS e c t i o n - 2 , M i r p u r , D h a k a - 1 2 1 6