Banking for Development

Nov 06, 2011 Features / Columnists, Ravi Dev

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Following the 1989 IMF’s prescriptions, our banking system was privatised. But this move failed to efficiently intermediate the savings of the populace into investments. And  – in contradiction to the predictions of “market fundamentalism – saw, in fact, the government being strong-armed 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. Taxpayers have to cover billions in interest payments to them annually – providing them with a risk-free investment option. In such a situation, 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 increased after liberalisation, the predicted lowering rates for loans never materialised. There was also no outside pressure for lower rates as the largest private corporations sponsored or affiliated with the new banks, which took care of their financial needs. The strategic developmental opportunity 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. The case can 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. 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.
Over the last two decades, 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 own) 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 very clear and specific in our articulation of our development strategy. 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 subsididisation of credit to exporters in the East Asian NIC’s have proven to 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.

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