The Financial Crisis 2007 2008

Published Date: 02 Nov 2017

INTRODUCTION

When the US Subprime crisis occurred in the August 2007, it was interpreted as apparently rather small, regional brush fire. Despite of the quick reactions from politicians, it soon developed into a global slump whereby many believed that the culprits were bankers, their bonuses, their greed, fraud, corruption and speculation. Even top-politicians like the President Barack Obama qualified the private bankers as the "fat cats" on Wall Street who are "greedy-for-money" who followed exclusively profit for short term interest without regard to risk. By mid-2008, in the face of tightening credit conditions, activity slowed and advanced economies fell into a mild recession whereas emerging and developing economies continued to grow. The situation was aggravated after the dramatic eruption of the financial crisis in September 2008 which followed the default by Lehman Brothers, the rescue of AIG, and the intervention in a range of other systemic financial institutions in the US and in Europe.

The causes of this crisis are attributed to the following (i)housing bubble (ii)imprudent mortgage lending (iii)securitisation (iv) Lack of Transparency and Accountability in Mortgage Finance (v)the rating agencies (vi) Credit Default Swaps (CDS) (vii) Over- the- counter derivatives (OTC) and (viii) the shadow banking system, amongst others.

The roots of the crisis go back much further, and there are various views on the fundamental causes. In order to keep the economy stronger, the Federal Reserve which was under the reign of Alan Greenspan, decided to keep the interest rate as lower as 1%, in 2004. Following this decision of Alan Greenspan, investors were discouraged to invest in the Treasury bill, which was offering a very low return, of only 1%. But, on the other hand, banks from the Wall Street could borrow from the Fed at only 1%, thus, making borrowing cheaper for them. Shortly after, Wall Street grew extremely rich as their strategies have been based on leverage and to maximise their profits they connected investors to homeowners through mortgages, that is, people who wanted to buy a home were linked to a mortgage broker who then contacted a mortgage lender to give them a mortgage. The family bought the house and became home owners. Later, this mortgage is sold to the investment bank and the mortgage lender remained no more the owner of the risk. The investment bank took millions of dollars and bought thousands of like mortgages, classifying them into different risk level and regrouped them under, what is known as, Collateralised Debts Obligation (CDO) and it was left to

the credit rating agencies. The CDO was then sold to different risk attitude investors for a small fee called the Credit Default Swap. After selling all of them, the investment bank grew richer and paid back its loans. This process satisfied all the participants as everything was running smoothly until that investors started demanding more CDOs which implied more mortgages. But the problem was that all those who were qualified for a mortgage, already had one. Therefore, they decided to lend generously to less responsible people wanting to have a home, that is, no requiring down payment, no proof of income and no documents at all. This category of mortgages was known as the sub-prime mortgages. Sub-prime mortgage lendings rose from $180 billion in 2001 to $ 625 billion in 2005 and in 2006, due to a number of factors, the bubble bursted. Firstly, there were no increments in the average hourly wages in the US since 2002 until 2009, where in real terms, this could represent a decline. Consequently, due to unaffordable houses, prices could not continue to rise. Secondly, as personal savings from disposable income fell below zero, fewer households had the requisite finance to support increases in debt. The sub-prime homeowners defaulted en masse on their mortgages, leaving banks with many houses in their CDO rather than regular payments. Value of houses started declining as supply of houses was constantly rising without having a matched demand for it. This resulted in a problematic situation for those still paying for a high price when their house was no more worth that high value and thus, they stopped paying and foregone their house.

Now, the bank had only houses in its CDO and no investors were ready to buy its risk. The bank had borrowed billions to finance these mortgages and could no more pay back the loans. All those who contributed to this process were in huge dilemma- the investment bank wanted no more mortgages from the mortgage lender, the mortgage lender had only mortgages and no money and the investors who bought thousands of these CDOs had no revenue. This is where exactly the whole system gets darker and soon all of them started declaring bankrupt. The fact that banks on Wall Street had borrowed millions from different countries were no more able to pay that back and thus, making them worst off. In others words, these banks as well had faced huge losses. There are other banks that have been affected although they did not participate in the "profit maximisation process" and some have been slightly or not been affected at all.

The structure of this paper is as follows, Section 1 is the introduction and Section 2 is the reviewing of the literature where with help of evidence gathered we have demonstrated the effects of the financial crisis on banks around the world under part (I) and in Mauritius under part (II). Section 3 is an overview of the Mauritian Banking Sector and Section 4 is the research methodology where details about the data collection will be given. The data analysis will be under section 5 and lastly, section 6 which concludes the paper.

SECTION 2.1: OVERVIEW

After the collapse of the Bretton Woods system, as warned Tobin [1] , there have been a string of crises in the global financial market. Before the 1997 Asian crisis, the world had gone through many other crises starting with the Latin American debt-liquidity in the early 80s then another crisis including the Scandinavian countries (Norway, Sweden and Finland) in the late 80s-early 90s, the EMS currency crisis in 1992, and the Mexican Pesos crisis in 1994. Even after the Asian financial crisis, Russian crisis and Brazilian crisis followed in 1998 and 1999, respectively. More recent episodes of the financial crisis is that occurred in the US in 2008. The Asian crisis in 1997 and the recent crisis have been the 2 major crises that had spread their tentacles in many countries.

SECTION 2.2: GLOBAL BANKS

During a crisis when one bank is affected, it has negative spill-overs on otherbanks. The systemic nature of banks reflects their extreme interconnectedness and thus, each individual institution can appear to be safe while the links between them mean that the system as a whole is vulnerable. Shocks to any part of the system can propagate speedily across the system and cause a domino like collapse. Because the sustainability of banks depends crucially on the confidence that depositors have in being able to redeem their funds keeping this confidence high is crucial to keeping individual banks viable and the banking system stable. Unlike other areas of an economy where a failure of a competitor is usually good for business, in banking a failure of one bank can cause a serious crisis of confidence in other banks and have systemic consequences. This can happen for several reasons:

Because banks often have large and significant exposures to other banks, the failure of one bank could inflict large losses on others.

