7 August, 2020

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Post-COVID-19 Reconstruction: Banks Alone Cannot Bail Out The Economy

By W A Wijewardena

Dr. W.A Wijewardena

Attack on banks

A section of politicians and civil society leaders has been critical of banks for not being of help, maybe sufficiently, to people for resuscitating the economy now virtually dead. It became dead following the disruption to economic activities emanating from the anti-COVID-19 measures adopted in the country since mid-March.

Banks for them mainly mean commercial banks, but a proper definition should include all financial institutions. The argument has been that banks have made super profits by lending to customers and now, when their customers are in trouble, banks have neglected their needs. The demand has been to make a redistribution of the gains made in the past in what normally happens in a socialist economy: you get from society and then in turn give it back to society.

The danger of the epistemocrats capturing power in society

When political leaders claim to possess this knowledge not known to others and they are assertive enough to gather followers around them, this demand becomes a social movement to be reckoned with. Such a system infested by social movements orchestrated by one section against another is far from the ideals of democracy. It has been aptly branded as ‘epistemocracy’ by Nassim Taleb in his 2007 book The Black Swan.

The danger of the proliferation of such epistemocrats in society is that they use their assertive power to gain authoritarian powers for themselves. Surely, that will be fatal not only to financial institutions but also all others.

Banks making super profits

Of course, there is an element of truth in the assertion that banks have been making super profits. Even in a background of the disruption of economic activities for eight months after Easter bombings of April 2019, the year has been extremely profitable to financial industry. In all, they have made an after-tax profit of close to Rs. 150 billion in 2019. This has to be viewed in the light of the shrinking of the real economy in US dollar terms from $ 88 billion in 2018 to $ 84 billion in 2019.

Financial institutions should, therefore, take pride in being able to outperform the real economy, but it has become the bone of contention by others. However, one should recognise that these profits have been made on a thumping asset base of about Rs. 15 trillion which is as high as a fifth of the size of the real economy. Hence, in terms of the asset base, it is only a return of 1% on assets employed and, therefore, not an enviable achievement that could be termed abnormally high. It is usually the norm throughout the financial industry globally.

Banks branded as Shylocks

However, historically, bankers, as money lenders, have been at the receiving end of society. They have been derogatively called Shylocks who demand ‘the pound of flesh’ unreasonably from their customers, a phrase that has come to be used due to a reference in Shakespeare’s ‘The Merchant of Venice’. Ancient European communities had disliked Jews for being too greedy when engaging in money lending business.

But the perception about money lending has been different among commercial communities in the Middle East and in India. Prophet Muhammad, while frowning on anyone at not repaying debt had also banned charging of interest on loans claiming that one is entitled only to the capital lent. However, the person who makes available funds is entitled to a part of profits if the user makes profits. This guide has been the principal ideal in Islamic lending. It has served as a moral guide for both the borrower and the lender by converting them to a team of entrepreneurs who should be ready to bear both losses and profits.

The Buddha: What is borrowed should be repaid

The Buddha had emphasised on the wholesomeness of leading a debt-free life in Anana Sutta or Discourse on Debtlessness in Anguttara Nikaya.

He had also upheld in Samagnaphala Sutta or Discourse on Fruit of Contemplative Life in Diga Nikaya that money borrowed should be spent prudently in further wealth building and should be repaid in full with interest to the lender.

He should use for his own family only what is remaining after fully repaying the debt. Thus, according to the Buddha, it is the responsibility of the borrower to use prudently what he has borrowed and settle his debt in full.

Kautilya: Compensate the lenders with interest

Kautilya, the 3rd century BCE Indian Economics Guru credited for the treatise on economics, The Arthashastra, had provided detailed rules and guidelines for lending and loan recovery to facilitate the smooth operation of the commerce-based ancient Indian economy. While lending agreements should be open, transparent and unambiguous, a lender should not increase interest, among others, if the debtor is ill or insolvent.

At the same time, those who have accepted deposits should compensate the depositor appropriately with interest. According to Kautilya, once agreed, interest should not be changed during the currency of a loan and no interest should be charged on interest on arrears. In all other situations, the borrowers have obligation to repay the loans together with interest and lenders have a right to recover those loans through the available legal channels.

Banks’ obligations are wider

In my view, banks have an obligation to four parties: their owners, depositors, borrowers and society at large. It is the owners who have risked their money by setting up banks which they have to run under a strict regulatory structure imposed on them by governments. In this case, governments have chosen to regulate banks to ensure the delivery of a stable financial system, a kind of a public good provision, according to economists.

