The previous column discussed several important roles of banks in a society. These roles are universal and apply to banks operating in developed or developing economies alike. Financial intermediation is yet another essential role of banks. In this crucial function, banks mobilise the savings of households, businesses and governments and channel these to those who need to invest in business or purchase large consumer items such as a car.
Banks are not the only financial institutions which perform the function of intermediation, however. This can also be done by finance companies, credit unions, mutual funds and others. Furthermore, financial institutions are not the only agents in an economy that intermediate between those who have an excess of funds (savers) and those who have a shortage (investors and buyers). Financial markets can also perform this task.
There is a vast array of financial markets. The degree of complexity ranges from one country to the next. In general, the more advanced economies such as the United States, Canada and United Kingdom tend to have very large and active financial markets. Germany, South Korea and Japan, for instance, have active and broad financial markets as well; however, they also depend relatively more on bank financing of businesses compared with the USA and UK.
On the surface, when we discuss financial markets we mean a set of money markets such as the interbank market where commercial banks borrow and lend each other reserves (the starting point of monetary policy); market for commercial papers (used by big businesses in the USA to smooth out cash flow in the short run); and the market for Treasury bills that the government uses to meet its short-run cash flow needs. These are not the only money markets – so named because the securities all mature in less than one year – but they are the most important ones for our discussion in this series.
Financial markets can also be classified as capital markets because the securities traded in said markets will mature in one year or longer. Some never really mature, such as stocks, unless the company fails or decides to change itself from being a publicly traded to a private entity. The United Kingdom has a set of bonds known as consols that do not have a set maturity. These never-ending government bonds will only come to an end if the government chooses to pay them off.
The most popular and most-watched capital market is the stock market. The stocks or shares are held by many investors ranging from individuals, pension funds, mutual funds to Sovereign Wealth Funds. Once the stock market is well-regulated and cheating is policed, the prices in this market will tend to reflect information in the public and even private domains. The prices could also foretell the state of the economy.
However, the stock market is not the most significant source of initial business financing in developed economies, let alone developing ones like Guyana and the countries of the Caribbean. The largest capital markets are the bond markets, comprising both government and corporate bonds. In well-developed, liquid, and properly-regulated bond markets, the yields (or market-determined interest rate) tell an important story about the state of corporate and government finances, as well as the future health of the economy. Of course, these yields can also be subjected to misinformed speculation as we see from the rating agencies of the US trying to rate the sovereign debt of emerging and developing countries. Often the analysts based in New York or London view other countries through a very narrow perspective given the way their undergraduate economics and finance programmes were structured. However, this should not detract from the important functions of bond markets.
In the case of Guyana, most financial intermediation to businesses and individuals takes place through commercial banks and a building society. Historically, the banks loaned out funds to well-established businesses with a long track record. However, they have ventured out more into personal loans, but tend to be a lot more reluctant to lend to small businesses. Bank loans to individuals for housing and motor cars have trended upward in the past ten years. As at end March 2021, the banks extended G$167.02 billion to the domestic private sector. Of that total, G$32.83 billion was made to individuals for home improvement, buying motor cars and other consumer durables, paying for education, and financing a few other big personal expenses. Although not classified as a commercial bank, the New Building Society (NBS) has consistently expanded loans for home ownership. For instance, NBS made G$23.5 billion in mortgage loans in 2011, G$42.1 billion by end of 2019, and G$43.02 billion at end of March 2021.
Banks choose to lend mainly to established business borrowers because of the endemic free market problem of information asymmetry, which I explained in the previous column. It has nothing to do with systematic racial discrimination. The racial discrimination bogeyman is used because our political leaders since the days of the ERP have simply failed to preserve the structures (some formed during the Burnham years) that would allow intermediation to first-time business owners. The banks have been more willing to support broad-based home ownership across the political divide. And when some of these political leaders had the chance in 2015 to address this problem, plaything economics like village economies was the talk in town.
Having mentioned the nebulous village economies, I want to make it clear that 2015 to 2020 was in no way a complete economic failure as some claim. There is simply no support in that data to show that 2015 to 2020 was a complete failure. Even the numbers presented show there was a consistent increase in home ownership, which clearly does not indicate a structural failure.
Plaything economics, however, will only produce a surplus of one-man ‘businesses’ that earn thin subsistence margins – against which banks will not be convinced to lend. In the modern era, entrepreneurs often emerge after being managers or supervisors inside a large existing business. Once knowledge of enterprise methods, supply chain, and market access is gauged, it becomes easier to spin off a new business.
In the free-market United States, the government actively funds new entrepreneurs. For example, the Defense Advanced Research Projects Agency (DARPA) is a low-keyed, almost secretive, government agency that funds promising scientific ideas that will both boost national security and have commercial applications. Therefore, someone with a PhD in computational biology could set up a company, employ seven people, and gain government contracts to test out new ideas. This is how the mRNA vaccine came about so quickly. The government was funding the applied part of the research for over a decade after the academics figured out the basic theoretical mechanisms of the mRNA. The Moderna and Pfizer vaccines did not emerge in one weekend as some said in pop media. Moderna is now a publicly traded company that employs more than 780 high-skilled people after it recently saved thousands of lives.
I am not saying the exact model can be replicated in Guyana, but plaything economics won’t do it either. Perhaps there is a role for some village economies in the form of sustainable heritage tourism. This still has to be tied into a broader economic network across the economy. Moreover, they would want to preserve the village heritage in some key areas. It seems like sugar production will be completely gone much like the degrading of the museums and art galleries. I guess it is okay to import Guatemalan molasses for Demerara rum.
On the other extreme is the unbalanced growth application of the Jagdeoian PPP. Unbalanced growth is not nefarious in spite of its name. The idea goes back to Albert Hirshman. The modern PPP application holds that if there is an excess supply of electricity (Amaila, natural gas, etc.), then there will be an excess of demand for entrepreneurship in other parts of the economy – hence, the initial unbalanced focus on power generation results in active entrepreneurship in other parts of the economy. I have my doubts, which have been expressed in my columns and academic research since 2009. I cannot repeat them here.
In the next column, I will address the question of whether lowering interest rates will stimulate bank lending and profit in Guyana.
Comments can be sent to: tkhemraj@ncf.edu
