Wednesday, 22 January 2014 00:00
“Give me a one-handed economist, all my economists say is ‘on the one hand …and on the other hand…” Harry Truman (US President 1945-53)
One can understand the frustration of the former US President when all the advice proffered by his economists was given with a cautionary alternate scenario. When grappling with urgent issues, rulers and administrators will much prefer to be given a clear course of action with predictable results as opposed to several options, the consequences of none being predictable.
But “on the other hand”, it is obvious that it is not easy, perhaps even impossible, to either define or predict all the complex and incalculable mixture of human activity which fall into the definition of economics.
As pointed out by economists, in general terms almost all human activity could be attributed to an economic consideration. At the minimum, procurement of the basic needs is a fundamental imperative for all of us. Human nature being what it is, from there on our needs and wants expand infinitely. President Truman was perhaps demanding too much from his economists when he asked for straight forward explanations of the vortex of complexities that a large, complex and globalised economy represents.
According to Nivard Cabraal, the Governor of Sri Lanka’s Central Bank, one of the targets of his Road Map for 2014 is the consolidation or merger of the various banks and financial institutions (finance companies).These institutions come under the purview as well as the supervision of the Central Bank which Cabraal has headed for about eight years now.
In recent times a few of the finance companies have come in for a lot of flak on account of their failure to honour the deposits of their customers. It is alleged, even by the Central Bank itself, that some of them were only thinly disguised “Ponzi” schemes! (A disguise, which evidently took in the monitoring body as well!)
It is argued by the Central Bank that as a country we have too many banks and that several of them, especially small banks which have come up in recent times suffer from capital inadequacy and poor management. The irony of the Central Bank now sounding the alarm about over-banking and capital inadequacy after supervising the setting up of several of such institutions by the government, and even having close kith and kin appointed to head those small banks is perhaps lost in the realities of the present times.
"An economist with a better than a mere average grasp of the realities of economic theory and practice will baulk at drawing only a rosy picture. Like the infamous hedging deal we went into with such cavalier disregard, every policy change could have unforeseen consequences. We do not know whether the Central Bank pointed out all the possible scenarios that could develop from consolidation of banks and the planned borrowings of foreign currency. While inadequacy of capital could cause many problems, the over-supply of capital or the inability to absorb such volumes of capital could also have dire consequences. In certain situations an intelligent economist would surely wish for several hands!"Main purpose
Apparently, the main purpose of the intended consolidation is the strengthening of the balance sheets of these institutions. By international standards these are admittedly tiny and by consolidating a few of them it is hoped that they will amount to something larger. As a large entity they may be able to attract more foreign funds needed for investment. As they claim, small is not beautiful in the rarefied field of banking.
Although not an economist, being a person of years of experience in financial services, Cabraal will readily concede that in economics some road maps could end up leading one to the wilderness. We remember the five year plans of the failed socialist countries which in hind-sight look almost juvenile in some of their assumptions.
Several writers have pointed out that consolidation of a few weak institutions, without addressing larger and fundamental issues, may not necessarily create a better institution. Warren Buffett the famous investor argues that a small company with a superior performance is far preferable to a large entity with a mediocre performance. Size, as the collapse of several banking institutions in the US and other countries only a few years back showed is no guarantee of stability. We have learnt that large does not necessarily mean strong.
Borrowing foreign funds the main motive?
It is a known fact that some private companies inflate their true value in order to obtain more credit. The risks inherent in such a course of action become obvious only when it is time to repay the debt. Sometimes things may work out all right, but not always.
If borrowing foreign funds is the main motive in merging the banks, how that money will be invested becomes a concern to all stakeholders. It is not the banks that want to borrow, but the government, through them.
Without any inkling of the intended projects on which these foreign borrowings will be invested it is difficult to assess what our return on those investments would be. For example, if they are to buy more aeroplanes for SriLankan Airlines, a huge loss maker as it is, the return on the investment will be speculative at best.
According to the reports available some of the larger banks and financial institutions in Sri Lanka currently hold an excess of local funds which are available for lending. But apparently there are no takers or large scale borrowers looking for such funding.
Mergers and acquisitions
Mergers and acquisitions are not necessarily an evil thing. Sometimes in order to grow institutions need to become larger. It is often an organic growth process where fundamental factors indicate a need for growth of the base. They then look for other companies with similar cultures or synergies to either merge with or acquire. Often such a process results in greater efficiency and productivity. Certain production processes and employment positions in one of the entities, or both, may become redundant on account of the merger.
Ordinarily when such mergers take place in the banking sector a primary concern of the central bank would be the monopoly power a few such organisations may acquire over this strategic sector. If the two major investment banks in a country were to merge into one, the borrower (investor) will have only one bank, one banking culture and policy to go to. The potential and the risks of his proposed venture will be assessed on the basis of only one stand point. The element of choice that competition provides him will be denied.
The primary goals of a Central Bank are the implementation of a monetary policy that provides growth, maintaining stability of financial systems, management of the currency system and providing of accurate data of the economy. Inevitably the central bankers are independent, scholarly and objective. By definition that role cannot be held by persons of doubtful integrity or partisanship.
Economy below target
It has been pointed out that despite the cessation of the war four years ago our economy has never reached the growth rates that other countries like China, India, South Korea, Thailand etc were able to achieve in their path to rapid development.
China maintained a double digit growth rate for many years. In a region which has seen such sterling economic performances we stand out as mediocre. If the remittances, which are the rewards for activities completely outside of our economy, are taken out, the story would be very grim indeed.
An economist with a better than a mere average grasp of the realities of economic theory and practice will baulk at drawing only a rosy picture. Like the infamous hedging deal we went into with such cavalier disregard, every policy change could have unforeseen consequences.
We do not know whether the Central Bank pointed out all the possible scenarios that could develop from consolidation of banks and the planned borrowings of foreign currency. While inadequacy of capital could cause many problems, the over-supply of capital or the inability to absorb such volumes of capital could also have dire consequences. In certain situations an intelligent economist would surely wish for several hands!
Or perhaps our Central Bank has become the one-handed economist that Harry Truman was looking for!
(The writer is an Attorney-at-Law and a freelance writer.)