Because banks often use similar systems and operate in similar markets, the failure of one bank might raise the prospect of the same problem turning up at other banks. Banks have become more like each other than ever before so this similarity can be a major channel of Contagion and a source of systemic risk.

Because banks are increasingly involved in financial markets, the failure of one bank might drive down the markets it operates in due to the forced selling of assets and securities. This happened on a large scale in the present crisis when a drop in the value of real estate mortgage backed securities, that banks the world over had invested in, fell in value triggering off a chain of forced sales and further drops in value.

Depositors might suspect that the bank has collapsed due to systemic risks which will also affect other banks rather than idiosyncratic risks peculiar to the bank in question. Public policy thus needs to focus sharply on preventing bank failure because this can impose costs on other banks as well as the broader economy and if failure is unavoidable, minimising systemic effects on other institutions.

The fundamental points that need to be addressed by banking regulation are:

Ensuring the soundness of an individual institution against idiosyncratic risks.

Minimising the spill-overs from one bank onto the broader banking system.

Ensuring the soundness of the banking system against systemic risks.

The Asian Crisis 1997-1998

As per Galina Hale (2011), prior to the Asian financial crisis, most East Asian countries fixed their exchange rates to the US dollar and ran current account deficits, which subjected their currencies to downward pressures. At the same time, private banks and large nonfinancial companies were borrowing large amounts, mostly in dollar, from foreign banks. While domestic banks were lending in domestic currency, companies and private banks borrowing in terms of dollar were collecting large shares of their revenue in domestic currency from domestic sales. As a result, borrowers accumulated large currency mismatches on their balance sheets as their liabilities were predominantly in dollars while their assets were in their domestic currency.

The real problem was that the East Asian financial systems were subject to two additional risk factors:

Maturity mismatches due to liabilities that were predominantly short-term and assets that were much longer term or illiquid, and

Excessive risk taking.

Credit was available abroad in cheap and large quantities because of the large implicit government guarantees. Banks were no more financing low-risk projects and were mainly going for riskier ones thanks to an international lending boom and easy access to credit from abroad. On the July 2, 1997, the Asian crisis began when speculators attacked the Thai baht by selling off Thai-denominated assets. Simultaneously, foreign investors withdrew the dollar-denominated loans to Thai institutions and the government was forced to let go his currency peg. The baht plunged 16% on the day of the attack and lost over 50% of its value by January 1998. In the months that followed, other East Asian countries experienced similar debacles. Financial contagion spread through the region so fast that it was nicknamed the "Asian flu." Only Hong Kong and China was able to maintain their currency pegs. The Hong Kong Monetary Authority intervened directly in the stock market, while China imposed capital controls. Banks and corporate balance sheets were under tremendous pressure as asset values declined dramatically relative to liabilities and all was due to currency mismatches. To make matters worse, amid the speculative attacks, bank access to overseas credit dried up as foreign investors executed a flight to quality. Many overseas bank loans had short maturities and banks were unable to roll them over as they had previously. As a result, when the exchange rate fell, banks found themselves with large portfolios of non-performing loans and that the currency mismatch between assets and liabilities meant that they were unable to service foreign currency loans. It must, of course, be recognized different factors played different roles in each individual crisis. As Caprio (1998) notes, excessive leveraging of corporate debt appears to have been the main problem in Korea, while in Indonesia, foreign exchange mismatches seem to have been a greater problem in the corporate sector (which indirectly led to banking sector problems).

The bank crises, especially the crisis in Thailand, were predictable. Models of banking crises (e.g., Demirguç-Kunt and Detrgiache) note that high rates of credit growth and large amounts of credit to the private sector are correlated with the probability of future crises.

In short, East Asian countries had to face severe banking crises. The nonperforming loans ratios skyrocketed because of prior excessive risk taking and most banks had to be recapitalised by their governments. Before the crisis, most governments in the region had balanced or nearly balanced budgets. But the fiscal costs of bank recapitalization led to big deficits, forcing governments to seek funds from the International Monetary Fund (IMF).

Economists formulated a number of policy recommendations aimed at preventing a repetition of Asianflu-type crises (see Eichengreen1999, Mishkin 1999, Rogoff 1999, and Roubini 2000). Bank regulatorswere encouraged to require greater transparency and supervise lending activity more strictly, payingparticular attention to currency and maturity mismatches. Some scholars urged that highly leveragedinstitutions be required to improve risk assessment and reduce leverage ratios

The Financial Crisis 2007/2008

The Global Financial Crisis which was emerged since mid-2008 tested the boundaries of the functioning of the Global Financial System and magnified the interlink ages between financial and real economy. When some of the Prime Wall Street Financial Institutions collapsed the US Sub Prime Market problems in August 2007 reached their peak leading to the worldwide confidence failure during September 2008. Financial Institutions were almost unwilling to lend to each other and Credit Market virtually froze. Since the credit crisis started in the United States, the American government arranged in Sept 2008, for an 800 Billion US$ rescue plan to save the financial market. The aim was to save the most important investment banks and insurance companies from bankruptcies to prevent further financial deterioration. Many central banks around the world presented similar rescue plans with different scoop .After the failure of the Lehman Brothers Bank on 15th September 2008 with US $600 billion and no rescue package from the US Government because the latter had no more the capacity, the financial system was severely affected. Given the interconnected nature of financial markets, the financial crisis in the USA spread rapidly through the financial sector and spilled over to other industrialised and emerging market economies. It spread to the real economies of countries across the globe, leading to the deepest global downturn since the Second World War. In some countries banks have not been able to remain resilient while in some other countries, banks were strong and healthy enough to face to sudden "disease" that was spreading around the world.

In an article (Anon), it was stated that in UK, in the late 2008, the Bradford and Bingley Building Society was nationalised and partially sold to the Spanish Grupo Santander Bank. Moreover, the UK Government also nationalised the struggling Royal Bank of Scotland Group, initially taking 58% stake, but eventually raised this to 84%. The UK Government also effectively forced the UK’s largest mortgage lender, Halifax Bank of Scotland (HBOS), which was in deep trouble, into the Lloyds TSB group and, in January 2009, took a 43.4% stake in the combined business. Other UK banks, such as Barclays and HSBC, although not nationalised, were forced to raise capital by new share issues to preserve their capital ratios.

