Why do central banks regulate commercial banks and not that of, say, bakeries? This was the fundamental question Giorgi Kadagidze, a former governor of the National Bank of Georgia, tried to answer during his presentation for ISET students, faculty, and executives enrolled in ISET’s Finance for Professionals course on Tuesday, March 15.

According to Mr.Kadagidze, banks, unlike bakeries, operate with other people’s money. They are taking deposits and are transforming them into loans. Mr.Kadagidze used an ordinary balance sheet to demonstrate some of the basic principles of banking regulation: “fit and proper” (essentially to make sure that a bank’s shareholders and principals are not thieves); capital adequacy (how much own capital does a bank has to compensate depositors in case some of its loans go bad); asset quality (for instance, are loans too concentrated in a particular sector), and liquidity (does the bank have enough cash to handle an increase in short-term obligations).

To illustrate the need for National Bank’s intervention, Kadagidze used the example of Georgia’s Intellect Bank which went into bankruptcy under his watch in 2006. To protect depositors, the National Bank agreed to transfer Intellect Bank’s assets and liabilities to the Bank of Georgia. Mr.Kadagidze attached crucial importance to a Central Bank’s independence in order for it to make the right decisions at the right time.

Giorgi Kadagidze took questions concerning the recent lari appreciation, deposit insurance, and the National Bank’s intervention in the Forex market. Additionally, he addressed questions about the regulation of micro-finance organizations and emerging online lending operations. According to him, micro-finance organizations should not be regulated as long as they do not receive deposits. Rico Credit has recently come under National Bank’s regulation precisely because it started accepting deposits. Finally, he discussed the puzzle of the stability of the share of non-performing loans in total loans. In his view, many borrowers benefited from a sharp decline in the prices of oil and other global commodities, which compensated for the increased costs of servicing USD loans.