Advanced Banking Law May 2013

ADVANCED BANKING LAW – MAY 2013

SECTION A

1. Branches of banks are for some distinct purposes separate from their head offices.

(a) Explain the principle of branch separateness. (8 marks)

The principle of branch separateness is rooted in long history whereby the branches of banks had considerable autonomy from their head office. To date, customers tend to associate more with their branches, that is, where their accounts are domiciled. The managers, at the branch, wield important decision-making power on matters like lending. It is against this background that the common law relating to branch banking developed.

Common law thus treated branches as separate from the head office for some purposes even though not separately incorporated. This is called the principle of branch separateness. The basic rule became that a customer must make demand for payment of money deposited at the branch of the bank where the account is kept. This means that a countermand of payment instructions must also be made at the branch where the original order was given. The rationale of this rule was that it was the customer’s branch which had the most ready access to the true state of his or her account.

(b) Critically evaluate the relevance of the principle of branch separateness to the banking industry in Malawi. (7 marks)

This principle of the separateness of branches was accepted throughout the common law world which includes Malawi. Given the organizational and technological developments in banking, there must be a question mark over the future of this rule. Branches are now linked electronically and there seems to be no reason why payment instructions should not be effected at any branch, at least within Malawi.

On the other hand, head office is generally liable for the acts of its branches under the general company law since, as stated earlier on, branches are not separate legal entities.

A problem may arise where a bank’s branches abroad have been closed, not at their own initiative but due to civil war or acts of government expropriating their business. The general law maintains that the head office will be liable to pay the depositors. However some jurisdictions such as the USA have enacted laws that limit the liability of the head office of a bank caused by its branches abroad in the event of civil war or expropriation. This statutory protection does not extend to non-payment because of illiquidity or insolvency. One should consider whether such law would be appropriate in Malawi.

2. Green Valley Bank is facing severe low liquidity. Upland Bank is one of the creditors for Green Valley Bank and is desirous of petitioning for the winding up of the Green Valley Bank.

(a) Advise whether Uplands Bank has capacity to petition for the winding up process of a financial institution. (5 marks)

Section 29 of the Financial Services Act provides that the proceeding for (compulsory) winding up of a bank shall be commenced by the Registrar of Financial Institutions or his agent. The bank itself, may petition for voluntary liquidation, with the prior approval of the Registrar.

In comparison, under the Companies Act 1984, a larger number of persons may petition the court for compulsory winding up of a company. Thus, the company itself; any creditor of the company; a member or representative of a deceased shareholder or trustee in bankruptcy of a bankrupt member; the Attorney General and the liquidator appointed in a voluntary winding up, may all petition the court.

This clearly means that the list of persons allowed to petition the High Court for the winding up of a bank has drastically been reduced and concentrated in the hands of the Registrar of Financial Institutions, with powers to determine the terms and conditions of the winding up of a bank. Therefore Uplands bank cannot petition for the winding up of Green Valley Bank.

(b) Briefly explain the priority of claims in the liquidation of a bank. (10 marks)

The priority of the payments in the liquidation of a bank, which is different from other companies’ liquidation, is as follows:-

i. First, payment to the liquidator for all expenses incurred in the liquidation process;

ii. Second, payment to the depositors in pari passu i.e. as if all the deposits were made on the same day;

iii. Third, payment to secured creditors;

iv. Fourth, payment to employees of all wages and salaries due, net of any liabilities to the bank;

v. Fifthly, payment to other creditors in pari passu; and

vi. Lastly, payment to the bank’s shareholders in accordance with their respective rights and interests.

3. Explain the following objectives of the Reserve Bank

(a) Banker and adviser to Government. (5 marks)

The Reserve Bank is typically the government’s banker. In other words the Reserve Bank performs for the government the services a bank ordinarily provides for customers with a current account, notably receiving and making payments and advising and assisting in the operation of the account. Beyond this the bank also provides other services to the government such as managing the public debt

(b) Maintainance of external reserves so as to safeguard the inter- national value of the Malawi currency. (5 marks)

To achieve this the Reserve Bank has implemented various schemes, for example, the Foreign Exchange (Forex) Bureau Scheme was introduced in 1994 following the liberalization of the Current Account in order to bring about diversity in the foreign exchange market, and that the Forex Bureau sub – sector was also intended to channel funds from the unofficial to the official thereby lessening activities of the black market. This scheme did not work particularly well as the operators of the bureaus lacked capacity and some resorted to illegal externalization of foreign currency. The Reserve Bank further responded to the situation by issuing the Exchange Control [Foreign Exchange Bureaux] Regulations 2007 requiring that an applicant for a licence for a Forex Bureau be either an Authorised Dealer Bank (ADB’s) or a Financial Institution. This, it is thought, strengthens the regulatory environment by ensuring that only institutions with the highest calibre of operational controls should deal in foreign exchange and that in Malawi such institutions are Authorised Dealer Bank and other Financial Institutions - See The State v Minster of Finance and the Reserve Bank of Malawi ex- parte Golden Forex Bureau and Others (the Forex Bureau Case) (2007).

The Reserve Bank will lend to other financial institutions in cases of liquidity problems, most especially when the inter-bank market is not liquid. In normal circumstances banks seek cover for the shortfalls amongst themselves on the inter-bank market.

4(a). Name three best known international standards established and accredited to the Basel Committee. (6 marks)

(i) capital adequacy;

(ii) the core principles for effective banking supervision; and

(iii) the concordat on cross-border banking supervision.