Governments in Belgium, France, Germany, Ireland, Spain and Switzerland took similar actions to the UK to save several of their now illiquid and undercapitalised banks. Iceland effectively lost its previously heavily aggressive banking sector. In the US, a total of 25 banks failed in 2008.Despite a sharp cut in central bank interest rates worldwide, interbank lending rates remained stubbornly high (showing the banks’ lack of confidence in each others’ financial security), which in turn lead to a severe reduction in both personal and corporate credit and a rapid downturn in the housing and construction markets.

According to S.D. khandare, during the initial phase of the crisis, the impact of the Indian financial markets was rather muted; however, since mid-September 2008, the impact on Indian financial market became amplified. Being well capitalized and having greater exposure to domestic conventional assets, the strength and resilience was derived in the balance sheets of Indian banks. The direct effects of the Global Financial Crisis on the Indian Banking and Financial System were almost negligible due to limited exposure to riskier assets and derivatives and the relatively low pressure of Foreign Banks (Thorat 2009). Prima facie, Indian banks faced the stress because foreign investors pulled out of the economy and created a liquidity crunch. There was suddenly less money to borrow or lend. The tightened global liquidity situation in the

period immediately following the failure of Lehman Brothers Inc. in mid-September 2008, coming as it did on top of a turn in the credit cycle, increased the risk aversion of the financial system and made banks cautious about lending (Subbarao, 2009).

Banks in Asia and in the Pacific were slightly affected because they were not directly exposed to the toxic assets. Initially, confidence about the region suffered, but as information indicating that the exposures were minimal spread in financial markets, Asia-Pacific economies were spared the worst. In Thailand, for example, banks held collateralised debt obligations (CDOs) representing just 0.04% of their balance sheets. Those banks with some exposure to CDOs, such as banks in Singapore, held relatively safe assets and were generally much less leveraged than those in the United States and Europe. Therefore, they were not particularly vulnerable to a collapse in the valuations of structured credit products.

In this deteriorating environment the crisis evoked unprecedented policyresponses. Both conventional and unconventional actions were taken by the national governments and central banks of several countries. The responses included varying combinations of monetary and fiscal measures, deposit guarantees, debt guarantees, capital injections and assets purchases which were coordinated globally. Restoring normalcy and strengthening financial regulation or supervision was the policy attention of advanced countries. EME’s were also to be active partners to find out meaningful resolution mechanism to this global problem. The forceful and coordinated policy actions got successful in diminishing the initial damages. Moreover, the unconventional measures have posed several challenges and risks while helping in the stabilizing financial system.

However, while many countries were fighting to safeguard their banking structure, Canada was a notable exception because banking system remains stable throughout, according to Michael D. Bordo and al. The comparative stability of the Canadian banking system emerged out of the very differentstructure of the financial sectors of the two countries from the early 19th century. Its banking system was created as a system of large financial institutions whose size anddiversification enhanced their robustness. Moreover it evolved into an oligopoly which wastightly regulated in a grand bargain whereby the chartered banks would provide financialstability in exchange for the Canadian government limiting entry to the industry.

SECTION 2.3: MAURITIAN BANKS

The Bank of Mauritius Financial Stability Report notes that the global financial crisis had brought financial stability issues to the forefront of policyconsiderations. The crisis highlights the need for strengthening financial sector regulation to ensurestability. All the banks operating in Mauritius have, so far, shown considerable resilience in terms ofcapital adequacy, balance sheet growth, profitability and loan delinquencies. The system has notwitnessed any serious liquidity crunch either, part of which can be explained by the non-dependenceof banks on large scale inter-bank borrowings to fund their operations and much less reliance on extraterritorialsources for meeting domestic asset build up. The foreign funds used for domesticdeployment was as low as 2 per cent of total domestic assets thus providing the insulation from theliquidity crunch in the global financial markets. There are no indications that the Mauritian banking sector has any direct exposure tothe toxic debt that has affected global financial markets, and banking soundness indicators are healthy.The banks in Mauritius do not have significant exposure to equities either by way of their investmentsor loans against the collateral of shares. As macroeconomic risks increase, financial strains, associatedwith an increase in credit risks and reduced risk appetite of banks, are likely to emerge in banks’balance sheets.It hasbeen sheltered with appropriate policies and strategies implemented in a timelymanner but it is not isolated. Basically the government has tried to be ahead of thecurve once it realised as far back as May 2008 that there were some signs that therecould be a global recession. The recent financial crisis has not been a real ordeal for Mauritian Banks but rather for other sectors like the tourism sector.

The banking sector has remained relatively sound, supported by relatively favourable domesticmacroeconomic conditions and the better performanceof domestic banking activities, which has compensatedto some extent the slowdown in global bankingactivities.

The banking sector is not overly exposed to Europe, its main exposure being to Asia, and principally India. Market risks have also remained moderate while credit concentration ratio has been well below theprudential aggregate limit of 800 per cent.Banks’ funding structure has not changed much, with continued greater reliance on deposits from customersrather than short-term wholesale funding.

Total assets growth has nevertheless comedown substantially, from 13.4 per cent at end-September2010 to 4.0 per cent at end-September 2011.The downgrade in the credit ratings of some majorinternational banks, headquartered mainly in Europe,over the past six months have not had any majorrepercussion on their business in Mauritius. Foreignownedbanks operating in Mauritius remain wellcapitalisedand have maintained relatively good accessto non-resident deposits and intragroup funding tofinance their core lending business. However, these outcomes emanating from the renegotiation of the double tax treaty between Mauritius and India would undermine growth prospects in this cluster. Banks in Mauritius are highly profitable compared to their counterparts in many advanced countries engulfed in the financial crisis. The profitability of most local banks has been underpinned by relatively elevated net interest income and fees and commission income representing, respectively, 62.7 per cent and 23.1 per cent of their total revenue as at end-September 2011. Banks’ exposures to market risk have remained Moderate. Banks are also little exposed to the risk that changes in interest rates may adversely impact on their earnings.

