In the banking system of Guyana, Caribbean economies and many developing economies there is a surfeit of liquidity. This column examines this phenomenon so as to set the stage for a later issue that will interpret the idea of Caribbean convergence that was recently revived by Mr Winston Dookeran, Minister of Foreign Affairs, Trinidad and Tobago. Excess liquidity is seen as a puzzle because instead of earning a higher interest rate on loans or some other domestic or foreign security, commercial banks hoard large amounts of liquidity in excess of the amount they are required to hold. Economists have invoked the concept of risk as a primary determinant of excess liquidity, which is made up of excess liquid assets (Treasury bills) and excess reserves – which in most countries including Guyana pay zero interest rate. The idea is an increase in risk – whatever its source – would motivate banks to hold higher levels of liquidity. This is obviously plausible, but it does not tell the whole story.
In spite of the fact that commercial banks could earn over 11% by lending to prime borrowers