The Economy: The need for a State Development Bank to propel Guyana’s Economic Development
As concluded last week, this week’s article is centred on the need for the establishment of a State Development Bank. The argument was put forward by this column that this mechanism is likely to be a catapulting long-term solution for the national development framework of Guyana’s economy.
Dominating the Business Summit, were an expression of concerns pertaining to the access of financing and the challenges in respect of acquiring investment capital – especially for small and medium-sized enterprises. In this respect, it is worthwhile to examine, firstly, the challenges and the current framework that exists viz-à-viz the domestic financial market.
Guyana’s financial market constitutes the Banking System, the New Building Society (NBS), Trust Companies, Finance Companies, Asset Management Companies, Pension Schemes and the Insurance Companies. The financial sector is, however, dominated by the commercial banks. Therefore, an examination of the structure of the commercial banking system is presented hereunder.
The commercial banking industry is characterized as an oligopolistic market structure mainly because of entry barriers that necessitate an oligopolistic banking sector. The size of the real economy does not allow for a competitive and contestable sector given its geographic dispensation, dispersed and rather a small population (Khemraj, 2009).
An Oligopoly is a market form in which a market or industry is dominated by a small number of sellers (oligopolists) because there are few sellers. Each oligopolist is likely to be aware of the actions of the others. The decisions of one organization influence the others and the decisions of the others influence one organization. Strategic planning by oligopolists needs to take into account the likely responses of the other market participants.
Khemraj (2009) argued that “with the prevailing private oligopoly, commercial banks would mark up the loan rate above the marginal cost of business operation and a risk-free interest rate”. He also posited that “the banks are likely to set the markup rate above the competitive natural rate, ultimately making access to credit to the private sector difficult and expensive.”
However, (Franklin Allen) argued that an oligopolistic structure with four to five major banks were fairly stable. He also pointed out that countries with too many banks were unstable due to the fact that too much competition leads to lower profit thus the banks are not encouraged to be innovative which can ultimately lead to failure as well, as is the consequence of any competition someone wins and someone loses (In this context – bank failure. e.g. in the U.S – Financial Crisis of 2007/2008).
Additionally, as was highlighted in last week’s piece, commercial banks are naturally risk averse because they are deposit-taking institutions and, hence – they have a responsibility to protect depositor’s funds which means they have to engage in prudent lending. Compounding the situation in which access to financing is apparently difficult for small and medium-sized enterprises especially; it is not necessarily the inherent nature of the commercial banks per se, but rather, a series of limitations with respect to the businesses themselves and by extension the management and owners of the said enterprises – so we could say it is twofold.
In the conduct of credit assessment, a borrower needs to fulfil certain qualifying criterion before the decision to approve a loan is made. One of the primary requirements in this process is collateral, and in many instances, this is one of the main limitations – lack of adequate and tangible collateral. Instantly, this may be a deterrent – much to the disadvantage of the prospective borrower.
It must be noted also, that having healthy collateral is not always a decisive factor in the loan approval process. The more important decisive factors in this regard are premised upon the borrower’s ability to repay – debt servicing ability, and, this other element might sound surprising – but in reality – the most crucial of them all is – the borrower’s willingness to repay.
Experience – over the last twenty-five years or so, has taught bankers that borrowers are not disciplined as they were for the period prior to 1992. This is undoubtedly one of the key reasons loans are consistently in arrears and also non-performing in some cases. This notion hinges on the fact that there has been, over this period, a paradigmatic change in the socio-cultural construct of the populace or put differently, one element of the market component within which the banks operate – that is, the customers.
In respect of the technical limitations of businesses – most small and medium-sized firms, lack crucial expertise in the industry within which they operate, sound financial management practices and particularly cash flow management. These, therefore, inevitably disqualify such entities from accessing financing through the commercial banks.
So then, in these given pragmatic circumstances, how would the establishment of a State Development Bank solve these problems? Development Banks are government-sponsored financial institutions with the primary mandate to provide long-term capital to industry. In view of providing a brief historical context, in Continental Europe and Japan, these institutions have played a fundamental role in the rapid industrialization process of those two countries (Gershenkron, 1952; Cameron, 1953; Daimond, 1957; Yasuda, 1993).
Despite this, however, there exists a general perceived notion that in the less developed countries, recent development banks have often failed to mirror the successes of earlier examples. Poor cost-benefit evaluations, high arrear ratios, and pervasive evidence of mismanagement and corruption, without doubt, are the causations of such disenchantments.
Given the inherent nature of development banks – they are largely not profit driven, unlike the commercial banks. As such, the success of a development bank is not measured against the traditional set of performance indicators – but instead – their contribution to economy-wide growth through the acquisition of and dissemination of financial expertise in new industrial sectors.
In addition, the structure and manner in which development banks are designed to operate are different from that of the commercial banks such that, they are required to have highly skilled and well-qualified experts in various appropriate fields. The reason for this is because development banks provide long-term capital for repayment over longer periods, as long as 20 years for example, while commercial banks generally could only extend long-term capital for up to five years maximum. Thus, it is this distinguishing factor that sets them apart. However, development banks are not to be viewed as competing institutions with commercial banks – they are more complementary financial institutions wherein – one extends long-term capital in the creation of new industries and the other sustains old or established industries.
Finally, it should be mentioned that in February 1970 the then government of Guyana established the Guyana National Co-operative Bank (GNCB) as a development bank, and was given the task to provide for the commercial financing requirements of Guyanese businesses, to support investment in new business areas and to extend financial services to rural communities. But, as discussed earlier, unfortunately, this institution failed largely due to its politically controlling nature. There exist sufficient evidence that corruption and political interference with these type of institutions are bound to bring about their demise.
Thus, this phenomenon is deemed to be compelling evidence for the enactment of a legislative framework for it to operate autonomously. If not, should the government pursue with the establishment of a much needed development bank; its failure will almost be certain, and it would not be able to effectively serve the purpose that it truly should – that is, to propel the economic development of the country – one that is characterized as a developing economy.