Mr. James Benoit, the CEO and Executive Director of AfrAsia Bank Ltd (News on Sundays, 2011) , he made it clear that Mauritius has not been spared by the crisis. The sector faced multiple challenges stemming from the impact of below-par economic evolution, low investment and sub-optimal conditions in money and foreign exchange markets. However, the impact has been in general moderate with an appropriate policy mix adopted by the government and the private sector. Although the crisis started out in 2008, Mauritius experienced a lagged effect and started to face significant consequences. It has recorded a higher growth rate of 3.9% andthe Bank of Mauritius has exerted efforts in 2010 to reduce liquidity through reverse repo transactions and special deposit schemes with banks and through notching up the cash reserve ratio. The financial system is well regulated, solid and highly profitable. It has ample liquidity to meet the financing needs of the economy. Thus, there was no need for government intervention, as in many other countries, to bail out the banks.

Mr. Rundheersing Bheenick, The Governor of Bank of Mauritius in his annual statement, stated that "As we engaged to deal with these snowballing challenges, the Bank remained alert and nimble, taking decisive and timely action to protect the interest of the Mauritian economy."

In other words banks have not been affected by the financial crisis and he gave details about the two bold measures taken in June 2012, in close coordination with the Treasury, to minimize the fallout from the euro debt crisis and the global economic downturn on the domestic economy. The measures targeted the sectors particularly vulnerable to the declining external demand in key markets.

Firstly, we embarked on a programme to build up our foreign exchange reserves, the Operation Reserves Reconstitution. The IMF has confirmed that this measure has helped us to reduce the growing misalignment of the rupee in relation to fundamentals. It resulted in an increase of our gross official reserves from Rs81.5 billion at the end of June 2011 to Rs86.7 billion at the end of June 2012, thereby raising our import cover from 4.6 months to 4.9 months.

The second measure is the Special Line of Credit in Foreign Currency. It was a very difficult move for a small, but innovative, central bank, to prepare to use its own balance sheet in a pre-emptive bid to bail out exposed sectors ahead of troubled times. Thanks to this measure, the Bank went to the rescue of economic operators which were directly affected by the mismatch between the currencies in which their earnings were denominated, mostly euros, and their outstanding debt in rupees. BOM was giving to highly-leveraged operators a unique tool to restructure their debt so that they would end up with healthier balance sheets.

Furthermore to this, the foreign exchange reserve has been consolidated in 2011.

This section will emphasise on the main features of the Mauritian banking sector. Mauritius is a small island economy in the Indian Ocean and inherited a bank-dominated financial system at the time of independence in 1968. The first set of control has been the regulation of banks’ interest rates by monetary authorities throughout the 1970s until late 1980s. Other repression policiesconsisted of the imposition of cash ratio and liquid asset ratio that were gradually tightened over the years as wellas the exchange control on current and capital transactions. In the mid-1970s, the monetary authorities tightened their control over the financial system in an attempt to regulate credit expansion and allocate it to productive sectors.

In the early 1980s, the control over the overall credit was modified whereby sectors were categorised into priority and non-priority and ceilings were imposed respectively on both types of sectors. Furthermore, banks were individually subject to a certain quantum of credit depending upon their extent of deposit mobilisation and credit creation. The early 1980s were marked by the beginning of the process of gradual liberalisation of the financial system. Controls over interest rates were gradually lifted. Exchange control on current transactions was no longer imposed as from mid 1980s. By late 1980s, interest rates were fully liberalised. However, quantitative controls in the form ofreserve requirements and credit ceilings continued to be imposed. The 1990s were marked by the relaxation of most of the remaining banking sector controls. Credit ceilings were gradually abolished and the exchange control act was suspended by mid 1990s. The cash ratio and liquid asset ratio were gradually lowered and the liquid asset ratio was brought down to zero in 1997.

The financial liberalisationprogramme was also accompanied by other market-oriented reforms such as a free float exchange rate, the auctioning of Treasury bills and the setting up of a secondary market for government securities amongst others. Most recently, transactions involving the repurchase of bank reserves and foreign currency swaps have increased enormously. In addition, bank branches expansion has also contributed largely to the institutionaldevelopment of the banking sector. From 32 in the

1970, the number of bank branches expanded significantly to reach 117 in1990 and 163 in 2003.

Market reforms were necessary for the development of the financial services sector which now comprises of an array of institutions including well-established banks, insurance and pension companies, stockbrokers, investment companies, non-bank deposit-taking institutions, leasing companies, credit institutions, money changers and foreign exchange dealers.

The Mauritian banking industry comprises of 20 banks, of which 7 are local banks, 8 are foreign owned subsidiaries, 1 is a joint venture and 4 are branches of foreign banks. All the banks are licensed by the Bank of Mauritius to carry out banking business locally and internationally. Some of the biggest and most reputable international banks are present in Mauritius and actively carry out international cross border activities.

Banks render several services in the country. Besides traditional banking facilities, they offer card-based payment services, such as credit and debit cards provide internet banking and phone banking facilities. Specialised services such as fund administration, custodial services, trusteeship, structured lending, structured trade finance; international portfolio management, investment banking, private client activities, treasury and specialised finance are also offered by banks. The international banks offer a wide range of global banking and financial services to corporate, institutional and private clients.

Prior to December 2004, banks were required to obtain a separate license and there were restrictions on using the domestic currency and operating in the domestic banking environment. The separate licensing requirements for banks engaged in "domestic" and "offshore" banking activities were removed by the new Banking Act, which came into effect in November 2004.

There is a good and strong regulatory framework for banks in Mauritius. Besides the Bank of Mauritius Act (2004) and the Banking Act (2004), the Bank of Mauritius (BOM) has issued several Guidelines governing the day to day operations of banks. Since 31st March 2009, banks have fully adopted the Basel II Framework with the BOM issuing several Guidelines for the implementation of the Basel II principles.

As at November 2011, banks in Mauritius had a total asset value of Rs 924.2 billion and the total amount of credit distributed to the private sector stood at Rs 248.8 billion for the same period. The average number of cheques cleared daily stood at 22,089 cheques, for an average amount of Rs 1,233 million. The number of ATMs stood at 426, for total number of transactions at 4,525,691, amounting to Rs 9 billion. The total number of cards in circulation stood at 1,324,610. 

