Country could ponder over reviving industrial development banks
IDBs have provided vital financing in past for giving push to industrialisation
IDBs have provided vital financing in past for giving push to industrialisation. PHOTO: REUTERS
LAHORE:
Gone are the days when industrial development banks (IDBs) provided much-needed development finance for promoting industrialisation in developing countries since development finance was considered to be quite significant from the perspective of economic development.
The process of economic development is complex and this complexity involves a lot of volatility and risk. Despite all odds, IDBs used to take on risks which played an important role in long-term capital development of a developing economy.
IDBs were also pivotal in industrial policy implementation and promoted diversification of industrial structure. The diversification furthered investment in industrial structure which was important for the long-run growth.
Then came the era of liberalisation of finance and the pendulum shifted from development banks to private banks. Private banks are limited liability institutions and focus on shareholder maximisation, which is achieved through short-term gains.
Private banks also favour market-based outcomes and employ modern risk management techniques. They normally issue credit card loans where risk is diversified and probability of default is low.
Similarly, they happily focus on consumer financing in a low interest rate environment. During 2003-07, car financing soared because of low interest rate and automobile and consumer industry enjoyed heydays in Pakistan.
The huge current account deficit of 2008 adversely affected the real and financial sides of the economy. On the demand side, borrowers became risk averse due to high interest rates as it became difficult for them to service the existing debt. On the supply side, these banks adopted a risk-averse behaviour by investing in safe assets.
Commercial banks left their core business of advancing loans to private sector and started investing in treasury bills, bonds and Ijara sukuk. The conditionality of zero central bank borrowing under the Standby Agreement and Extended Fund Facility of the IMF pushed the government to borrow from commercial banks.
The higher interest rate environment made banks afloat and profitable from 2008 to 2014. At one time, treasury bills and bonds constituted around 85% of liquid assets of the banking sector, which is now down to around 80%.
The current low interest rate environment is quite challenging for commercial banks. Most of treasury investments have started to mature and relending to government would be less profitable under the current settings. Interestingly, consumer and car financing have increased in the last six months.
Sitting on huge cash
However, large-scale industrialists are sitting on huge cash as reported by the State Bank of Pakistan. They are quite cautious since they are not sure of higher aggregate demand.
Normally, industrialists invest when they expect that higher aggregate demand would continue in future since sporadic aggregate demand dampens their expectations. The lack of demand from the industrialists would further weaken the profit expectations of banks.
The capital development of a country is significant from a medium to long-term economic perspective. The role of IDBs is to complement the private sector in the development of productive capacity. IDBs would help in promoting technological upgrading since it is a risky venture.
It is difficult for commercial banks to finance technological upgrading schemes. This upgrading would also help in diversifying the industrial structure.
In short, this is high time that policymakers ponder over the important issue of development finance since low level of investment has led to economic stagnation. Artificial stimulation of economy through consumer financing is neither sustainable nor suitable keeping in view the high aspirations of youth in Pakistan.
The writer is the Assistant Professor of Economics at Suleman Dawood School of Business, Lahore University of Management Sciences
Published in The Express Tribune, March 28th, 2016.
Gone are the days when industrial development banks (IDBs) provided much-needed development finance for promoting industrialisation in developing countries since development finance was considered to be quite significant from the perspective of economic development.
The process of economic development is complex and this complexity involves a lot of volatility and risk. Despite all odds, IDBs used to take on risks which played an important role in long-term capital development of a developing economy.
IDBs were also pivotal in industrial policy implementation and promoted diversification of industrial structure. The diversification furthered investment in industrial structure which was important for the long-run growth.
Then came the era of liberalisation of finance and the pendulum shifted from development banks to private banks. Private banks are limited liability institutions and focus on shareholder maximisation, which is achieved through short-term gains.
Private banks also favour market-based outcomes and employ modern risk management techniques. They normally issue credit card loans where risk is diversified and probability of default is low.
Similarly, they happily focus on consumer financing in a low interest rate environment. During 2003-07, car financing soared because of low interest rate and automobile and consumer industry enjoyed heydays in Pakistan.
The huge current account deficit of 2008 adversely affected the real and financial sides of the economy. On the demand side, borrowers became risk averse due to high interest rates as it became difficult for them to service the existing debt. On the supply side, these banks adopted a risk-averse behaviour by investing in safe assets.
Commercial banks left their core business of advancing loans to private sector and started investing in treasury bills, bonds and Ijara sukuk. The conditionality of zero central bank borrowing under the Standby Agreement and Extended Fund Facility of the IMF pushed the government to borrow from commercial banks.
The higher interest rate environment made banks afloat and profitable from 2008 to 2014. At one time, treasury bills and bonds constituted around 85% of liquid assets of the banking sector, which is now down to around 80%.
The current low interest rate environment is quite challenging for commercial banks. Most of treasury investments have started to mature and relending to government would be less profitable under the current settings. Interestingly, consumer and car financing have increased in the last six months.
Sitting on huge cash
However, large-scale industrialists are sitting on huge cash as reported by the State Bank of Pakistan. They are quite cautious since they are not sure of higher aggregate demand.
Normally, industrialists invest when they expect that higher aggregate demand would continue in future since sporadic aggregate demand dampens their expectations. The lack of demand from the industrialists would further weaken the profit expectations of banks.
The capital development of a country is significant from a medium to long-term economic perspective. The role of IDBs is to complement the private sector in the development of productive capacity. IDBs would help in promoting technological upgrading since it is a risky venture.
It is difficult for commercial banks to finance technological upgrading schemes. This upgrading would also help in diversifying the industrial structure.
In short, this is high time that policymakers ponder over the important issue of development finance since low level of investment has led to economic stagnation. Artificial stimulation of economy through consumer financing is neither sustainable nor suitable keeping in view the high aspirations of youth in Pakistan.
The writer is the Assistant Professor of Economics at Suleman Dawood School of Business, Lahore University of Management Sciences
Published in The Express Tribune, March 28th, 2016.