Public ownership of banks, besides
preventing periodic economic crises, can subordinate the profit
motive to social objectives and fashion a system of inclusive
finance, argues C.P. Chandrasekhar.
5th December 08 - C.P
Chandrasekhar, Frontline
In a reversal of its recently held
position, the Congress party has declared that publicly owned banks
are one of India’s strengths and that the nationalisation of banks
was one of the party’s important achievements. This has, as
expected, upset those who have supported the party’s two-decade
long flirtation with financial liberalisation, which included an as
yet unfinished drive to privatise public sector banks.
The declaration was first made by
Congress president Sonia Gandhi at the Hindustan Times Leadership
Summit. She argued that while the ongoing “economic upheaval”
could “grievously affect the most vulnerable sections of our
society”, her party had partially insulated India’s poor from
becoming “victims of the unchecked greed of bankers and
businessmen”.
Elaborating, she said: “Let me take
you back to Indira Gandhi’s bank nationalisation of 40 years ago.
Every passing day bears out the wisdom of that decision. Public
sector financial institutions have given our economy the stability
and resilience we are now witnessing in the face of the economic
slowdown.”
Coming from the Congress party chief
at election time, this could be dismissed as mere rhetoric that is
unlikely to influence policy. After all, the United Progressive
Alliance chairperson had noted in the same speech that, the response
to the economic slowdown resulting from the crisis should not be a
return to the era of controls.
But the cynics were surprised when
just days after Sonia Gandhi made her remarks, Finance Minister P.
Chidambaram took the cue from his leader and extolled the virtues of
a nationalised banking sector. Speaking at a function organised as
part of the M. Ct. M. Chidambaram Chettyar centenary celebrations, he
emphasised that India’s public sector banks were strong pillars in
the world’s banking industry.
This was because, unlike the chief
executives of private banks in the United States, public sector bank
managers did not violate regulations in search of profits. For a
Minister who has been pushing for the dilution of banking
regulations, the privatisation of public banks, and the relaxation of
the cap on voting rights of shareholders in banks, this is indeed a
reversal of position.
Three factors may have contributed to
this change of opinion. First, the evidence that the managers of
private banks pursuing profits had dropped all diligence and made
decisions that have threatened and are still threatening the
viability of leading banks in the developed capitalist countries.
These include banks that the advocates of financial liberalisation
and privatisation upheld as models of modern banking.
Second, the recognition that the only
way in which the losses made by these banks could be socialised and
their viability ensured was for the government to invest in their
shares so as to recapitalise them. Across the world, the response to
the financial crisis has shifted out of mere measures to inject
liquidity into the system to backdoor nationalisation of these banks
so as to save them from bankruptcy and to ensure that they keep
lending.
Finally, the evidence that on an
average, the public sector banks in India have weathered the
financial storm much better than the private banks, including some
that had been celebrated as the post-liberalisation icons of
innovative banking.However, if the argument stops here, the explicit
or implicit defence of nationalisation and support for public banking
can only be partial and circumstantial.
What needs recognition is a
conceptual case for regulated, public banking that emerges from the
current and previous financial crises. It is now widely recognised
that the current crisis can be traced to forces unleashed by the
transformation of U.S. banking in the 1970s, when it moved away from
the “lend and hold” model in which the interest margin – or the
difference between interest paid on deposits and the interest charged
on loans – determined the profits of banks.
With interest rates being controlled
or regulated, this margin was small and implied that the
profitability of banking was low and below that of the rest of the
financial sector and even that of many non-financial industries. In
fact, during the inflationary 1970s, profitability sank even further
because savers moved out of bank deposits, returns on which were
regulated, to other kinds of financial instruments.
There was a good reason why the
banking system was thus regulated. As financial intermediaries, banks
accept deposits from the public at large, including small savers.
These deposits are insured against risk, are liquid and can be
withdrawn at will.
On the other hand, the banks that
pool these deposits provide medium or long-term advances to borrowers
who are risky targets, creating loan assets that are relatively
illiquid.
Given the risk carried by these
intermediaries, which are crucial to the real economy, they had to be
protected and the savings of small savers and households secured
through regulation, including regulation of interest rates. A
consequence was that banking was an island of low profits, resulting
in a conflict between this profit scenario and private ownership.
