The commercial banks have been coming under pressure from the business community for not taking on more risk by extending credit to small- and medium-scale businesses, as well as start-ups. Mr. Winston Brassington made a similar call last week during a presentation titled: “Interest rate, Liquidity and Our Banking Sector” (SN: Sep 29, 2021). Mr. Brassington made several crucial points. For the purpose of this column and a few more I will write on the Guyanese financial sector, I wish to emphasise four. Firstly, the banks can expand loans by lowering the interest rate. Secondly, reducing interest rate and expanding credit would likely increase bank profitability. Thirdly, Guyanese banks are quite conservative in their lending. The persistently high liquidity levels were proffered as evidence supporting conservative lending. Fourthly, a credit guarantee system could assuage the fear banks have for not extending credit to the three classes of borrowers mentioned above.
Before moving on to what banks actually do in a society, let me clarify one matter. Commercial banks are not meant for lending to new business start-ups. Someone has got to assess that risk associated with entering a completely new venture. Usually this task is assumed by angel investors and venture capitalists. The task of financing new enterprises is also done by state-owned development banks where these exist.
Moreover, as a society, before getting to venture capital and such exotic financing methods, we may want to first ensure there is enough liquidity on the Guyana Stock Ex-change. An Excel spreadsheet with the historical time path of the composite index and all currently traded securities would be a good starting point, too. Nevertheless, it is nice to see that the stock exchange’s website was finally improved. We will return to the stock exchange in a later column in this series.
The loan officers at commercial banks are essentially doing two things. Firstly, they screen new borrowers to make sure they are not lending to gamblers. The new borrower is expected to enter the door with a good business plan, previous cash flow statements and sufficient collateral, among others. The latter screening is meant for addressing an inherent problem in loan markets known as adverse selection. The unfortunate outcome of a liberalised and privatised banking system, owing to the logic of adverse selection, is that not everyone who walks through the door will get credit. Some will be rationed out of the free market. Completely privatised health insurance free markets also work this way by rationing out the poorest and most sick – especially those with pre-existing conditions.
Secondly, once the borrower gets the loan, the bank has to monitor the borrower to make sure he/she is using the funds according to the agreed terms. The bank, for example, wants to make sure that a $5 million loan for business is not used for remodelling the home of the borrower. This is the problem of moral hazard, which is a well-known outcome in general insurance and loan markets. Banks have other important social functions such as pooling risk and safekeeping of deposits for families and firms. There are other useful social roles of banks, but we do not have space to outline all of them.
If the scientific notion of adverse selection tells us that not everyone who wants a loan will get one, then who takes care of the legitimate call for credit by small investors? It cannot be cooperatives. Mr. Brassington mentioned loan guarantees, but he did not go far in fleshing out this point in what was an otherwise enlightening presentation. Let’s take the so-called bastion of capitalism, the United States, as an example. The federal government guarantees a large percentage of mortgages made to families. It does not accomplish this objective by directly writing cheques to families. It has two government-backed financial institutions (development banking, anyone?) with strange names: Fannie Mae and Freddie Mac.
Fannie and Freddie often buy up the mortgages that community banks and other commercial banks previously made and are currently held as interest-earning assets. By purchasing the mortgages, the balance sheet of the commercial banks is freed from an illiquid asset that would be tied up for 30 years (previous mortgage loans). The banks then use the new cash injection from Fannie and Freddie to provide loans to other families who want to buy a home. Without these two government-backed agencies, the home ownership rate in the USA would be significantly lower – many who currently own a home would be renting. Asset or wealth inequality in America would be further lopsided had Fannie and Freddie not existed.
As a country, we did not think for ourselves. We followed the dictates of the IMF and World Bank and closed down our development banks and one large government- owned commercial bank: Guyana National Cooperative Bank. The development banks came under severe stress because of their foreign currency mismatch and the large currency devaluations. Instead of recapitalising the banks and professionalising the political influences, Dr. Jagan – who once hired the great economist Nicholas Kaldor to craft a budget – allowed the banks to fold operations. It was clear that the Jagan of 1992 was not the visionary critical thinker of 1962.
I personally do not believe government should be involved in commercial banking, which is perhaps a task better performed by the private sector. How-ever, there is a tremendous role for a development bank – perhaps focusing on the small- and medium-scale borrowers. It is a fact that these borrowers will come with a higher probability of default – hence, bank revenue and profit will decline as provisioning is made for bad loans. It is also important that the best new small businesses receive guaranteed assistance once certain performance standards are met. It is a social good that these borrowers obtain loans for enterprise because some, not all, will break out to become successful businesses. Private commercial banks that have to account to shareholders will not and should not be expected to perform this task. It is also possible that once a development bank is in place, it can share syndicated loans, thereby spreading risk, along with the private commercial banks. Loan guarantees will not be enough.
My critics will say that I am not considering the inefficiency and corruption in the Guyanese public sector. I concede that a substantial part of the Guyanese civil service is a battle ground for political espionage and sabotage. After all, I have written about the soft tit-for-tat conflict that has been playing out for decades. However, I prefer to ask the question how might the civil service move closer to the developmental state in the tradition of Peter Evans. How to achieve the embedded autonomy that Evans wrote about? It is possible to carve out some semi-autonomous government-backed agencies for the purpose of economic development. A skilled and independent board can be hired, a CEO who actually knows about banking and risk employed, as well as Chartered Financial Analysts and qualified economists.
My critics will reply, why has the Jagdeoian PPP refused to operationalise the Natural Resource Fund? After all, the Fund should be a model of semi-autonomous governance. My critics may have a point on this one, but I will write about the financial system, nevertheless. Today’s column set out some of the big questions that the next few will address. Does lowering the interest rate expand credit and increase (or harm) bank profit? How much money do the banks make by charging fees versus interest? How much in-come goes to depositors and what alterative might exist in place of the low deposit rates?
Does excess liquidity have anything to do with loans? How does the excess liquidity influence the foreign exchange market? What about the structure of loans, including non-performing loans? What are some recent trends in the Guyanese stock market? Does the price appear to be efficient or collusive? Finally, I will close the finance series with a discussion of crypto “currencies”.
Comments can be sent to: tkhemraj@ncf.edu
