Wednesday, September 30, 2009

Free market (8) - Access to credit

Banks provide credit to businesses. They charge an interest rate comprising of the cost of funds (i.e. the interest that they pay to deposits) and the credit spread (i.e. the additional fee to cover the risk of default by the borrowers, expenses and profit).

In a competitive environment, the credit spread narrows and banks make a modest profit. Under volatile market conditions, the credit spread can increase sharply as the banks take advantage to increase their profit margins.

Some banks take advantage of the market volatility to recall loans and increase the interest sharply. The borrower has no recourse, but to pay the high interest rate, as this is a commercial term.

The banking industry is able to make huge profit at the expense of the business and consumer sectors. Some lawmakers have described the practice as predatory or usurious.

During an economic crisis, the Government has to step in and guarantee the credit for small businesses, as the banks are not prepared to take the risk. Some people refer to this practice as "lend you an umbrella during the sunny days and take it back when it rains".

Is there a better way to provide credit for businesses, rather than rely on the banking industry, especially if the banks do not have a social conscience and exploit the situation to make huge profits?

In my view, there should be a state owned development bank that is willing to offer financing on fair terms to the essential sectors of the economy, i.e. those that meet the needs of the population for their day to day living. These loans are for small businesses to buy the tools, equipments and stocks to run small businesses to provide goods and services for the population.

It is also possible to have large numbers of community or cooperative banks to provide the lending to the small businesses. These banks can draw their funds from the state owned development banks on fixed terms.

This type of structure ensures that there is healthy competition among the large number of banks. The lending should be restricted to the cost of running a business, and not for speculation in properties, including commercial properties.

If businesses have access to credit on fair terms and are not subject to exploitation by the banks or by speculative forces, they can provide their goods and services at fair prices, stablilise the cost of living and increase their economic efficiency.

A large source of economic instability and crisis in past years is due to speculation in property and cost of credit, and in exploitation by the owners of these resources. It is better for these two key sectors to be controlled (and still reflect the market) but to remove the exploitation of the market.

Tan Kin Lian

Tan Kin Lian


Anonymous said...

Surprise surpise but we do have a state owned development bank. It is called DBS - Development Bank of Singapore.

Of course the way DBS operates is anything but a state owned development bank is supposed to operate.

Anonymous said...

bank waste money on rediculous advertisement too like the recent one where the whole branch employees dressed up to wish a customer happy birthday. we all know that this thing will never happen in real life so why waste money and try to be kidding. All these cost are beared by customers ultimately.

Anonymous said...

Retiree received zero interest on their saving!

Bad Loan, who subsidise you?

Why must society subsides Bad Loan?

Sim Wei Jian said...

I shall state my stand clearly that I'm for the free market and believe that the government should stay out of economics as usually, the more they try to help, the worse the problem becomes.

As anonymous 955pm said, why must society subsidies bad loans? There must be a reason why private banks do not want to take on lending to risky businesses, regardless of size, big or small. They must have done their credit background check and looked through their business models etc and deem the loan a bad idea. Private banks, as rightfully pointed by many people, simply just want to make money, hence they are regulated by the fear of a loss or default. They are responsible to the people who deposited money in the bank and the shareholders.

Government has no such issue with loss or profit. It will gladly take on loans with low credit ratings. It can "guarantee" credit to those businesses that the private banks refused. These are also the businesses that are the most likely to go bust and the loans turning bad. If they're not, the private banks would gladly take them on. Ultimately, the lousy loans will be on the government's list and eventually, it's the taxpayers that are subsidising these bad loans. Like what happened to Fannie Mae and Freddie Mac...

One might argue and point out that Fannie Mae and Freddie Mac were involved in property speculations. However, their very starting point was for the welfare of the people. The goal of those entities under the Home Ownership program of George Bush was to allow more affordable home financing by charging "fair" interest rates "so as to not profit from the people". In the end, the whole country is subsidising those bad loans.

If there is anything the government can do, is to lower regulations and allow more banks into the scene. Or even let small local banks grow on our own soil. Let more private banks do the risk taking, not the taxpayers. By enforcing more and more regulations, they're denying more and more banks from operating and hence indirectly creating a monopoly for the more established banks to profit from.

I'm sorry if I have been a wet blanket on many occasions but I hope that I can offer a different perspective in these discussions.

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