On one thing, however, economists will all agree: that reforming the financial sector is undoubtedly one of the crucial prerequisites of embarking upon a path of efficient, market-oriented economic growth. At the heart of such a growth process lies the allocation of resources by linking savings to investment. By performing this essential task, financial markets work as the "brain" of the economic system, the central locus of decision making. If they fail, not only will the sector's profit be lower, but, more importantly, the performance of the entire economic system will be impaired.

Bangladesh has come a long way in implementing market-oriented reforms including in the financial sector. As economic liberalisation replaces rigid control, a new more marketed-oriented, but more sophisticated, kind of economic and commercial regulatory framework needs to be put in place. In the financial sector in particular, there needs to be a delicate balance between regulation and entrepreneurial freedom. Much of the present malaise in our financial sector can be attributed to the fact that we went for liberalisation without providing for adequate regulation and supervision. The country's nascent stock market was greatly damaged by the end-1996 episode of phenomenal boom and bust; it was mainly created by the machinations of some unscrupulous share-traders who took advantage of the laxity in regulation.

In commercial banking, interest rate deregulation along with the setting up of banks in the private sector has not led to the desired result from market competition. The spread between the average deposit and lending rates of interest, currently as high as about 7 percent, has, if anything, increased instead of decreasing. This high interest rate spread is explained by the high rates of loan default, which raises the cost of financial intermediation, while the relatively efficient private banks, including the foreign ones, can reap excess profits. In order to attract deposits, some private banks are increasing their rates of interest on deposits, which in turn make them lend to high-risk borrowers at higher lending rates, thus jeopardising the long-term financial health of those banks. Market competition provides, at best, limited discipline. The East Asian experience shows that a mildly positive rate of interest on deposits in real terms (that is, after accounting for inflation) is good for economic growth, but high lending rates of interest are not. It is worth mentioning that in the West European industrialised countries, interest rate regulation in some form or another existed even as late as the early 1980s.

The nationalised commercial banks are burdened with huge problems requiring fundamental structural reforms. Their management is weak, corruption and fraudulent practices are rampant, the quality of staff is extremely poor, they are burdened with huge excess manpower and there is undue political and trade union influence vitiating their entire management culture. The problems of the private banks are of a different nature. Their main problem has been the large-scale "insider lending", with some sponsor-directors simply plundering away depositors' money. It is only after the central bank could enforce some measure of regulation on the behaviour of the sponsor-directors that the loan default rates in the private banks started to generally improve. So far, Bangladesh Bank has successfully contested in court to remove as many as 53 bank directors for being loan defaulters and eight others for indulging in other improper practices. Many of these directors even refuse to comply with the regulation that their defaulted loans be adjusted against their shares held with the banks.

Although the private banks now account for nearly a half of the country's banking business, the state-owned banks still play the major role in rural banking and in providing term loans for industrial investment. In our financial system, there is a "missing middle" between microcredit and formal banking, so that small enterprises are the most credit-starved part of our economy. In respect of term lending, the banking sector generally suffers from weaknesses in investment appraisal capability. These are difficult problems with no readymade solutions, and we need to have a road map to address them.

The stock market can be a source of investment finance and there is undoubtedly a need for reviving it. I do not however share the belief held by many that the stock market can and should replace commercial banking as the major source for raising funds for investment. It has rarely happened elsewhere. In the developed industrialised countries, only a negligible fraction of investment funds are raised from new equity or bond issues. The stock markets there resemble more like a gambling casino where individuals trade in risks. Even in the emerging economies, such as those in East Asia, bonds and equity have accounted for a lower share of investment finance, compared to both profit retention and bank finance. Nevertheless, in a newly industrialising country, a vigorous, well-regulated stock market can play an important role in raising investment funds both domestically and from abroad.

Very recently, the government has taken a number of important regulatory measures in further consolidating the financial sector reforms. These measures are to do with strengthening the legal procedures for loan recovery, rationalising the criteria for loan rescheduling particularly to discourage habitual loan defaulters, facilitating the cleaning up of the banks' balance sheets through loan write-offs, beefing up the capital base of the banks, and taking measures towards making the bank boards more accountable and competent. The boldness of these reforms has taken many by surprise. It should be realised that the strength of these reforms lie in their being based on home-grown ideas based on a realistic assessment of our own circumstances. We should view this reform process as a continuing, evolving one -- a learning-by-doing exercise, where further modifications can always be made if need be.

A "fit and proper test" has been introduced for qualifying to be a bank director. In fact, most countries impose restrictions on who can own a bank, so as to ensure that the owner-director should have a minimum level of expertise and should not be a person who has a record of abusing trust. Unfortunately, political affiliation rather than the professional track record of sponsor-directors has often been the criterion for granting permission to open new banks.