As at March 2011, banks in Mauritius had a regulatory capital to risk-weighted assets of 17.2%, a regulatory Tier 1 capital to risk-weighted assets of 14.6% and non-performing loans net of provisions to capital of 8.2%. In terms of asset Quality, nonperforming loans to total gross loans stood at 2.8%, and in terms of Earnings and Profitability, banks had returns on assets of 1.4%, a return on equity of 19.3%, and an interest margin to gross income ratio of 70.0%.A new bank, licensed to conduct Islamic banking business in Mauritius, started operations effective 31st March 2011.

4.0 Introduction

This chapter is devoted to the methodology adopted to meet the main objective of the study, that is, to analyse the impact of the financial crisis on banks in Mauritius.

"The purposes of doing research are multiple, such as to describe, explain, understand, foresee, criticize, and/or analyse already existing knowledge or phenomena in social sciences. The job off a researcher is often that of an observer and each observation is prone to error. Therefore, we go out and research to find a better truth."(Ghauri et al, 1995, page 6). As suggested by Crouch and Houdsen (1996), the research methodology influences the findings of a research significantly. Therefore, the planning and organization of the research process carefully involves five steps:

Define the problem and research objective

Develop the research plan

Collect the information

Analyse the information

Present the findings

4.1 Research Objectives

This research identifies financial statements as a vital source to situate the performance and financial position of banks in Mauritius, as well as being the primary source of information to investors. However, by merely looking at figures we cannot say much and therefore, a ratio analysis technique is used to analyse performance of banks.

The main objectives of this research are to:

Investigate whether the financial crisis 2008 had an impact on banks in Mauritius

See how far banks have been able to protect themselves from the effects of the crisis by analysing their financial statements.

Assess the strategies that they have been using to remain resilient.

Analyse the effectiveness of these strategies

Find out about the long run strategies to protect banks

4.2 Research Design

After identifying the problem, the researcher must arrange his ideas in order to write them in the form of an experimented plan or what can be described as "Research Plan".

Basically, there are two methods of obtaining data namely Primary data and Secondary data.

Primary data will be obtained from observations, fieldworks and by conducting formal interviews accompanied by questionnaires. In other words, primary data are those which are collected afresh and for the first time and thus happen to be original in character.

On the other hand, secondary data means data means data that are already available, that is, they refer to data which have already been collected and analysed by someone else. When the researcher utilizes secondary data, then he has to look into various sources from where he can obtain them. In this case, he is certainly not confronted of original data. Secondary data may either be published or unpublished data.

Secondary data will be obtained from accounting magazines, working papers, audit reports, research and articles on the subject matter. Secondary data generally involves previously cumulated data on particular events. The benefit of using this source of data is not related to time and costs aspects but also in terms of credibility.

Researchers must be very careful in using secondary data. He must make a minute scrutiny because it is just possible that the secondary data may be unsuitable or may be inadequate in the context of the problem which the researcher wants to study. In this connection, Dr A.L Bowley very aptly observes that it is never safe to take published statistics at their face value without knowing their meaning and limitations and it is always necessary to criticize arguments that can be based upon them.

The research plan has been carried out to cater for the following determinants.

4.3 Data source

In order to achieve the objective of this dissertation, the research method will be carried out in terms of secondary data. The secondary data has been obtained from books, articles, magazines, and audited annual reports. All the financial reports have been obtained from the internet.

4.5 Data Collection

It is generally accepted that accounting data derived from financial statements are the most important source of information for ratio analysis. In that respect, the fact that trends in performance and financial condition of a company can be detected over a longer time span, six years data is used (from 2006 to 2011).

4.6 Data Analysis

To obtain a better perspective over the years, the ratio analysis has been applied where data has been extracted from Income Statements and Statement of Financial Position to compute ratios. The findings derived from the financial statement analysis are represented by help of charts, Microsoft Word and Microsoft Excel.

For further analysis, a simple regression analysis will be used to measure performance of banks in Mauritius, using again the Microsoft Excel.

4.7 Limitation of the research

For the research purpose we used the ratio analysis technique which carries certain limitations such as accuracy depends on quality of information disclosed or they can be misleading if accounts are not inflation adjusted. Secondary data might not always be reliable.

5.1 Introduction

Different methods are used to assess soundness and safety of financial institutions. The first part of this section is devoted to the Ratio analysis and the second part is a simple regression.

5.2 Ratio Analysis

Financial ratio analysis involves calculating and analysing ratios that use data from one, two or more financial statements. Ratio analysis also expresses relationships between different financial statements.

Ratio analysis is essentially concerned with the calculation of relationships which after proper identification and interpretation may provide information about the operations and state of affairs of a business enterprise.

The analysis is used to provide indicators of past performance in terms of critical success factors of a business. This assistance in decision-making reduces reliance on guesswork and intuition and establishes a basis for sound judgment.

"The purpose of accounting is to convey information, but ‘absolute’ numbers in isolation are generally meaningless" (Randall H. 2000)

The relationship between different items in the Statement of Financial Position and/or Income Statement is represented by ratios. In essence, ratios show relationship of one aspect of a company’s affairs to another ( Cosserat G et al. 1995).

As advanced by Lewis M. (2004), Konar D. (2005), Randall H. (2000) and Choi C et al. (2005), the ratio analysis can be broken into five main groups of ratios. They are:

Liquidity Ratios

Profitability Ratios

Investment Ratios

Gearing Ratios

Efficiency Ratios

5.2.1 Limitations of Ratio Analysis

Although the use of ratios will most certainly help users of accounts in making decisions, mainly investment decisions, like any other tools, they do, however, have limitations. According to Randall H. (2000), these are as follows:

Ratios only show the results of carrying on business; they do not indicate the causes of poor ratios. Further investigation is often required.

The accuracy of ratios depends upon the quality of the information from which they are calculated; the required information is not always disclosed in accounting statements and account headings may be misleading.

Ratios can only be used to compare ‘like-with-like’.