4(b). Malawi’s constitution embraces a liberalized free market and economy. The regulation of banks and other financial institutions is viewed as unnecessary overregulation. Using the concept of ‘Systemic Risk’, justify the rationale for regulation of banks and financial institutions. (9 marks)

Systemic risk looms large in the regulation of banking and financial institutions. While there is a concern to protect depositors against loss through default by individual institutions, public policy is also concerned with confidence in the system as a whole. Part of the conventional wisdom in banking is that default by one institution can spread to undermine other institutions. This is systemic risk. It is separate from the other risks facing individual banks such as credit risk, market risk, and operation risk. Let us analyze situations giving rise to systemic risk:

Systemic risk derives in part from interbank linkages. If banks have large interbank deposits with a failed bank, for example, they may in turn suffer illiquidity or in extreme cases insolvency. Because the exposures which banks have to other banks can be enormous, techniques such as loss-sharing are impractical. Systemic risk derives also from linkages between banks through the payment system. With net settlement systems, banks send innumerable payment instructions to other banks during the course of the day. At the end of the day, the instructions are netted and settled. If a bank fails and is unable to settle the payment obligations it has accumulated to other banks during the day, those other banks are in jeopardy of defaulting on the payment obligations they have in turn contracted. Fear of contagion through the payment system has been a major factor in the move to real-time gross settlement, where each payment obligation is settled immediately.

Then there is systemic risk because of the public perception that other banks are in the same position as the suspect or failed bank. There is a run on these other banks as the public moves to banks perceived to be the very strongest, or there is a flight to cash. These banks may be perfectly healthy, but will face liquidity crisis if there is a rush to withdraw deposits.

In view of the above, it is critical that banks and other financial institutions should be regulated even in the face of a liberalized economy.

5. Critically examine the adequacies and inadequacies of the current licencing requirements of a bank as a means of prudential regulation. (15 marks)

Licensing is central to the prudential regulation of banking. The notion prevents undesirable activity by obliging those who provide banking services to meet a range of standards and threatening to withdraw approval in the event of any breach of standards. While licensing can be a very powerful tool of control, its success depends on the thoroughness of the vetting, its effectiveness in practice, the extent to which the behaviour of those licensed is monitored and the capacity of the regulatory authority to take disciplinary action against those who infringe standards. There can also be a tension between effective licensing on the one hand and the monopoly effects produced by preventing entry, on the other.

According the Banking Act 2009, section 4 prohibits a person from transacting banking business in Malawi without being licensed under the Financial Services Act 2010, and generally permits only companies to be licensed. In that regard, therefore, no person can apply for a banking license without initially satisfying the requirements for the registration of a limited company under the Companies Act, 1984.

The Companies Act, 1984 requires the following for any consortium of two or more persons to be registered as a company (streamlined as fitting to qualify for application for a banking license):

· There should be at least two or more persons acting in consent;

· The company will be private or public and limited by shares;

· The company should register with the Registrar of Companies its Memorandum and Articles of Association. The Memorandum of Association should be signed by each shareholder including the number of shares held by each;

· The Memorandum of Association should outline the objectives of the company.

The minimum capital requirement for a bank ensures that companies with substantial capital are incorporated as banks.

In considering an application for a banking licence, the Registrar is required to look into various matters. Here are some of them:-

i. The validity and accuracy of the documents and information submitted;

ii. The financial condition, resources, integrity and previous business ventures of the shareholders associates and affiliates;

iii. The integrity, working experience and qualifications of the proposed directors;

iv. The capacity of the applicant to maintain adequate capital and comply with the Banking Act 2009 and other laws; all applicants for a license must display the availability of sufficient sources of funds to capitalize the bank.

Aside from providing the minimum amount of capital required the applicants have to demonstrate the ability to maintain the capital levels above minimum and that they will not fully depend on dividends from the bank to meet their financial obligations. The financial capacity of the applicant needs to be strong enough to be able to provide additional financial support for the bank if need be.

v. The structure of the organization; the Act requires at least 2 executive officers to effectively manage a bank, of course with other qualified personnel.

On a balance, the above noted licencing requirements and conditions adequately regulate banks.

SECTION B

(a) List 5 financial institutions as per the definition embraced by the Financial Services Act, 2010. (5 marks)

(i) banks; securities dealers;

(ii) securities brokers;

(iii) investment advisers;

(iv) stock exchanges;

(v) investment companies;

(vi) portfolio managers;

(vii) insurers;

(viii) reinsurers;

(ix) insurance brokers;

(x) microcredit agencies;

(xi) microfinance institutions;

(xii) SACCOs;

(xiii) pension funds;

(xiv) credit reference bureaus,

(xv) building societies and finance or leasing companies, among others.

(b) In your opinion, is the definition of a financial institution unnecessarily very broad?(5 marks)

the Act ensures that all operators in the financial services industry are regulated unlike the position before the passing into law of the Act, when only banking, capital markets and insurance entities ware supervised through repealed Acts; Banking Act 1989, Capital Market Development Act 1990 and the Insurance Act 1957. The definition is therefore not unnecessarily broad.

The Financial Services Act contains detailed provisions relating to the role and duties of the board of directors and that of internal and external auditors of prudentially regulated financial institutions. Guidelines on corporate governance issues include requirements to be followed when appointing directors, chief executive officers, external auditors, etc, and the need to put in place board committees to enhance board oversight of management decisions within prudentially regulated financial institutions.

As an example, the appointment of the directors, executive officers, managers and external auditors is subject to the approval of the Registrar and the Registrar has varying powers to issue Registrar’s Directives. The Act sufficiently deals with corporate governance issues pertaining to a financial institution.