However, unlike other businessmen, owners of banks can put in a minimum amount of money as capital and operate the bank exclusively out of the money borrowed from the public by way of deposits. This is a highly dangerous game because if those borrowed moneys are not lent prudently, the bank owners will not be able to return the money they have borrowed or pay interest on them or both. In either case, depositors stand to lose and if they lose confidence in banks, they would not place their savings with them. Hence, banks have to take care of depositors as if they protect their own eyes.

Lend further money to keep an ill-fated borrower alive

At the same time, banks have an obligation to their borrowers because it is those borrowers who keep a bank above the waters by paying interest on the money they have borrowed. In this case, a bank has to resolve a dilemma as cogently put by Leonard Woolf in his fiction depicting the plight of the residents in a southern village during colonial times, The Village in the Jungle. There is a Muslim trader who comes to this village from Batticaloa on foot. He advances money to villagers so that they could eat enough and cultivate various grains which they could give back to the Muslim trader in settlement of the money they have got.

However, when the trader comes back, he finds that many villagers have not been able to produce any grain because they had been down with malarial fever for most of the time. But these grains are so valuable to the trader that he has to give more money to villagers as advances because to recover the original moneys, they have to survive and produce those grains. Hence, it is a repeat exercise year after year.

This dilemma of the Muslim trader is in line with the guidelines of Kautilya that a creditor should not insist on repayment of money he has lent if the borrower is ill or insolvent.

Politicians should not play reverse Shylock strategy on banks

Banks have a responsibility to society at large because they are social institutions that provide a host of services: functioning as a depository of savings, meeting the fund requirements of needy individuals, keeping the economy going and helping people to become prosperous. These obligations to society are beyond their profit goals. Hence, a bank has to very carefully balance the obligations to owners, depositors, borrowers and society at large. Hence, any relief given to borrowers should not conflict their other obligations.

The economic catastrophe that has been created by the unexpected COVID-19 pandemic has placed banks in this crucial choice-making position. A bank cannot abandon its borrowers and at the same time disregard its obligation to depositors. If one is done to the exclusion of the other, the bank loses and so does the society. Hence, politicians should be careful in not playing the reverse of the Shylock principle: demanding the pound of flesh from banks.

Central Bank’s timely action to provide liquid cash

Surely, the banks have a responsibility for supporting their borrowers. The Central Bank, having recognised this need, has created a special fund of Rs. 50 billion to provide refinance to lending institutions which will provide relief to borrowers in the form of providing a debt moratorium and lending the needed funds to overcome the present impasse at a highly concessionary rate of 4%.

Banks which can borrow funds at 1% from the Central Bank have to repay the same within 20 months. This is, in my view, a sufficient period for any businessman to put his business back to operational form. This is the most immediate requirement and the Central Bank has correctly addressed the issue.

Voluntary savings by curtailing consumption are real savings

However, the medium to long-term reconstruction of the economy cannot be done solely by using bank lending. In this connection, the distinction made by the Indian economist, B.R. Shenoy, who was a lecturer in economics at the University of Ceylon in early 1940s, between voluntary savings and involuntary savings, outlined in a book published in 2004 under the title Theoretical Vision, would help us to understand the issue.

Voluntary savings are those surpluses made by people by curtailing consumption. For instance, if a man produces 100 kg of rice and eats only 80 kg, he leaves a surplus of rice amounting to 20 kg. Those savings are real savings and are available for further investment in productive uses. Further, when businessmen realise that people have curtailed consumption goods, businessmen will divert those real savings to produce real products. Shenoy calls them ‘higher-order goods’ which economists today call investment goods. It changes the structure in the economy by moving from production of bullock carts, for example, to trucks, from bullock driven ploughs to tractors, etc.

The proliferation of these higher-order products will help an economy to produce more consumption goods of high quality later. What is needed for long term economic prosperity is the boosting of these voluntary savings which are also real savings. A must for the generation of these real savings is the generation of a surplus in the current account of the balance of payments.

B.R. Shenoy: Involuntary bank made savings are a disaster

Involuntary savings are those savings which are generated by artificial credit expansion by banks with support from the country’s central bank. These savings are imaginary savings arising from the imaginary assets of the financial institutions as against the real savings made by people by curtailing their real consumption.

For instance, consider this case: the central bank prints one rupee and makes it available to government to finance its budget. In economist’s terminology, this is called creating reserve money or monetary base just like a magician waves a magic wand to make a rabbit appear out of nowhere. Nobel Laureate Milton Friedman chose to call such money ‘helicopter-dropped money’ because they are just printed by a central bank and dropped on people from the sky.

A part of this money goes back to the banking system enabling it to create multiple deposits and credit simply by making book entries. Those book entries create assets for people as well as for banks, but they are simply imaginary assets without any real baking like the 20 kg of rice saved by a person in our previous example. The danger of such imaginary assets is that they appear to be solid right now but can meltdown if the economic system is hit by a crisis like a global financial crisis or a pandemic as the world has faced today.

