Banking for Development

Jan 11, 2009 Features / Columnists, Ravi Dev

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Last week, we discussed the sad truth that even though we swallowed and followed for over twenty years the latest IFIs dogma in the quest for growth – “financial liberalisation”, among the other prescriptions of the Washington Consensus, our economy is still moribund as ever.

The privatisation of our banking sector failed to efficiently intermediate the savings of the populace into investments and – in contradiction to the predictions of “market fundamentalism”, which removed the government’s role by privatising the banking sector – saw, in fact, the government being strong-armed by the IMF to issue T-Bills to “mop up excess liquidity”!

In our estimation, while in general banks should be allowed to determine their own strategies– they cannot have it both ways: especially when taxpayers have to cover billions in interest payments to them annually; providing them with a risk-free investment option. In such a situation, believe that authorities have a legitimate interest in ensuring that those market forces do indeed function competitively: let the chips (and interest rates) fall as they may.

While the number of banks has increased after liberalisation, the predicted lowering rates for loans never materialised. There was also no effective pressure for lower rates as the two largest private corporations (Banks DIH and DDL) sponsored or affiliated with the new banks that took care of their financial needs. The strategic developmental opportunities needs of the country in agro-manufacturing, value added wood products, mega-agricultural farms etc were left languishing as “potential”.

Public sector intervention in an industry relates to its public good characteristics: while money is arguably not a public good per se, its availability for accomplishment of national goals clearly is. In our case, we cannot go on waiting for the private banking sector to screw up the necessary gumption to assume the risks for which they are granted the unique privilege of creating money in our financial system in the first place and the case may be argued for official intervention.

We floated the idea of a return of public banking and a development bank or public banking with a development window, to address the financing needs of a strategy of directed preferential credit for identified sectors/industries to jump start our growth rate.

We have to be very clear about the very different orientations between private and development banking. Private banks are totally profit driven while public and development banking temper that drive with a social perspective.

The difference has become very clear in the present financial crisis when the managers of private banks in their quest for maximising profits succumbed to greed as they switched from the original “lend and hold” principle to the “originate and distribute” model in banking. Public and development banking “subordinate the profit motive to social objectives and allows the system to exploit the potential for cross subsidisation. As a result, credit can be directed, despite higher costs, to targeted sectors and disadvantaged sections of society at lower interest rates.

This permits the fashioning of a system of inclusive finance.” The public banking managers, held to the socially driven standards were less prone to the excesses of their private counterparts and their banks have remained less adversely affected.

Of recent, recognising the inherent contradictions in private banking, there has been a move towards opening “community banking” window in several private banks. For example, the British Bank NatWest advertises: “Our Community Development Banking specialists can help you by: boosting access to credit in low-income areas; helping to provide access to finance for voluntary and community projects; backing social enterprise projects; developing alternative markets and strategies; promoting the role of banks in tackling financial and social exclusion. Through its activities, NatWest is committed to confronting the social, economic and political issues that stop us from becoming a society where enterprise is available to all.”
In Germany , the non-private sector is the dominant sector in the banking industry and ensures that there is sufficient liquidity in the oft overlooked small business sector through its policy of “Mittelstand”. Why should we be diffident about public and development banking? We need our own Mittelstand here.

In the last two decades of our stagnation under liberalisation, we have been able to evaluate the performance of governments that followed a more interventionary role in their financial sectors. There have been successes and failures and we now have the benefits of their (and our) experience.

As one review pointed out: “State intervention in financial markets appears to have been most efficient in cases in which politicians delegated authority to institutions that were subject neither to capture by private sector forces nor to their own meddling. In such settings, allocational decisions were more likely to reflect concerns about efficiency and growth.

Insulation was not enough however; state officials also had to have the organisational and material resources to monitor business activity and to discipline it through the threat of sanctions in the case of non-compliance. In short, the government needed the organisational, financial and ultimately political resources to extract a quid pro quo from the private sector.”

From the foregoing discussion, it should be obvious that we have to be very clear and specific in our articulation of our development strategy. There is also the need for the widest societal acceptance of the strategy since crucial aspects, especially in the beginning, would be subsidised from the public coffers. In our failed experiment with government intervention in the ‘70s, it is now conceded that our strategic industrial policy– import substitution industrialisation (ISI) – was flawed.

Our markets were never large enough to generate efficiencies of scale and tariff protection made the operations complacent and inefficient. The subsidisation of credit to exporters in the East Asian NIC’s have proven to be more dynamically efficient: the need to compete in world markets provided the necessary discipline for efficiency and exposure needed to start a virtuous circle of incorporating innovations.

There are the wider political implications implicit in the creation of what we have previously labelled a “Catalytic Entrepreneurial State” within which the need for directed preferential credit arises. These will be addressed next.

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