Republic Bank, in a brave move, has announced its intention of taking the former Barbados National Bank in to wholly-owned control. The announcement has led to a muted discussion among some Barbadians, with the professor of economics at Cave Hill, Michael Howard, ‘advising’ local shareholders to sell to the foreign owners.
Apart from the principle of clean hands, the professor’s advice, which also includes keeping the local subsidiary out of the hands of the government, appears to lack any real understanding of banking and its role in intermediation and, even more, economic growth. It is silly advice and should be ignored. Of course, there is no doubt that Republic Bank has behaved impeccably in its dealings both with the Barbados Stock Exchange and investors, but with other unscrupulous operators there is every opportunity in such a move to undermine shareholder value. Is the acquisition going to create value? What about cultural differences, or are they saying Barbadians and Trinidadians share a common culture? What stress and prudence tests have been applied? Retailing banking has reached such a comfortable state in the Caribbean that it is difficult to find common performance measures of success.
We know, for example, that customer satisfaction is not a measure shared by the former BNB, since Republic Bank neither formally informed all its account holders when it took control of the bank, when it changed its name, nor of its intention to buy out minority shareholders. In simple terms, it could not give a hoot what Barbadian shareholders think about their management style.
As to motivating its employees, shortly after then prime minister Owen Arthur told a London audience at the Lambeth Town Hall of the decision to sell off the bank, I had a discussion with a middle manager in the Independence Square branch and she told me they got the news from the CBC 7pm news. So, there is no real reason to assume that The Republic Bank would pass any efficiency test. Part of this perceived institutional arrogance (or incompetence) is an assumption that the servicing of small businesses, the drivers of economic growth, such as cash management, assisting businesses to focus on treasury funds, is not a priority for the Trinidadian-owned Republic Bank.
But the real issue is that The Republic Bank has not apparently spelt out its medium or long-term strategy apart from announcing a thirst for expansion. Nothing is said about the management of risk, which is the fundamental issue facing the wider Barbadian economy, and in particular the hotel and leisure sectors and households. What is the purpose behind the acquisition of all minority shares in the former BNB?
Until these questions are answered the Financial Services Commission should keep a wary eye on developments.
Retail banking is not just a commercial business, it is also a central part of national security, which is why the Pentagon and CIA in the US and GCHQ in the UK, the principal western intelligence and military agencies, take such a close interest in financial services. In short, Barbadians cannot just sit back and assume that the foreign owners of local banks have the national interest at heart. The absence of a Barbados-domiciled retail bank is not only a serious blow to the financialisation of local businesses and households, the key drivers of prosperity and economic growth, it also reflects the paucity of our economic policy-making and the lack of strong demands from a powerful consumer and business organisations.
In large measure, the rather careless claim by some officials that Canadian-owned banks are a benefit to the island is not only an example of regulatory ignorance, but of the lack of confidence in locally designed bank regulation and supervision.
One of the first lessons in financial analysis is the search for the red flags that companies use to bury bad news. It means dredging through annual reports, separating the dross from the substance, erasing all the nonsense about how philanthropic the chairman is and what wonders the company does for the community, and looking for the bodies buried in the audit report and senior executives’ statements.
It also means forensically examining the waffle surrounding the massive turnover of the company, yet when it comes to paying corporation taxes, declaring a loss. What separates a financial analysts or journalist from an accountant is that whereas an accountant searches for ways of fiddling the tax authorities, or as they would put it, avoiding unnecessary taxation, the others look for ways of exposing them.
Preparing consolidated accounts is one of those grey areas in accounting that financial analysts, forensic auditors and journalists particularly focus on; it is like a financial grave yard, lots of bodies, many of them unmarked. The professional bodies, both GAAP and the IFRS, even have a different set of rules for accounting for subsidiaries whether wholly or majority-owned.
Let us take, for example, a retail bank, especially a cross-border one, which wants to shift money from one jurisdiction to another, by hoodwinking the tax authorities. One simple way of doing this is by owning 100 per cent of the subsidiary; in this way, management accounting methods can be used to shift costs, repatriate funds and readjust the balance sheet without any external persons having a clue. Of course, Republic Bank will not do any such thing, but it is something regulators must consider.
One way of shifting costs is through the movement of senior managers and executives, often as a career move, but in the majority to carry out specific tasks. In reality, the firm takes responsibility for costs, such as accommodation, travel, etc, which are written off against taxation; what should not be is salary, since few transfers, permanent or temporary, involve changes in pay. However, for internal accounting purposes, management accountants could put salary costs down to any number that comes in their heads.
Let us say, for example, that the management accountants double the salary of the manager, it means that the other 50 per cent increase is shifted from the subsidiary in one jurisdiction, to in most cases the home office, to be used as the executives and senior managers see fit.
Or, take another example, if head office wants to develop its loan book without leveraging; one way of doing this is by shifting liquidity from the periphery subsidiaries to the centre, not only neutralising the chances of local managers to manage, but also removing vital cash from local borrowers, including small and medium enterprises and households. Management of the loan book is important for retail banks.