To rescue banks, real resources have to be transferred to banks from taxpayers to the banking system. In Sri Lanka, within a time lag of some 18 months, banks can create seven rupees out of a rupee imaginarily created by the Central Bank. These savings, according to Shenoy, do not help a country to put its economy on a solid long-term growth path.

He emphasised that they must necessarily lead to disaster, though at first, they may produce outward symptoms like the country heading toward an economic boom. Hence, Shenoy dismissed such attempts of using involuntary savings claiming that they are not a substitute to voluntary savings which are real in nature.

Sri Lanka should go for real sacrifices

Voluntary savings are a sacrifice made by people and Sri Lanka’s long-run reconstruction depends on making such sacrifices across the board. That has to be made by all, from the President downward to the lowest stratum in society, voluntarily. Some private companies have already started the initiative by enforcing a pay-cut at high rates at high levels and low rate at low levels. It is similar to paying back to the company what the employees have got.

For instance, a 50% pay cut means that the person concerned has agreed to work six months free of salary for the company to enable it to wade through the difficult period. Similarly, if ministers voluntarily go for a 50% cut in their perks, they would be providing their services free of payment for six months to the nation. This is similar to the old Rajakaari Kramaya or Compulsory Service to the King that was there during the times of ancient Sinhala kings. The beauty of this move is that it will set the appropriate example for others to follow.

Hence, banks can help the economy to pass the current impasse but they cannot bear the burden of long-run reconstruction by producing imaginary paper assets.

*The writer, a former Deputy Governor of the Central Bank of Sri Lanka, can be reached at waw1949@gmail.com

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Latest comments

  • 3
    0

    Banks have been making super profits not only that they have been spending on things lavishly. Bank employees have been paid handsomely, while farmers and entrepreneurs had a tough time.
    It is time bank employees make sacrifices. Should make pay cut during this year. Bank should become more cost conscious in their spending for buildings and interior decor and spending lot of money on fancy imported software which do not work properly.
    Government like the way control consumer prices put ceiling on spread on interest, fees for services.
    Author should know how the central bank does not supervise the financial institutions. Only way they do supervise is to increase the entry barriers by the capital ratio by the international world of financial institution and regulator crooks.
    They should lower the barriers and improve the supervision

    • 0
      0

      I think it i s hight time, Rajapakshe stolen funds to come out from the deposits.

      Billions could well be a greater help to the country.

      Bps looted as their pockets would have been overflown –
      Just now I heard German New Sender RTL confirming that Germans would not plan to travel to asia this year as had been before. Estimations say, over 40 mio of Germans tarvel to asian countries in every summer.
      This will definitely be a GREATER loss to SRILANKEN TOURIST industry.
      Months ahead willb e not fine for Srilanka. Only blessing good leaders could get some donations from outside world, but I dont think Rajapakshes would be respected by anyone.
      Thanks to CBK and Ranil W- entire world including us donated a lot at the time, TSUNAMI killed nearly 40 000 srilankens. But this time, they would not do so, for two reasons.
      Srilankens are not grateful
      That we know from their reactions.
      And the leaders of the day are bitch’s sons that would not care about the people .. and their needs but their pockets. They once proved it… Sarath N Silva is still alive – and heard he is not yet gone to mad – he can prove if his public statements ABOUT BP Mahinda is still valid..
      And CBK is also still there, she will reveal the ground realities of those funds rained from EUROPE. We alone, thanks to my friends worldwide collected over 50 000 dollars sand transfered to the accounts in Galle Area. But I dont know those funds were ended up being offered to who were really in need.

  • 2
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    Some valuable ideas worth thinking. Banks when they made billions also paid large sums to the Govt. by way of taxes. There is a bigger role that the govt. should play. If we are closed for three months govt. to make good the money lost by the community. Rs. 50 billion promised by the CBSL is not enough.50 billion at max 25 million is enough only for 2000 entities and the big players will gulp it. How will the SMEs manage like a 20 room tourist hotel. Banks will request collateral. Further for them it should be long term money as they will take a longer period to recover. We have our hands full due to weak govt. revenue when taxes were reduced and the lost income from liquor and tobacco.Segment wise analysis and assistance to the most needy is recommended.

    • 1
      1

      China will bail out Sri Lanka.

      • 0
        0

        Silva!

        ……… and take over Srilanka, slowly but steadily.

  • 1
    0

    Dr. WA Wijewardane,

    Prostrate to the Rev. Chinese who gifted ( in German, gift mean poison) , the Wuhan China-19 virus, renamed COVID-19 virus, instead to the saffron clad Para-Sinhala Para-“Buddhist “ monks, whom the imbeciles, mean Measured IQ 79, keep prostrating, and saying useless Pirith to contain the China virus.

