Monday, February 9, 2009

Banks & Profitability

In the excesses of the current economic era, the greatest culprits are the banks. Executives pay themselves huge salaries and bonuses while they take entire economies plus all their customers to the cleaners. I agree that their pay should be cut down to size and that their bonuses should be used as part of the insurance money for depositors.

Banks are a monopoly in the flow of the financial resources of the country, very much like the Russian gas pipelines for Europe. Banks can dictate which no ordinary citizen can protest, with the unwitting connivance of the central bank, if the central bank is not wise enough. If central banks are not careful enough, they can agree to give the mandate to banks to add-on all sorts of charges for the customers, not unlike the bills of some private hospitals that can charge you an arm and a leg for a cold.

I do not know the source of the wisdom of the central bank that allow banks to impose high administrative charges onto the costs of funds to arrive at the Base Lending Rate which even banks, despite their marauding tendency, are even ashamed to impose on their customers such that the Average Lending Rate (6.08% pa in 2008) is lower than the BLR (6.70% pa in 2008).

An ALR lower than the BLR must be an embrassment for the managers of a banking system. In theory, the BLR is the best rate that a bank gives to its best customers. The BLR should be like selling almost at cost but with a small margin to cover costs. Customers with excellent credit ratings should be given the BLR. For the average loan rates of banks to fall below the BLR means that the BLR is grossly mispriced and has failed to provide the price reference for the loans market. Maybe the currently pricing of the BLR is in tune with the people's preference for a discount, whether buying decisions are made on the basis of the discount rate regardless of the extent of the initial over-pricing. The mispricing of the BLR is a way to confuse the market.

Technically, in a down economy, the policy concern is to put cash in the hands of savers and lower the cost of borrowing. In a properly structured banking system, this means to lower the cost of funds as that the cost of borrowing can be cut, as the mark-up is already basic and small. In a situation like ours where the mark-up is high, it is possible to maintain the deposit rates while lowering the mark-up so that the lending rate can be lowered.

The average interest rate for fixed deposits was 3.29% pa in 2008 and the savings deposit rate was 1.42% pa. The BLR of 6.70% pa in 2008 was a mark-up of 3.40% over the average fixed deposit rates and 5.28% pa over the savings deposit rate. The ALR of 6.08% pa in 2008 was a mark-up of 2.79% over the average FD rate and 4.66% over the SD rate.

I think the banks, with the approval of the central bank, have done a disservice to the small depositors. The argument may be that small savings depositors are a cost to the banks in terms of the infrastructure, but banks do impose charges for services even to small depositors using the ATM. If the central bank can provide bonds at 5% to senior citizens over 55, a more effective way is to cut the margins of banks. One way is to cut the fat salaries and bonuses of senior executives. There used to be a shortages of senior executives as the number of banks expand. But the consolidation of the banking system into an oligopoly of the chosen few must mean that there is no such shortage.

One reason for a hugh mark-up is to provide the cover for bad loans. In other words, get the good customers to subside the bad customers. This is the sure way to ruin an economy - by lending money for unproductive uses and taxing the productive borrowers. Such an argument may be a cover for the incompetence of bankers, that they do not anymore know how to lend prudently and in a way that is healthy for the economy. This complete loss of perspective has a cost that depositors pay with their poor interest rates and borrowers pay with their higher than necessary loan rates.

Or, is this mispricing of our financial resources a product of bad economic thinking right at the top where it is possible for political leaders to direct bankers to fund privatised projects which may have doubtful economic viability. Has the elite in this way rob the country of its wealth by ruining its whole sense of trust and truth, so that only the dishonest can have a future in this system?

1 comment:

de minimis said...


This is an excellent and incisive piece. Bank Negara needs to seriously look into this cartel-like attitude of Malaysian banks who have loaded very heavy charges on Malaysian bank customers for decades now. If Bank Negara does not protect financial consumers then who can?