Bernie Madoff, Stanford Bank and the other rogue firms and operators are not the only beneficiaries of creative accountancy. It is a black spot that the profession and policymakers have been trying to iron out since at least January 1970. There are the usual red flags to watch out for: the changing of reporting dates, the incentives executives have to boost share prices, if returns look too good to be true, quite often they are too good to be true; if a firm (or government) could borrow at lower rates and choose to do so at higher rates, then something is wrong; no one is that generous – all these and more add to the manipulation of the profit and loss accounts and the balance sheets.
One reason for this is the flawed short term demand on companies to report to stock exchanges and shareholders every quarter and to show growth in all these figures, whatever the circumstances, whatever the reality. The other distorting feature is incentivising senior executives based on this flawed quarterly report and its encouragement for chief executives and finance directors to cook the books in the short term (three years is now the average length of service) then move on, leaving some unlucky successor to clean the proverbial mess.
The regulation and supervision of retail bank subsidiaries and branches call for, part from everything else, highly sharpened forensic auditing skills, which so far have not demonstrated themselves outside the private sector in Barbados, or indeed most of the English-speaking Caribbean./
We only have to look at the hundreds of pages of documentation related to the Stanford Bank to see that, certainly in the case of Antigua, these skills are missing.
I have said in the past, and will again, that Barbados badly needs a new Companies Act, which not only provides extensive duties on non-executive directors, auditors, executives and directors, but which also details internal auditing transparency and the legal responsibilities of parent companies in relation to subsidiaries and branches. I also firmly believe that even though corporation tax is relatively meagre as part of major firms’ overall revenues, in most jurisdictions, companies still use the provisions of GAAP, IFRS and FRS to avoid paying taxation for many of their cross-border subsidiaries, on the grounds that they pay income tax, VAT and national insurance. Nonsense. Corporation taxes should be based on annual turnover, unless there is a compelling and transparent reason why not, and a negotiated settlement with the revenue authorities. Further, under current consolidation practices, apart from the fact it contradicts the implicit principle of true and fair undertaking, consolidated accounts are often anything but.
In instances when a majority-owned subsidiary is taken under wholly-owned control by the parent company, the subsidiary should be treated as a fixed asset investment at their carrying market value (including assets and liabilities) and, subsequently, that valuation should be used as a basis for ongoing accounting within the wider consolidated figures. Until there is a radical overhaul of the Companies Act, and of accounting practices to accord with international commercial behaviour, small economies such as Barbados will be susceptible to the sharp practices of international firms.
Analysis and Conclusion:
Since 1970 accountants organisations have been trying to put their house in order, so far, however, without any success. So much so, that inspite of the relatively new International Financial Reporting Standards, the US is still sticking to the redundant GAAP rules, and ignoring the rest of the world. Like most things, the US will either have to fall in line or it will be left behind still wallowing in the myth of its own supremacy. But, at the heart of general accountancy practice are other structural deceptions: writing down assets over a three year period, for example, while still retaining ownership.
For example, most companies buy new vehicles every three years, which they write down over a three-year period (the key reason why they sell), during which they deduct the cost before taxes (from you and I), then sell the vehicle at the end of that period and pocket the cash. They do this with computers, other office equipment, and so on. The biggest fiddle, however, is that of property ownership, which is often owned through debt, which is tax deductible. But they benefit from the increasing valuation of the property, which goes untaxed, while lev4eraging the property on a rolling basis. It is nothing short of fraud.
One other device used by high finance is the principle of carried interest, which in most GAAP/IFRS jurisdictions is tax free. Carried interest, quite often used by private equity, is often allowed to escape paying taxes on the basis that it is in fact based on debt and leveraging. We need new accounting rules forcing corporates to account on their balance sheets and income statements for every material asset, including depreciations.
In terms of regulation coherence and harmonisation, we have had nearly five years of chaos at Clico to inform us that there is no effective regulatory cohesion between the two jurisdictions, even if we play at being members of Caricom/CSME.
So, in the case of Republic Bank, we can confidently assume, that questions of capital ratios, financial distress, size of loans books, off balance sheet operations, securitisation, etc are off the agenda, apart from the requirements of the Basle committee.
As for the local business environment, it is incumbent on our policymakers, regulators and financial professionals to make sure that our accountancy rules are in line with the majority of the world and not just operating in the interest of a small, if influential, group of accountants and investors.
But it remains a discussion-free zone. Don Marshall, one of the few Barbadian academics audacious enough to enter public discussion on economic policy, recently suggested that Barbadian investors in Republic Bank (formerly BNB) should expand their share ownership, rather than sell to the majority share holder. He was contradicted by his colleague, Professor Michael Howard, in my view incorrectly on investment grounds alone, whose suggestion is for shareholders to sell.
In conventional financial economics Mr Howard is right: if a big buyer enters the market that intervention should drive up prices. But the situation in Barbados is not that conventional; it also reaches in to the dark areas of accounting practices, take over regulations and politics. Given this, I would rather suggest that Barbadian retail investors should sell their shares in The Republic Bank to the highest bidder, then the government should launch a Post Office Bank and all account holders in The Republic Bank should transfer their accounts to the new bank.
In simple terms, if the Trinidadian bankers think they could take Barbadians to the cleaners, they should be given a huge surprise. Finally, in any rule changes or policymaking, we must align taxation policy with accounting profits.