Moral hazard and our RMG industry

This article was published in the Dhaka Tribune on May 7, 2013 in the opinion segment. Here is the link.

Risk and reward should ideally go hand in hand. If we take excess risks, and it leads to success, then the reward is usually high. However, when excessive risk results in something bad, we must be ready to bear the costs of that decision.

In economics, “moral hazard” refers to a situation where one party takes excessive risk because that party knows that it would not have to bear the costs of that risk. Such an environment promotes excessive risk taking which is usually detrimental to the whole society and the economy.

The best recent example of moral hazard is the US government’s bailout of the financial sector that fell into problems after the sub-prime bubble burst. The financial sector had earlier taken huge risks in real estate and also reaped the benefits through huge profits and personal bonuses. However, when things went south, they got bailed out by the general people of the country.

What does RMG have to do with moral hazard? A lot, actually. The typical RMG factory owner knows that if there is a problem in their factory caused by their negligence (Tazreen Fashions and Rana Plaza are both cases in point), their associations will come to their rescue. So by giving less attention to worker safety they are able to lower some costs and take higher risks because they know they will be bailed out.

The other interesting information that I came across was that banks have decided to raise around Tk1bn for the Savar victims.The newspaper article mentioned that they did it on the request of the central bank. A few might have taken initiatives at their own discretion but I would contend, for most, the central bank request had a lot to do with it.

Why should banks pay for a mistake made by garment factory owners or building owners? Even though some people believe that banks should be more responsible before lending to organisations, I think that banks should stick to their core operation. The responsibility of checking whether a building meets construction standards is not the core operation of a bank and thus should be left to relevant authorities like Rajuk. Banks are already in a fragile situation due to loan scams, political problems, real estate slowdown, etc, and asking them to pay for others’ mistakes is a recipe for disaster.Tomorrow if banks get into trouble, who will bail them out? Of course it will be the average citizen of the country who did nothing wrong.

Being an optimist I honestly believe that most of the factory owners do care about the safety of their employees. It is a few rotten ones that are causing the image crisis we presently face. But we can still blame BGMEA on the grounds that they are not penalizing the rotten ones for their failures.

So, it is the responsibility of the factory owners, the foreign buyers and the BGMEA to pay for the rehabilitation of the victims and not the responsibility of banks. Of course people are free to donate of their own free will but making an innocent group pay for the mistakes of other people will only exacerbate the problem.

Asif Khan, CFA

Asif Khan is presently a Research Analyst (Financial Sector) for Exotix which is a frontier market focused investment bank. He has more than 6 years of work experience as equity analyst in both buy and sell side roles across Asian frontier markets. Asif is a CFA Charterholder and has a dual major in Finance & Economics from North South University.

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