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Financial sector reforms, unintended results

Since 2008, governments all over the world have increasingly turned to the various economic instruments available to them to deal with the undesirable financial circumstances that have assailed their economies.

Opinion by Kevin Msipa

These instruments include the use of lower interest rates, quantitative easing, legislative enactments, and at times even employing invocations.

Zimbabwe is no exception, though the genesis of its economic misfortunes are different.

Other governments, unlike Zimbabwe, have through their central banking authorities employed the lender-of-last-resort to some considerable effect.

Through quantitative easing authorities have been able to make credit available in the economy and keep interest rates low. The legislative agenda has tended to be employed with the view of a long-term effect.

In the absence of the right to exercise sovereign will over the currencies presently in use, Zimbabwe’s government has tended to lean heavily on the remaining alternatives available to it, particularly  the use of legislation to impose its will on economic outcomes.

This is in effect like a carrot and stick approach to problem solving, save that it is only the stick available for use.

Ultimately, it means underwriters of government policy are the banks, and by extension the depositors.

More worrying has been the inadequate reflection on the unintended consequences of these enacted measures. In the economic sphere an act, habit, institution or law produces not only one effect, but a series of effects.

Of these effects, the first alone is immediate, it appears simultaneously with its cause; it is seen.

The other consequences appear subsequently; they are not seen. We are fortunate if we foresee them. There are two types of economists: those who confine themselves to the visible effect while the others take into account both the effect that can be seen and the effects that must be foreseen.

Yet this difference is tremendous, for it almost always happens that when the immediate consequence is favourable, the later consequences are disastrous, and vice versa.

The fixing of the interest rate is the most worrying of recent actions by the authorities. If there is one price in the economy that is more important than any other, it is the interest rate. This is popularly thought of merely as the cost of borrowing “money”.

Some economists have called it, more broadly, the price paid for the services of capital. It would be much better to call it the price of time.

It is the discount on future goods as against present goods. It affects the price of all securities and all price relationships.
Authorities, taking a cue from other governments all over the world and driven by Keynesian economic thinking are attempting to boost economic activity by making the price of capital cheap.

The difference is our government has no influence on the production or supply of the good whose price they wish to fix. The fixing of the interest rate amounts to an attempt to overcome this failing.
What happens when you price a sought-after good cheaply? There is excess demand for it.

But what happens when the supply of that good is fixed at least in the short-term? Bottlenecks appear in the system and another measure is used to clear the system. Rent-seeking behaviour takes root and access to the little supply of credit in the system is determined by those empowered to make lending decisions.

Misallocation of capital to sub-optimal economic ventures becomes inevitable. The 10% differential proposed bears the hallmarks of a thumb-sucking expedition. For example, the net interest rate in Kenya for 2012 came to 11%. This would imply Kenya has a marginally riskier business environment at present.

Regulatory authorities’ efforts at strengthening corporate governance is to be commended. However, efforts to curtail the level of individual shareholding in a financial institution do not augur well for the future prospects of the financial sector. This goes to the core of the incentives available to an entrepreneur in any economic undertaking.

All the great business stories of our time from Apple, Econet, Facebook, Equity Bank, Innscor and Google have one common trait. All had individuals who could impress their vision and will on their economic landscapes while risking all in order to attain their goals to all our benefit. Talented individuals and capital will increasingly shun the industry because the combination of stringent legislation, fixed interest differential and capped shareholding mean lower economic returns for prospective capital.

Delinquent behaviour stems from undue influence on the decision-making apparatus. It is driven by access.

Access is not limited to shareholding, but also abuse of office whether by the board as reported by the Zimbabwe Independent in the case of the National Social Security Authority or by management in the case of Lehman Brothers, Bear Stearns, Barclays (global) and the Icelandic Banks.

In this part of the world, while banking laws require reform, the biggest challenge has been implementation of such reforms. Given our storied past with bank closures and alleged insider malfeasance, it is a tragic indictment on our society that from the fall of ENG right through to closure of Royal Bank, not a single individual has been made to account for their misdemeanours.

Bank charges and fees and commissions charged by banks warrant debate but government’s attempts to introduce uhuru banking through the back door doesn’t augur well for the finance sector.

For example, government is the single largest employer in the country. It pays civil servants an average of US$350 per month. This means more than 200 000 civil servants must enjoy free banking. If it is believed there is 80% unemployment in the country, then all these individuals will enjoy free banking. The question that stands unanswered is: who is going to pay for this politically contrived gift?

In 1969, Indira Gandhi nationalised India’s 14 largest banks accusing them of being monopoly capitalists. Pursuing noble goals as all politicians, we are told,  she sought to increase access of banks to India’s rural population, re-orient credit to perceived neglected areas and reduce control of big business houses who only made loans to their affiliated companies. She succeeded to a large degree but at what amounted to a huge cost.

The efficiency of the whole system sank. Productivity and profitability plunged. By 1990 banks’ gross profit dropped to 1,1% of working funds. Bad debts grew to 20% of all advances. Banks became havens for corruption, having been “captured” by those with influence.

Service levels became deplorable. Productive sectors inevitably suffered and this is one of the reasons why India’s economy grew at a stunted rate till the economic reforms of 1991.

Unless government reverses much of the raft of proposed changes, prepare for our local version of the Indian experience. But our experience will be more acute because the banking sector is already under considerable strain.

Local banking standards will suffer, while a proliferation of “executive banking units” will be re-introduced to try and circumvent government policies. Remuneration of employees will stagnate and increase the probability of corrupt practices, as employees look to augment their incomes.

The financial sector sits at the epicentre of our economy. The fortunes of the economy are inextricably tied to its fate. We must tread carefully.

Msipha is a finalist of the chartered financial analysts (CFA) programme. He writes in his personal capacity.

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