Professor Rehman Sobhan gave us the real reason that we want to privatize the state owned banks. Given that he made this point while receiving a gold medal from the Bangladesh Economic Association for his services to economics in the country it’s worth examining what his point is.
It comes in two parts: The first that the formal banking system is simply too politically controlled. Who you know matters more -- even which political party you support, most certainly which politicians you do -- in gaining a loan rather than what you’re going to do with it or whether you’ll repay it in full and on time.
This is a recipe for the misallocation of those scarce funds. Things which it pleases politicians to fund aren’t, necessarily at least, the things which are going to make the country richer.
It’s also true that knowing a politician or two doesn’t make the recipient of a loan a good businessman nor that their idea is going to be successful. Thus, this just isn’t the manner in which we desire loans to be allocated.
So, we’d very much like to get politics out of banking. The method of doing so is, of course, simply to get politics and politicians out of banking.
There does have to be at least some State involvement in banking in a country with its own currency. That’s what the central bank is for. But after that dual function of regulating the banking system for solvency and creating the price of money (that’s what the interest rate is, the price of money) that’s all we do want the government to be doing here. Simply and only because we don’t want government, or politicians, to be determining who gets to borrow money.
Well, ok, the politicians are just fine with it but the rest of us shouldn’t be.
Professor Sobhan also goes on to tell us that, empirically, it is the lower income groups who are the most reliable in repaying their debts.
Politically allocated credit can, obviously, rely upon political pressure to waive part or all of that pesky requirement to repay a loan. Which is what does happen at times. Lower income groups don’t have that political power and thus just have to repay or they’ll lose the security they offered for their loan.
Think it through a little, losing the apartment you live in because you’ve not paid the mortgage is more of an incentive to repay than the ability to wine and dine a politician to gain some lenience from the bank.
So, we should sell, heck maybe just give away, the state owned banks. As I’ve mentioned before, it doesn’t matter who gets them either. Subject to the usual central bank regulation that we don’t get out and out crooks running them, any and every private bank is going to be subject to the same disciplines of the market. They will end up lending to those most likely to repay because that’s just how markets do work.
A bank is a mechanism -- a hugely useful mechanism and a vitally important one -- for recycling peoples’ savings into investments.
We make deposits of our savings into the bank, the bank lends them out (and if we want to use modern monetary theory, those deposits still fund loans made) to people who do things with them. The bank lives off the difference in interest rates between deposits and loans.
Crucially, the bank must also pay off the costs of bad loans, those not repaid, from that interest rate margin. So, a bank which has to do this, one without any political direction or the ability to tap into taxpayer funds, is going to lend to those who are most likely to repay. For that’s how a profit is made and losses avoided.
Further, the banking system provides maturity transformation -- we generally want to save for a shorter period of time than people want to borrow for. Banks borrow short and lend long, that’s actually the best description of what banking actually is. That’s how we transform our own savings for those few months or a couple of years into the 20 and 30 year loan that enables someone to buy a home or finance a factory. It’s vital that this is done efficiently.
Given this restriction that the market places upon people it doesn’t in fact matter who has the banks initially. Either they get with the program and make such sensible loans or they make losses. At which point they either go bust, leaving space for others, or they get taken over by those who will do better. That is, the initial allocation of ownership doesn’t matter, we will still end up with a sensible banking system as a result of purely market processes.
That sensible system being where loans are made to those who can and will repay them and not to those who can’t or won’t.
The political implication of the economics Professor Sobhan is telling us is therefore obvious. The current banking system relies too much on political power for credit allocation. We’d like to change this, the method being simply to take politics itself out of the credit allocation done by banking.
Make all the banks private sector ones, subject to normal market pressures. It doesn’t matter who the current ones go to either, for those market pressures will lead to good banking, by definition, good banking being only lending to people who are likely to repay.
In Bangladesh that’s the lower income groups, not the politically connected ones.
The privatization of banking therefore makes the economy both more efficient and also fairer. Two very good reasons to just get on with it then, aren’t they?
Tim Worstall is a Senior Fellow at the Adam Smith Institute in London. He also writes for the Continental Telegraph