    PS. The imbecile Para- Sinhala Para-“Buddhists “, mean Measured IQ 79 are accusing the Muslims for introducing the China virus pandemic, which President Trump is accusing the Chinese and WHO being in cahoots with the Chinese. Are the Rajapaksa’s in cahoots with the Chinese as well?

  • 1
    0

    Political hyenas in CT seems clueless on Economics to come up with suggestions and advice to people how to resuscitate their lives as the economy now virtually dead.

  • 1
    0

    Dr WA Wijewardana,

    The Para-Sinhala Para-“Buddhist “ Govt has not , that was elected by the imbeciles, mean Measured IQ 79, can now milk the imbeciles, Tax the imbeciles and order them to prostrate to saffron clad monks, or they can prostrate to the Chinese, who gifted ( gift means poison in German), the Wuhan Cuba -19 virus, renamed COCID-19 virus.

    Why banks don’t have no more money?

  • 2
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    As a shareholder of some Bank Shares, I can say that the share price has plummeted during the last two years because of the sky high taxation of banks and hence the drop in earnings per share. The non-performing loans have also increased significantly. Neither the banks nor the government can bail out non-viable businesses. We need to attract new investments to the Hambantota Free Trade Zone to absorb the people displaced by the closure of some businesses.

    • 0
      0

      Lal

      Agree 100% with you. Return on assets are around 1% which is pretty low.

      Most banks are trading at a discount of 70% to the book value.

      If anyone has money, a good buy if willing to hold on for 10 years at least.

      Any investor into the banking sector has lost money over the 5 years.

      Ranjith

  • 3
    0

    We have too many banks with merge capital base for the size of the economy and population. Owing to this situation available capital is not put well for use of the economy. The banks should marge and create large banks with big capital base to lend more and serve the economy well. Banks are the engine of the economy, and it’s their primary duty to service it fairly and equitably. This would propel the economy to higher growth else present day situation of banking is like the poli mudalalis, just leading against real security and collecting interest but not serving economy well to create wealth and prosperity for all. It’s a case of prosperity for their the share holders, depositors, and employees and not for others. Australia with economy of nearly USD.2 trillion, only has four big commercial banks, similar situation in Malaysia and Singapore too.

  • 0
    0

    As a shareholder of some Bank Shares, I can say that the share price has plummeted during the last two years because of the sky high taxation of banks and hence the drop in earnings per share. The non-performing loans have also increased significantly.

    I thought Sri Lankan State banks are not in the stock exchange even though this guy says he has bank stocks.

    I do not think ever what the conventional – economists say would ever work FORGET development, at least to get out of the economic deep pit that the Sri Lanka is in. If Sri lanka goes the conventional way, it never becomes, economically a decent country. forget development. There are many third world countries that are in the same deep pit. Lanka’s good fortunes are there and foreign influences are there as long as youth working overseas send their money to Sri lanka. After that many parliamentarians also leave or people will make leave politics.

  • 0
    0

    Capitalist economies have a built in safeguard in view of labour laws under which they can hire and fire employees easily. We are neither here nor there being a mixed economy with killing labour laws. In USA as at 16th there were 4.2 to 5 million retrenchments and the Govt will take them over and pay the benefits. Companies will survive and come back later.

  • 0
    0

    The Coronavirus is NOT that roots cause of ongoing crisis of recession and depression of Economic of impact of USA and World. It is goes to root cause of that hegemony of USA Imperialist Economy and WESTERN civilization as a whole.

    The writer is Neoliberalism Economics, which speciality of Banking sectors of with his past experiences of that nexus to Central Bank of Sri Lanka.

    The Rightly said by one writer of West “…….Watching schools and universities have been given the idea of a liberal education ,without the substance of historical knowledge…” . What is that ? “…….Watching the financial crisis unfold,I realized that they were far from alone ,for it seemed as if only a handful of people in the banks and treasuries of Western world had more than the sketchiest information about the last Depression…..”by Niall Ferguson.
    Well “….They have been taught isolated ‘modules’ ,not narratives ,much less chronologies. They have been train in the the formulaic analysis of documents excerpts ,NOT key key skill of reading widely and fast……”

    Many of ours Economist also lack of a major policy switch to the use of a Neo-liberal” Market economy” for development of national economy.It was failure to deliver last 40 off years since 1977 of policies of an initiated by UNP-JRJ .
    The UNP set of policies remain unchanged since 1994. …until now.
    We have not look at sustainability of development path of Market economy by ours policy makers @
    They were confined to Neoliberalist model of development by cash pumping to market by Banking system. Aim of that bailout of NOT resolved ongoing crisis.
    It will work for temporary solution for the crisis. !@

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