The plight of the banks in the Western world during the current crisis has often been contrasted with the relatively unscathed banking sector in Asia.
Banks in the developed countries were excessively leveraged, they went in for all kinds of undesirable and opaque derivatives and their compensation structure was way out of proportion to that of other professions. Moreover, the banking sector was aided and abetted in all this by a very lax regulatory system.
In sharp contrast, the Asian banks have come across smelling of roses. Earlier derided as outmoded and staid and—what was an even greater cause for opprobrium—part of the public sector, Asian banks have acquitted themselves rather well during the crisis. They haven’t lost their capital, their exposure to fancy derivatives was minimal and, instead of the invisible hand, they were regulated with an iron hand by their central banks and their governments.
Their close ties with the government, earlier disparaged as a reason for their inefficiency, are now acknowledged as having some advantages. One of them is that it implicitly guarantees account holders their deposits with the banks. Another, seen from the Chinese and Indian public sector banks, is that the government has only to tell them to lend and they dutifully do so. They do not, like their Western counterparts, tighten lending standards at a time when governments are desperately trying to get people to increase consumption.
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It’s no wonder then that the so-called Asian banking model is back in fashion. In a research note on “Emerging markets and financial sector liberalization”, Deutsche Bank analyst Markus Jaeger writes that policymakers in emerging markets are likely to take a dim view of the financial liberalization policies earlier promoted so vigorously by the foreign banks.
The opening up of the banking sector fully to foreign banks, earlier touted as essential to increase efficiency, will now be put on the back burner. For instance, the Reserve Bank of India, which had earlier said that it would consider opening up the banking sector to foreign banks in 2009, has now decided to defer it and continue with the current policy and procedures relating to foreign banks in the country. The note says, “Concerned about the possibility of “reverse contagion”, EM (emerging market) policymakers will be more selective and more cautious before further opening their doors to foreign banks.”
Secondly, the note points out that the ability of governments to force public sector banks to lend during the crisis will make them reluctant to relinquish control in the form of guidance, public ownership and control of banking assets. Also, deregulation is likely to be a dirty word in the lexicon of policymakers for some time and it’s very unlikely that emerging market banks will follow in the footsteps of their developed market counterparts and deregulate their financial services sector.
One of the many trenchant critiques of the Anglo-Saxon banking model has come from a well-known and respected commentator on central banking and professor emeritus at the London School of Economics, Charles Goodhart. In a paper on “Banks and Public Sector Authorities”, he takes a close look at the Asian model and identifies its key features. These include: 1) A much greater willingness to have a sizeable proportion of the domestic banking system under public sector ownership and/or control; 2) Much greater direct influence of the public sector, especially the ministry of finance/central bank, in providing “guidance” on the quantum of bank lending and even guidance on the sectoral distribution of such lending; and 3) short-term profit maximization is often less crucial.
Rewards and incentives come less in the form of pecuniary rewards (e.g. bonuses) and more in the form of ascendancy to a higher rung in the ruling hierarchy. The main factor, though, is the much greater role of the state in banking.
The Anglo-Saxon model, says Goodhart, “has now been shown to be flawed and will have to change in several significant respects. The public sector, the state, has clearly become the guarantor of all systemic financial institutions, providing both liquidity and solvency insurance. Fear of bankruptcy, especially within the context of limited liability, will not restrain moral hazard.”
I’m not so sure the Asian model is all it’s cracked up to be. State-directed lending led to plenty of bad loans in Indian banks before they were recapitalized in the 1990s. If the banks’ obsession with fancy derivatives and light regulation are what lead to crises, how would that explain the crisis in the closely regulated Japanese banking system in the 1990s? And doesn’t the origin of the present crisis lie in the subprime mortgages peddled to borrowers who couldn’t afford to pay back their loans—something that could happen in any country when credit is cheap and plentiful? Also, it’s still too early to tell whether the surge of loans by Chinese banks won’t end in tears. In short, the so-called Asian model is no panacea.
The key to bank busts is the taking on of excessive risk. Whether that’s done through plain vanilla loans or exposure to sovereign debt (as happened to the US banks in the 1980s) or to derivatives does not matter. How to regulate that risk effectively is what needs to be discussed, rather than socializing it by nationalization. Perhaps what is needed, as Goodhart says, is a synthesis of the Anglo-Saxon and Asian models.
Manas Chakravarty takes a weekly look at trends and issues in the financial markets. Your comments are welcome at firstname.lastname@example.org