It was this conflict that led to the
financial liberalisation of the 1970s and the 1980s in the developed
countries, when processes euphemistically referred to as financial
innovation were adopted to boost the profits of the banks.
As a part of that, banks shifted to
the “originate and distribute” model in which they created credit
assets not to hold them but to pool them, securitise them and sell
them to other investors, transferring risk in the process. The banks’
own incomes now depended not on net interest margins (after
accounting for intermediation costs) but on the fees and commissions
they were paid to serve as factories that produced financial assets
for investors with varying tastes for risk.
In the process, banks migrated to a
world where expected and realised returns were much higher than
earlier, resolving the conflict between private ownership and lower
relative profitability.
Unfortunately, that transformation
also generated all the elements that underlie the current and
previous crises. The number of bank failures in the U.S. increased
after the 1980s. From 1955 to 1981, U.S. banks averaged 5.3 failures
a year, excluding banks that were protected by official open-bank
assistance.
On the other hand from 1982 to 1990,
the banks averaged 131.4 failures a year, or 25 times as many as from
1955 to 1981. During the four years ending 1990, banks averaged 187.3
failures a year. The most spectacular set of failures was that
associated with the “savings and loan crisis”, which was
precipitated by financial behaviour induced by liberalisation.
Thus, there is a fundamental
contradiction in private enterprise capitalism. If the banking sector
is regulated, it cannot deliver the profits that are considered
adequate by private investors, who are given returns elsewhere in the
system. On the other hand, if regulations are relaxed to facilitate
the pursuit of profits, it will result in bank fragility and “the
poor become the victims of the unchecked greed of bankers and
businessmen”, as Sonia Gandhi noted. The only solution, therefore,
is the nationalisation of banking, or the core of the financial
system.
Such nationalisation, which delivers
a resilient banking system, yields many favourable outcomes:
• It ensures the information flow
and access needed to pre-empt fragility by substantially reducing any
differences in the objectives and concerns of bank managers, on the
one hand, and bank supervisors and regulators, on the other. This is
a much better insurance against bank failure than efforts to
circumscribe their areas of operation, which can be circumvented.
• It subordinates 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.
• It gives the state influence over
the process of financial intermediation and allows the government to
use the banking industry as a lever to advance its development
efforts. In particular, it allows for the mobilisation of technical
and scientific talent to deliver both credit and technical support to
agriculture and the small-scale industrial sector.
This multifaceted role for
state-controlled banking allows the government to combine policies
aimed at preventing fragility and avoiding failure with policies
aimed at achieving broad-based and inclusive development.
Directed credit at differential
interest rates can lead to economic activity in chosen sectors and
regions and among chosen segments of the population. It amounts to
building a financial structure in anticipation of real-sector
activities, particularly in underdeveloped and underbanked regions of
a country.
The importance of public ownership in
realising these objectives cannot be overstressed, since it requires
subordinating the profit motive to larger social goals, which would
not be acceptable to a privately owned and controlled banking system.
It hardly bears emphasising that the
achievements of India’s banks after nationalisation have been
remarkable. There was a substantial increase in the geographical
spread and functional reach of banking, with nearly 62,000 bank
branches in the country as of March 1991, of which over 35,000 (or
over 58 per cent) were in the rural areas.
There was a sharp increase in the
share of rural areas in aggregate deposits and credit. In fact, a
major achievement of the banking industry in the 1970s and the 1980s
was a decisive shift in credit provision in favour of the
agricultural sector. From an extremely low level at the time of bank
nationalisation, agriculture’s share of credit rose to a peak of
about 18 per cent by the end of the 1980s.
In sum, public ownership of banks,
besides preventing the system from periodic crises caused by the
behaviour encouraged by the pursuit of private profit, delivers many
growth and welfare benefits.
It is, therefore, gratifying that the
combination of a financial crisis and the pressures of electioneering
have forced the government to retract on its mindless advocacy of
financial liberalisation and recognise the benefits of public
ownership. Whether this will influence policy is, however, yet to be
seen.
No comments:
Post a Comment