Ratios tend to ignore the time factor in seasonal businesses, example, widely fluctuating stock levels and debtor levels

They can be misleading if accounts are not adjusted for inflation.

5.2 Overall Analysis of Banks in Mauritius

In 2008, the levels of deposits and advances of the banking system witnessed steady growth. The banks in Mauritius, in general, did not rely on wholesale market borrowings to fund their operations. The system had not witness any liquidity crunch; the banks held 28.8 per cent of their deposits in liquid or near liquid assets as at the end of December 2008. Though there was a marginal decline in the liquid assets to deposits ratio, it was more an indication of better balance sheet management. The Basel Committee on Banking Supervision had issued a paper on Principles for Sound Liquidity Risk Management and Supervision in June 2008 to address the lessons drawn from the subprime crisis.

The Mauritian banking system continued to be highly profitable. Banks recorded an aggregatepre-tax profit of Rs12.6 billion over the past year, representing an annual increase of 21.6 per cent. One measure of profitability, return on average assets, remained stable at around 2 per cent and the return on average equity maintained its upward trend with a ratio of 24.1 per cent as compared to 22.8 per cent a year earlier.

Profitability continued to be underpinned by strong balance sheet growth and rising interest income on the back of a low level of NPLs. Total income of banks increased by Rs10.7 billion during the year ended 30 June 2008, representing an increase of 28.2 per cent over the previous year. Advances, investments in securities and placements with other banks continued to be the main sources of income for banks and accounted for 83.4 per cent of their total income. The growth in profits was driven mainly by higher revenue from lending activities. Total interest income rose by Rs8.6 billion to Rs41.9 billion in 2007/08. Interest earned from loans and advances increased by Rs5.0 billion while interest earned on securities increased by Rs0.8 billion. On the other hand, total interest expense, comprising interest paid on deposits and borrowings rose by Rs 6.4 billion during 2007/08. Consequently, the net interest income of banks increased by Rs2.2 billion orby 19.9 per cent. Pre-tax profits derived by banks from the local markets amounted to Rs5.6 billion whereas profits of Rs7.0 billion were realised from foreign sources.

In 2011, the capital adequacy of banks is most often assessed on the basis of tier 1 capital as a ratio of risk-weighted assets. The sector’s tier 1 capital ratio (excluding branches of foreign-owned banks operating in Mauritius) has hovered around 12.9 per cent over the year to end- September 2011. In level terms, tier 1 capital has increased by 16.4 per cent during this period, of which around 94.8 per cent originated from retained earnings. Tier 1 capital across most banks composed mainly of common equity, which is the component of capital having the highest loss-absorbing capacity. As an indication of the comparative health of the banking sector, the dispersion of total resources by tier 1 capital shows that around 49.2 per cent of total assets were held by banks having tier 1 capital ratios of more 12.0 per cent as at end-September 2011 compared to 35.5 per cent a year earlier. Overall, banks’ strong capital positions mean that many of them are well positioned to meet the more challenging Basel III capital standards when they would be phased in gradually over the years.

The leverage ratio of the banking sector (excluding branches of foreign-owned banks operating inMauritius), which measures banks’ total assets to tier 1 capital, has increased by 20 basis points over the past twelve months to 4.9 per cent as at end-September 2011 (Chart 3.23). During the same period, banks maintained a relatively equitable balance between leverage and tier 1 capital ratios commensurate with the growth in total on- and off-balance sheet assets and their equivalent in terms of total risk-weighted assets

The annual growth rate in banks’ assets growth slowed to 4.0 per cent as at end-September 2011, from 13.4 per cent a year earlier, mainly as a result of a deceleration in global banking activities of foreign banks in the wake of adverse international economic developments). The growth of Segment B assets, which constitute 61.1 per cent of total banking sector assets, has fallensignificantly to 1.1 per cent in the third quarter of 2011 compared to 17.3 per cent a year earlier while the growth of Segment A assets has slightly improved to 8.8 per cent from 7.5 per cent a year earlier.Advances and cash and balances with banks remained the two major components of banks’ assets The share of advances increased to 62.5 per cent of total banking sector assets as at end-September 2011, from 55.3 per cent a year earlier, while the share of cash and advances in total banking sector assets decreased to 24.4 per cent, from 29.0 per cent.

Banks’ profitability has tended to be high in Mauritius compared to their counterparts in major advanced economies where, among others, lower trading revenues, lower demand for credit, and higher funding costs have weighed on profits. Quarterly reports have indicated that the annualised pre-tax profits of banks – which constitute the sum of pre-tax profits for the four last quarters – soared to a record Rs17.4 billion as at end-September 2011, from Rs11.2 billion as at end-September 2010. This was due, in part, to the disposal of the custody business by one bank and partly, to the realisation of the profits upon the disposal of some investments by a few foreign owned banks operating in Mauritius. However, even excluding those exceptional gains, the level of pre-tax profits was higher by historical standards. Higher earnings have boosted banks’ return on equity (ROE) and return on assets (ROA). The mean ROE has increased from 14.2 per cent as at end-September 2010 to 16.3 per cent as at end-September 2011 (Chart 3.31). Likewise, the mean ROA, as measured by the ratio of pre-tax profits to average assets, has edged up from 1.2 per cent as at end-September 2010 to 1.4 percent as at end-September 2011 (Chart 3.32).

Net interest income remains the dominant source of revenue for the sector (Chart 3.33). As a percentage of total assets, it increased from 1.9 per cent as at end- September 2010 to 2.1 per cent as at end-September 2011. The improvement in net interest income was notable despite the low interest rate environment and hikes in the cash reserve ratio requirement during this period. Net fees and commission income increased to 0.6 per cent of total assets as at end-September 2011, from 0.4 percent a year earlier. Trading income remained volatile, reflecting shifts in market conditions, butwas slightly higher in 2011. Net trading income as a percentage of total assets increased from 0.3 per cent as at end-September 2010 to 0.4 per cent as at end- September 2011.The other components of income improved significantly to 0.3 per cent of total assets as at end-September 2011 compared to a more modest ratio of 0.1 per cent recorded a year earlier. Consequently total operating income, expressed as a percentage of total assets, increased from 2.8 per cent as at end-September 2010 to 3.4 per cent as at end- September 2011. Banks’ non-interest expense to total assets was unchanged at 1.3 per cent while net loan impairment charges stood at 0.2 per cent as at end-September 2011. As a result, the sector’s cost-to-income ratio contracted from 43.0 per cent as at end-September 2010 to 36.8 per cent as at end-September 2011, which represents an improvement compared to the preceding year.

