Financial Liberalisation As A Chimera
the execution of interest rate deregulation. It is now recognised that dismantling of interest ceilings were designed without regard to the state of the economy, the banking system and its nature, the quality of the liability structure of the borrowing firms and other issues. It came, therefore, as a surprise to the original progenitors of the policy when actual results of interest rate deregulation diverged from what was expected. The hiatus between the ex-ante and ex-post consequences of interest rate deregulation should not, however, be ascribed to the inappropriateness of the policy; it is closely connected with sequencing the order in which financial reforms are implemented. The increased freedom of entry into the financial sector and freedom to bid funds through interest rate and other instruments can lead to excessive risk-taking. Deregulation of interest rates can facilitate a too rapid growth of some financial institutions and allow unqualified persons to enter into business. The financial system
that emerges from regulatory changes can also propel concentration of power in banking, inter-locking of ownership and lending patterns.
Where should we then stand on the issues involved? Clearly, financial reforms cannot be dodged. At the same time, they need not follow the same pattern. It is a process and not an event. Some variation in its mode and content is to be expected. There are some basic considerations which have to be kept in view. It should be recognised that while financial reform is aimed at eliminating distortions in the markets induced by government intervention, it does not necessarily create perfect credit markets. Financial reform, therefore, has to be built on the initial conditions often ignored. These are portfolio of financial assets, information channels and a stock of human capital as reflected in the bundle of skills of employees and managers. Adjustment in all these is time-consuming. The incentive system which affects the behaviour of banks also takes time to change. Banks chart out the risk profile of their loans influenced partly by the tradition and partly by the interventionist approach in the pre-reform
period. After reform, there will have to be, of necessity, an adjustment in banks portfolio. But letting them adjust from strict controls to freedom can be dangerous if they do not upgrade their skills in risk management and their information about potential clientele. It is, therefore, necessary to have in place the infrastructure to facilitate the management to readjust asset portfolio in a manner that would promote the dynamic class of borrowing enterprises. Otherwise, the management may go in for a safe haven like risk-free government bonds.
The second initial condition is the lack of information channel. In the absence of carefully audited financial statements and developed equity markets, banks need to build up a long-term relationship with their clients. The supply of bank loans depends on the efficiency of their information channels, the rate of return on substitutes like government bonds, owners disposition to risk and other regulatory constraints.
In the same way, human capital and management systems should be considered as vital as their portfolio in the determination of the banks role in the real economy. Without skilled and appropriately motivated staff and a properly designed incentive system, even the best bank portfolio can turn sour.
Economics will not gain impetus from reforms if two basic ingredients of the market economy are ignored. One is the quality of governance and the other is the clarity in delineation of property rights. Governance in a generic sense is everything that establishes order in a civil society. Unfortunately, a prolonged period of over-administered economy has created a jungle of rules and regulations, and a mindless bureaucracy. For maintaining the freedom of choice and impersonal nature of transactions which are the hallmark of market economies, the government should assume the role of a facilitator of the market economy, and not its custodian. Government intervention is a matter of politics and should be played that way.
It is imperative also, to formalise property rights. This can be achieved by embodying them in universally obtainable, standardised instruments of exchange registered in a central system, and governed by legal rules. Property rights then can enter the market place in a form adapted to massive and frequent exchange like checks, share certification, promissory notes bonds and contracts which facilitate transfer of resources to their highest valued use.
It is only then financial liberalisation would cease to be a chimera.