Public banking anyone?

Jan 04, 2009 Features / Columnists, Ravi Dev

The financial crisis in the developed economies has spurred a vigorous debate about the very nature of the banking industry that is at its epicentre.

The de-facto nationalisation of some of the largest banks in the world that was forced upon the governments of the US, UK and several other European countries has brought to the fore once again the old debate about the role of governments in the financial sector – including that conferred by ownership.

In Guyana, back in the ’70s, the PNC had launched the Guyana National Co-operative Bank (GNCB) as a public bank, competing with the several commercial banks then operating, and the Guyana Co-operative Agricultural and Industrial Development Bank (Gaibank) as a development bank, securing its funds from grants and loans from the international community.

In the ‘80s the government effectively assumed control over the entire banking industry through varying levels of nationalisation of the private banks.

The rationale offered for our massive government intervention was same as is being touted now in the developed world – market failure, albeit of a different type.

In our case, GNCB as a public bank was responding to the unmet need for a more distributed and accessible banking system while Gaibank was intended to fill the endemic financing gap for targeted entrepreneurial activities left unattended by the commercial banks.

The market failure sought to be corrected in the present meltdown is the credit-crunch consequence of the inability of the market to value the “toxic assets” held in the portfolios of all their major banks.

Our system quickly degenerated into a classic, criticised “repressed” financial system in which the government maintains artificially low interest rates, inducing an excess demand for credit which the government must now allocate.

The low interest rates (effectively so when the high inflation rates were deducted) became an effective disincentive to savings and combined with the inability of the government to borrow internationally, eventually resulted in low investment and thus low growth.

This situation was exacerbated by all the other potential negative features of development banking: cronyism, rent-seeking and corruption by bureaucrats, misallocation of funds in misconceived schemes etc. By the eighties we had reversed into negative growth.

When we entered into a Structural Adjustment Program (SAP) in 1989 with the IMF, we accepted the other model of a financial system – one that was totally privatised and “liberalised” – putatively subject only to market forces with government reduced to a “non- distorting” regulatory role.

The privatisation of our banking system, including the dissolution of Gaibank and the sale of GNCB, was energetically pursued by the PPP government after they took office in 1992.

It is rather ironic that the PPP has been subjected to sustained charges of corruption after they willingly divested the most lucrative potential source of graft.

We have now experienced over a decade of an ever increasingly liberalised financial system – both in the world at large and in our own Guyana.

Externally, we have seen to the world’s present peril that a participatory of government is vital in the financial sector: the social function of overall national development that necessitated the invention (and the ongoing maintenance) of the banking system will inevitably be eroded and vitiated by the workings of unmediated human greed. A system driven only by the profit motive cannot do otherwise.

While we have been spared the worst excesses of the slide into financial depravity experienced up north – through our relative “underdevelopment in financial instruments” – we have, on the other hand, unfortunately also not witnessed any turnaround in banking efficiency or the financial intermediation necessary to foster growth of our economy.

Our privatised banks have maintained and even extended the dispersion of branches into the countryside but these have been deployed to more efficiently trawl for deposits rather than for disbursing more loans.

In this former task, they have been singularly successful but in their reluctance (even refusal) to service the domestic entrepreneurial potential necessary for our development, they have piled up billions and billions of dollars lying idle in their coffers.

Theoretically, in the financial liberalisation model, the private banks were supposed to have competed with each other to lend the funds secured from deposits leading to the lowest possible rate of interest and still make a profit over the rate offered to attract deposits. It was to have been the best of both worlds but it never reached Guyana.

Rather than leaving the financial market to do what was necessary to clear itself – offering lower rates to borrowers – the government, upon the IMF insistence, offered the banks a way out: Treasury Bills.

The banks then simply lowered their rates to depositors so that they still made a profit and we got the worst of both worlds – lower rates for depositors and the highest rate for borrowers.

To rub salt into the wounds of taxpayers, the government pays the banks billions in interest every year for the pleasure of keeping their money locked away – “sterilising excess liquidity”! The “spread” – the difference between the deposit interest rate and the lending rate – has always been in double digits.

The banks were being rewarded for not doing what justified their existence in the first place – taking risks to lend money.

The IMF was forcing the government to facilitate market imperfection squared! What did it matter if no new business could be set up if they had to service loans at 20% interest?

In our considered judgement, and one we have been promoting the longest time, we threw out the baby with the bathwater when we closed down our development and public banks.

The raison d’etre for those institutions is even more evident – and necessary – today, when our rate of growth has stagnated at less than one percent over the last decade.

We have emphasised that contrary to what the IMF and its guiding ideology stipulated, there were, and are, numerous examples where public banking – either in conjunction with its private counterpart or alone – have been successful in achieving the goals of industrialisation. Historically, as late developers, there has been first Germany and then Japan, followed by Korea and Taiwan and now China where public banking was, and is, dominant.

Even India, which had of recent begun to embrace liberalisation, has now recanted and is extolling public banking. We simply have to rectify the downside risks inherent in government ownership, which in our case, having tried the model, can be easier identified.

Surely the IMF cannot complain now that nationalisation of banking is being practiced in the heart of the Washington Consensus. (To be continued.)