5.3 Analysis of The Mauritius Commercial Bank Ltd (MCB)

The Mauritius Commercial Bank Ltd. (MCB) is the leading banking institution in Mauritius while being a key financial services provider in the region. Besides playing an influential role in the socioeconomic development of the country, the MCB consistently relies on its sound business model to pursue a sensible diversification strategy, alongside consolidating its domestic banking operations. It was incorporated in 1838 and listed on the Stock Exchange of Mauritius in 1989. The MCB has market shares of above 40% in respect of credit to the economy and local currency deposits and of over 50% of cards issued in Mauritius. It also has the highest market capitalisation of around USD 1.5 billion on the local stock exchange, representing a share of nearly 25%. The MCB has an extensive network of 40 branches, entirely redesigned according to world class infrastructure concepts.

In order to assess the performance of MCB amidst the financial crisis, figures from year 2006 till year 2012 has been considered.

The Performance ratios

Return on Average Asset (ROA)

YEAR

Pre-tax profits

Total Assets average

ROA=(Pre-tax profits / Total Assets average) %

2012

5,129,144

173,596,447

2.95

2011

4,630,997

155,297,296

2.98

2010

3,676,573

147,363,963

2.49

2009

3,928,156

135,409,573

2.90

2008

3,296,429

117,355,234

2.81

2007

2,311,353

94,516,015

2.45

2006

1,918,865

88,003,572

2.18

Table 1

As we can see, after the year 2006 ROA has been rising rapidly and at higher rates till reaching its peak in the year 2009 with a percentage of 2.90. However, we can note a drop down of around 0.41% for the next year because of the fall in pre-tax profit and a rise in total asset. The fall in pre-tax profit is due to ha fall in interest income. The fact that the rate of interest had been lowered, lesser interest income was generated and the rise in total asset was due to an increase in loans and advances to customers. In 2011,it reached its highest , profit and asset total have both increased which have consequently improved ROA and in 2012, there was a minor fall of 0.03%.

Return on Equity (ROE)

YEAR

Pre-tax profits

Total Average Equity

ROE = (Pre-tax profits/ Total Average Equity) %

2012

5,129,144

21,098,813

24.31

2011

4,630,997

17,826,541

25.98

2010

3,676,573

15,158,688

24.25

2009

3,928,156

13,253,175

29.64

2008

3,296,429

11,343,832

29.06

2007

2,311,353

9,294,757

24.87

2006

1,918,865

9,440,905

20.33

Table 2

The ROE rate has been a very fluctuating one. In 2009, the ROE was at its highest with 29.64% and in 2010, it had a drastic fall of 5.38%. There was a fall in pre-tax profit

accompanied by an increase in share capital and share premium as well as retained earnings. In 2011, the ROE was improved but in 2012, we find a small fall again.

Non-Interest Income to Operating Income

 

2012

2011

2010

2009

2008

2007

2006

Operating Income

9,514,271

8,366,466

6,984,958

7,120,934

6,371,472

4,955,731

4,189,790

Net Interest Income

5,745,930

5,351,885

4,687,099

4,550,012

3,665,383

3,026,586

2,657,732

Non-Interest Income

3,768,341

3,014,581

2,297,859

2,570,922

2,706,089

1,929,145

1,532,058

Table 3

YEAR

Non-Interest Income

Operating Income

Non-interest income to operating income

2012

3,768,341

9,514,271

39.61

2011

3,014,581

8,366,466

36.03

2010

2,297,859

6,984,958

32.90

2009

2,570,922

7,120,934

36.10

2008

2,706,089

6,371,472

42.47

2007

1,929,145

4,955,731

38.93

2006

1,532,058

4,189,790

36.57

Table 4

Non-interest income is expressed as a percentage to total operating income. We can note that non-interest income accounts for a small percentage of total income whereas interest income is always more than 50%. Both have been increasing from 2006 till 2012 in terms of amount but in percentage term, non-interest income to operating income ratio was at its highest in 2008 and lowest in 2010. This is explained by the fall in dividend income and in profit arising from dealing in foreign currencies in 2010.

The Liquidity Ratio

YR

Loans

Total

Deposits

Total

Loans to deposits ratio

 

Banks

Customers

 

Banks

Customers

 

 

2012

2,287,026

127,396,940

129,683,966

2,776,618

138,032,675

140,809,293

92.10

2011

2,268,761

112,345,481

114,614,242

2,829,395

124,849,823

127,679,218

89.77

2010

1,940,302

101,743,388

103,683,690

3,067,436

121,878,417

124,945,853

82.98

2009

2,222,735

89,128,211

91,350,946

3,569,403

110,937,039

114,506,442

79.78

2008

1,568,519

70,325,172

71,893,691

2,373,015

95,173,010

97,546,025

73.70

2007

934,445

60,004,700

60,939,145

1,536,428

73,901,031

75,437,459

80.78

2006

54,944,098

54,944,098

997,600

68,210,975

69,208,575

79.39

Table 5

YEAR

Total Deposit

Total Loans

Difference

 

 

 

 

2012

140,809,293

129,683,966

11,125,327

2011

127,679,218

114,614,242

13,064,976

2010

124,945,853

103,683,690

21,262,163

2009

114,506,442

91,350,946

23,155,496

2008

97,546,025

71,893,691

25,652,334

2007

75,437,459

60,939,145

14,498,314

2006

69,208,575

54,944,098

14,264,477

Table 6

The loan to deposit ratio is a ratio expressing the percentage of loan to deposit, that is, 1: L where L< 1. Thus, after having gone through table 5, we can note that in 2008 the ratio is at its lowest whereas in 2012 it is at its highest. This is so because in 2008 there was an approximately 26.3% deposit more than loans thus reducing the ratio. But in 2012, there was more loans given out than deposits and the difference accounted for only 7..9% which was comparatively very low than that of 2008.