The minimum required paid-up capital of a bank has been raised from Taka 20 crore to Taka 100 crore (the comparable figure for Pakistan, for example, being Rupee 100 crore). The logic of such a measure along with ensuring capital adequacy is not often well understood. In addition to other regulatory measures, it is a means of indirectly influencing the incentives or motivations of owner-directors. The larger are their investments in the bank, the higher are their stakes in seeing that the bank is run profitably. Consequently, they will be less tempted to secure personal gains to the detriment of the bank's interest or even to plunder their own bank as some of them have done in the past.

As for the recently introduced regulations regarding the size of the bank boards and the length of tenure of the directors, let me make a general comment. I agree that there should not be too abrupt changes and that any transition process should be a smooth one. At the same time, owner-directors should have no legitimate interest in the running of their bank except to ensure that they get fair returns from their investments. It is, therefore, in their own interest to see that the bank directors are competent enough to carry out their responsibility. How can having sons and daughters and daughters-in-law on the board, irrespective of their expertise, serve that purpose, unless there are some hidden agenda? Public companies should not be looked upon as family businesses, more so in the case of banking companies where the depositors' interests are involved. In a recent survey of bank regulation in more than one hundred countries, in 80 to 90 percent of the cases, the regulatory authorities are found to have wide-ranging powers regarding bank restructuring and reorganisation, including the removal and replacement of management and directors and superseding of share-holder rights (Papers on Financial Services, Brookings Institution Press, 2001).

Auditing standards are crucial to improving corporate governance, whatever reforms in the regulatory framework may be introduced. Sound accounting practices are needed not only to ensure compliance to regulation but also to accurately assess the net worth of banks; since if the true net worth is negative, the government may be left holding the bag in the event of bank closure. The Institute of Chartered Accountants in Bangladesh (ICAB) deserves credit for its efforts in raising the accounting and auditing standards in Bangladesh by adopting the international standards. The ICAB may now consider taking steps, through legal provisions and professional self-disciplinary measures, to ensure mandatory compliance of the adopted standards by all its members. This may require, among other things, amending the Bangladesh Chartered Accountants By-laws 1973.

Global experience shows that mere transplanting of standards from outside will not produce the desired outcomes unless steps are taken to address the fundamental weaknesses of corporate governance. Much depends on the structure of incentives regarding financial reporting and disclosure. To get decent data, there must be a demand for it among creditors, managers, investors, and others who act on the basis of accounting information and a reliable means of penalising those who make fraudulent disclosures. For example, if corporate businesses are run as family-owned firms, the informal "insider" information will tend to displace the demand for arm's-length, objectively verifiable financial disclosure.

Reliable external auditing is supposed to be the main vehicle of independent oversight on management by the company boards. The owner-directors of banks should therefore demand such auditing in their own interest for the sake of transparency, unless they have things to hide. It seems curious that some bank boards have been rather negligent in ensuring a sound system of internal and external auditing in their banks. Bangladesh Bank has already made it mandatory for banks to follow international auditing standards. Suggestions have now been made to make such auditing even more rigorous, particularly in providing more in-depth information regarding financial risks and in revealing the so-called "related party transactions" (that is, transactions with entities in which bank directors have an interest).

It has also been suggested that the audited reports of the banks need to be more widely publicised and that the financial fundamentals of the banks in a capsular form may be displayed in every bank branch. Surely, the public has a right to know where their deposits are safe, since only up to one lakh taka of deposits are currently insured. This will help a healthy competition, since the banks will be able to attract deposits on the basis of their established reputation -- as some foreign banks do -- instead of having to engage in a warfare of bidding up the rates of interest on deposits.

Lastly, I should emphasise the role of moral and ethical standards of behaviour in corporate governance. The market economy, particularly the financial markets, cannot function without trust -- trust that contracts will be honoured and that the money lent by one party to another will not be stolen or diverted to illegal purposes. The incredible accounting frauds involving the US corporate giants like Enron and WorldCom that led to the loss of billions of dollars worth of investments by ordinary shareholders revealed the ethical bankruptcy of a large part of corporate America. This is a reminder that bookkeeping is not merely a numerical exercise -- that the auditors and accountants must be alert in detecting the red ink on the moral balance sheets as well. Let our accounting profession not share the blame that is attributed to economists: that they know the price of everything and the value of nothing.

Wahiduddin Mahmud is Professor of Economics, University of Dhaka. The article is based on his keynote address at the 30th Foundation Anniversary of The Institute of Chartered Accountants of Bangladesh (ICAB), May 27, 2003