Integrated financial sector, national goals needed

Ralph Thomas, Contributor

Our top athletes run faster than anybody else in the world, not just because of their excellent physical endowments and training discipline, but also because of the efficiency with which all their organs and muscles work together in a coordinated and sequenced way, to achieve the outcome of maximising speed over a given distance.

In the same way, all institutions of different types in the financial-services sector of a country must operate in an integrated and coordinated way and be synchronised with national goals and objectives in order to achieve a common purpose, that of the advancement of the country's economic goals and human development.

In the case of Jamaica's financial services sector, we tend to view its components in a fragmented way and not as a unified financial-services industry. These institutions should form an essential conduit through which the life-blood of financing flows efficiently to different sectors of the economy, impacting communities and persons of different social strata in a way that promotes parti-cipation in a coordinated set of economic activities that result in sustainable national economic growth.

In the same way that we judge the performance of our athletes by the measurable outcome of their efforts, which is the heart-stopping time recorded on the clock, we must also evaluate the effectiveness of our financial sector by examining the key indicators of performance relating to the success of its clients (depositors and borrowers) and the general advancement of our society and economic growth. We must make the necessary changes when there are deficiencies, in order to improve the outcome.

Organic view

In this organic view of the industry, the users of financial services, such as depositors, borrowers, investors and even government, are also part of the collective body, the interests of which must be balanced for the good of the whole. If the banks' customers experience decline, so will the banks. While Jamaica's financial sector has shown extraordinary growth in the last few years, the benefits have accrued to those who own the shares of the institutions and they have been handsomely compensated for placing their capital at risk. We must consider how other stakeholders can be better rewarded for their contribution to the industry.

Householders and large and small businesses contributed deposits which constitute the total liabilities of $516 billion of the commercial banking sector in 2009. These deposits fuelled bank loans (reflected in total commercial banks assets of $582 billion) which is the primary source of bank profits. It is evident that appropriate consumer protection regulations can promote a better balancing of the interests of both these stakeholders and contribute to overall growth and economic deve-lopment, which can ultimately benefit the banks and their customers.

While commercial banks dominate the financial-services industry, other institutions play key roles but are still lagging, based on the imperatives to grow the economy. Building societies are very efficient deposit gatherers who mobilise funds in the form of savings, to be used to finance long-term mortgage loans and growth in the housing sector. They have widened their scope to include remittances and general insurance and maintain an important link to the diaspora. They are also making creative inroads into small and micro-business lending, an area of activity not adequately served by either the commercial banks or development banks. Building societies are savings and loans institutions and not commercial banks, and, because of governing regulations, are unable to compete on a level playing field with commercial banks, except in the market niches that the regulations permit.

There is untapped potential in the four building societies operating in 2009, which can only be unlocked by changing the governing regulations to permit them to play an even more pivotal role in development. More thought must be given by the governing authority, the Bank of Jamaica, to determine if they can transition to commercial banking and deepen competition within the industry as it may be beneficial to the financial system as a whole.

However, their form of mutual ownership and the manner in which they are controlled present certain impediments to achieving their full potential, making it difficult to transition to other forms of ownership which would enable them to list on the stock exchanges,if they so desire, and access additional capital for growth.

Investment banks (merchant banks) can play a key role in sourcing much-needed capital for enterprises but tend to focus on the larger deals in the capital markets, which are sources of profits. They have no natural source of funding and must rely primarily on other financial institutions for funding to support financing activity. One of the key unmet challenges facing our economy is the raising of capital for small and micro-businesses, who are one of the potential engines of future economic growth. Mechanisms must be developed to provide these enterprises with the advice and capabilities of investment bankers to source capital, which implies the creation of pooled venture funds for such pur-poses, in collaboration with the public-sector financial institutions, an initiative which ought to be spearheaded by the Development Bank of Jamaica.

Development banks are government-owned entities designed to promote economic growth and development, and traditionally provide long-term funding, primarily on a project basis, and funding for export activity and agriculture. In the case of the Development Bank of Jamaica (DBJ), the pendulum has swung to a business model where low interest rate funds sourced abroad are down-streamed to borrowers through the intermediary of the commercial banks and other entities. This doesn't work very well as the commercial banks' own standard of evaluating risk is used along with sometimes onerous collateral and other requirements, plus an interest margin on top of the DBJ base rate. This business model needs to be revisited and a new paradigm created for the development banks to play a more direct role in the area of credit extension to small and medium enterprises.

Refocusing of the banking industry must be supported by the requisite modifications to outmoded laws and regulations on bankruptcy, and elimination of the legal diffi-culty in obtaining perfected liens or security interests in the assets being financed, because of archaic laws and regulations in this area. Such legislative improvements and other measures would broaden the pool of collateral available to support loans, and this would be beneficial to all financial institutions and promote expansion of credit for productive purposes.

New permanent capital

Small and medium-sized enterprises must be infused with new permanent capital and working capital, made available to support higher levels of productive activity. This thrust should be spearheaded by a reformed and re-prioritised DBJ, with enhanced capabilities to support deeper involvement with this sector, and accompanied by elimination of the frictional costs of working primarily through intermediaries. The required skills to make this work must be obtained by looking both locally and at the diaspora, where a tremendous pool of talent to fuel local economic growth remains untapped.

A significant export thrust to expand foreign markets is required. This requires a coordinated national policy initiative which would have to be supported by appropriate trade policy and employment of the machinery of our foreign embassies and missions; in a redirected strategic priority to exploit to the fullest extent the commercial possibilities of the numerous foreign relationships created over many years.

Crowded out

Government-financing activity crowds out the private sector and a better balance must be achieved. All parts of the economy must work efficiently to promote growth. We are in a race to achieve the goals of the national development plan, Vision 2030, but our untied shoelaces have caused us to falter at the starting gate, as there are many disconnects in the Jamaican economy that must be addressed in a well-integrated economic plan that includes reshaping the financial sector to achieve its full potential.

A highly positive and creative approach must be taken by the governing authorities, who should engage in meaningful consultations with stakeholders in the financial-services sector, to obtain the right clinical diagnosis in order to arrive at the correct solutions that would take the sector forward. The intended effect of modernisation of the financial-services sector is to ensure that our institutions work together in harmony to conduct well-sequenced and timed actions that promote sustainable economic growth at the fastest pace possible, and in accordance with the best interests of all our people.

Ralph S. Thomas is a senior teaching fellow of the Mona School of Business - UWI (Policy and Strategy and Risk and Treasury Management) and a financial consultant, and was vice-president of The Bank of New York, Mellon. Feedback can be sent to columns@gleanerjm.com or ralphthomas003@yahoo.com.