Capital Adequacy Ratio

CAPITAL ADEQUACY RATIOS (%)

YEAR

Capital & Reserves

Total Assets

Capital & reserves/Total assets

2012

21,463,578

173,596,447

12.36

2011

18,193,724

155,297,296

11.72

2010

15,531,896

147,363,963

10.54

2009

13,629,032

135,409,573

10.07

2008

11,720,309

117,355,234

9.99

2007

9,679,046

94,516,015

10.24

2006

9,833,735

88,003,572

11.17

Table 7

Despite that in 2008, the bank had had a very low ratio, it improved considerably the following years till reaching its highest in 2012 with 12.36%. The rise in capital and reserves was due to increase in share capital and retained earnings.

Investment Ratios

INVESTMENT RATIO (%)

YEAR

Earnings yield (%)

Price earnings ratio (times)

Dividend yield (%)

Dividend cover (times)

2012

10.2

6.35

5.32

3.6

2011

10.1

5.30

5.75

4.2

2010

10.1

9.9

3.7

2.7

2009

13.3

7.5

4.2

3.2

2008

9.1

11

2.6

3.4

2007

9.5

10.6

2.8

3.4

2006

13.2

7.6

3.8

3.5

Table 8

After analysing thoroughly the ratios, we can conclude that the bank has been resilient to the recent financial crisis despite that in 2010, it had a low performance. In order to protect itself, different strategies have been used. Firstly, the diversification strategies, where there was a pursuance of ‘Bank of Banks’ strategy to meet the outsourcingneeds of regional banks and MCB diversified its services for its non-banking component.

Secondly, it reinforced its brand image with refreshed visual identity as wellas a goodvision and mission statements. It also enhanced setting out of branchnetwork; digital screens promotingthe visibility of the Bank’s offerings and it launched of new product bundlesfor the up-market customersegments. The MCB financed landmark projects, supported SMEs and improved its Internet Banking service adding new features. It enforced its capital adequacy and contributed more to the sustainable development.

5.4 Simple Regression Analysis

To enforce our view on whether MCB has been affected by the crisis, a simple regression is carried out. Furthermore, this analysis takes into consideration the lacking elements in carrying a ratio analysis and supplement the research. The model that is considered is as follows:

,

where, the endogenous variable i, j,t Y is defined as the change in the annual real growth rate of banking institution i that is MCB in country j, that is in Mauritius between 2006 and 2012. The equation includes the bank’s dummies () and the following variables measured in 2006; and representing the performance and capital adequacy ratio. Initially we estimate this specification by ordinary least squares and decide whether the bank is affected or not.

Source

SS

df

MS

Model

133.564492

3

44.5214972

Residual

3.62964783

3

1.20988261

Total

137.19414

6

22.8656899

Number of obs

7

F (4, 2)

36.80

Prob> F

0.0072

R-squared

0.9735

Adj R-squared

0.9471

Root MSE

1.0999

AG

Coef.

Std. Err.

t

P>|t|

[95% Conf. Interval]

L

-.2341025

.8071081

-0.29

0.791

-2.802681

2.334476

INV

.1704978

.1562405

1.09

0.355

-.3267292

.6677247

IC

1.495739

.9123783

-0.25

0.200

-1.407856

4.399334

_cons

-6.174302

3.007604

-2.04

0.133

-15.74584

3.397235

The results can be written in regression equation form as:

AG=-6.17-0.23L+0.17INV + 1.5IC , where

AG= Annual Growth

L= Loans

INV= Investment and

IC= Interest income

From the equation, we can understand that loans do have a negative or indirect relationship on the annual growth of MCB whereas investment in securities and interest income are directly related to annual growth. But how far is this explanation justified?

In order to prove that any dependent variable has significant impact on the independent variable, their p-value should be p<0.05 and if p >0.05 then it is insignificant, meaning that it does not affect the independent variable.

Here, when we consider the p-value for L, we see that p=0.791 > 0.05, thus, it did not affect MCB’s performance amidst the financial crisis. This is so because when banks in

Mauritius, more specifically MCB has not been over generous in giving loans. It always had a very strict requirement for loan purposes. Therefore, loans did not affect it.

Considering the other two factors, we also note that both are insignificant at 95% confidence level. Their p-value are p=0.355> 0.05 and p=0.200> 0.05 respectively, showing that they equally do not affect the performance of MCB. The simple reasoning behind having all these factors turned to be insignificant is that the MCB does not have any exposure to any toxic assets.

Therefore, we can say that banks in Mauritius have not been affected by these variables but there may be other variables that could have affected their performance. We can say that banks have been slightly affected because when we have computed ratios we saw that in 2010 MCB’s had a slowdown in its performance.

CONCLUSION

The financial crisis of 2008 underlines the need to review the regulation of risk managementof banks, but also of bond insurers and the reporting activities of credit rating agencies. Thecrisis is a serious threat to financial stability that has already required cash injections into the global economy, with inflationary implications. The crisis was initially the product of risk management techniques developed by banks to conduct business despite Basel II restrictions. Many banks were affected but very few have been able to remain resilient.

Although the crisis started in 2008, banks in Mauritius have experienced a lagged effect and have been affected in 2010. But remedial actions have been taken immediately and thus, today they are performing in a ‘nearly’ healthy environment and are innovating and diversifying their range of services. The Bank of Mauritius has also granted the Islamic banking patent Shari’ah compliance in 2009 to a Century Banking Corporation and to HSBC. The objective behind this was to prevent banks from being affected by the crisis. Islamic banking is said to have been remained unaffected during the crisis and thus, many banks around the world have been adopting its principles.

Finally, what can be concluded is that the Mauritian Banking sector has been resilient till now to the effects of the Global Financial crisis. This may be partly due to the fact that that our banking sector is not involve in trading the toxic assets and partly due to the fact that the lagged effect of the crisis has curbed its impact and has allowed the banks to be more proactive and take appropriate measures.