Fix Mexico's banks, not China's

It always puzzled and shocked me that some Latin American and Eastern European countries have private credit to GDP ratios of merely some  30%.  What can you do with so little credit? It is barely enough to sustain basic investment given some reasonable assumption of asset-to-GDP ratio.

I notice that bank in Asians' definition is quite different from what people outside Asia define banks.  In Asia,  bank lending strikes you as commercial and industrial (C&I)  lending that finance purchase of equipment and building of factories, while outside Asia banks focus on mortgage and consumer lending, and seldom go beyond working capital financing when they lend to businesses. So Asian banks are actually development or long-term credit banks in Western definition, and certainly we cannot evaluate their performance based on the same safety requirments, if we want them to promote economic growth. Development banks will certainly be more leveraged and have higher NPL ratio as they lend to risky long-term projects. In the meantime, in Asian's definition, many Latin American countries don't have a banking sector at all, if only bank lending that finance future growth is counted as banking.

Here comes the trade-off between stability and economic growth.  I assume that it is C&I lending that really matter to economic growth. If banks never finance equipment purchase or long-term investment, then they are stable, but in the meantime they are not really doing their bit to the economy.  This is why Mexican banks are in relatively good shape now in balance sheets. In China, lending has historically been 100% C&I loans, while in the United States C&I loans account for only 15% of banks' loan portfolio. Certainly NPL ratio will be higher if you do C&I, but we have to understand why we need banks in the first place when it comes to development: we first want them to do C&I so as to promote economic growth, and then come in the second requirement that we want them to stable.  Stable banks that don't do much C&I lending is no better than "narrow banks".   10% C&I loan ratio is good for the U.S., because academic studies  show that at this very mature stage of development the overwhelming sources of financing for U.S. big corporations is not external finance, but  internal cash flows (i.e., the old money). This however doesn’t  work for developing countries.

Inefficient allocation of funds is certainly one main reason why non-performing loan ratio is high, but high NPL ratio only means that the private benefit of the failed projects are negative, the social benefit could still be positive. For many developing countries, it may not be profitable to invest in roads, dams, power plants, etc, but there is no question that the society’s benefit is far higher than the cost. In China’s case, the high NPL ratio is more a result of banks sharing some fiscal burden with the cash-constraint government at the beginning of the reform. Also, after reforms, some fiscal expenditures are no longer allocated by the bureaucracy  system, but through the banking system (which I admit is certainly also heavily influences by the government.)  Research however shows that Chinese banks allocate funds more efficiently than the governments. Certainly, they are still very inefficient, but please compared it to the alternative that the government would allocate the funds, and please take into account the stable fiscal stance in China as a result of this transfer of duty to “private sector”.

What happens in many countries is that, when we emphasize stability (particularly after crises) , many banks switch completely to residential mortgage, consumer, and working capital lending, which also help reduce their risk-weighted assets defined by Basel Capital Accord. But then they are not banks anymore, in the sense that real banks should do C&I lending and finance expansion and growth of the industrial sector.  When banks are privatized they will certainly switch immediately to mortgage and consumer lending, which are same and sometimes also very profitable, and you don't have a real banking sector anymore to achieve poverty-reduction goal.

Maybe Singapore's Temaesek with DBS bank is solution struck in the middle?  Let the private sector do what they want to do (montage, consumer and working capital lending), and let the public sector do what public sector should do (long-term credit). State-owned banks can be very inefficient, but it is still more efficient than letting ministry of finance to directly allocate long-term credits.

Comments

[maggie]

Hi this is a great site. I am doing my accountancy and law coursework and this article will be a great reference. I also liked the other article on ratios and am going to compare it with the ratio analysis I stumbled upon at http://www.thefinanceowl.com/ .
Anyway keep up the great site
Maggie

[Payday Loan Advocate]

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