Too much of the same
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"The shift of internationally mobile finance capital away from developing countries shows how imperfect and inefficient global capital markets can be."
There is a common view that developing countries – particularly some of the larger and stronger emerging markets – have been faring rather well in the latest round of the ongoing global financial crisis. Indeed, there have even been some arguments that the successive rounds of crisis are weakening the developed world, first the US and then Europe, while some developing countries continue to forge ahead, thereby accelerating the global shift in balance of economic power.
This view is overly simplistic. The past few years have made it clear that “decoupling” was a mirage. Developing countries – even the strongest ones like China – are neither immune to the storms raging in financial markets in industrial countries, nor to the impact of recession in the core of capitalism.
There has been a remarkable degree of global synchronicity in the changes in the rates of growth of national income over the past few years. The transmission of recessionary tendencies operates through several channels. They include changes
- in the exports of goods and services,
- in international capital flows,
- in patterns of migration and remittances and
- in world trade prices for essential goods like oil and food.
Volatile capital flows matter greatly. Rapid movement of highly mobile finance capital was made possible by financial liberalisation in past decades. Similar policies were adopted to greater or lesser extent across the developing world, so capital markets have become much more integrated. These policies created new and similar forms of financial fragility almost everywhere.
Today, any new global trend can cause movements of finance in or out of a developing country, even when there is no real change in the “fundamentals” of that specific country’s economy. It is worth noting that in 2009, for example, the worst performing stock markets were not those of developed countries that were the epicentre of the crisis, but those of emerging markets like China, Brazil and India – even though the underlying data in these economies were more favourable than in the USA, for example.
Obviously, the shift of internationally mobile finance capital away from developing countries to the advanced core of capitalism in periods of global turmoil does not reflect any objective assessment of the relative current and potential future economic prospects of the regions concerned. It does show, however, how imperfect and inefficient global capital markets can be, and how "flights to safety" can be determined by criteria that are not necessarily economic.
Turbulent commodity markets
The dynamics of global finance affect developing countries in another way because financial players have been becoming increasingly active in global commodity markets. Financial deregulation allowed unrestricted activities by an increasing number of players on commodity exchanges, and speculation has grown dramatically. The result is the excessive price volatility in international markets that we have witnessed in recent years.
Not only have the prices of grain and other food crops changed sharply, but prices for oil and mineral resources have risen fast too. Speculative behaviour is clearly behind such volatility, but the effects are not confined to financial markets. These prices directly affect the real economies of developing countries.
These forces affect all developing countries, but they are felt differently in different places. In particular, the extent of financial contagion and likelihood of local financial crisis depends on how far the developing country concerned has gone along the road of financial liberalisation. Countries with large external debts and current account deficits face particular problems.
The developing countries that have gone furthest in terms of deregulating their financial markets along the lines of the US model – for example Indonesia – are likely to be the worst affected. They may well yet face financial crises of their own.
By contrast, China, which still keeps most of its banking system under state control, is relatively safe, despite the dangers of explosive growth in its shadow banking system. At least, the People’s Republic did not allow many of the financial “innovations” that caused the current mess in developed markets.
Loss of diversity
It should now be evident for all to see that the global homogenisation of the past decades was unhealthy. The regulatory structures that evolved in financial systems across the world have led to conformist patterns of behaviour among financial institutions. Accordingly, these institutions have become more fragile and more susceptible to contagion.
So far, current regulatory practice and even the proposals to reform them do not recognise the dangers of over-homogenisation. Nonetheless, steps need to be taken to reverse the trend. It is a recipe for disaster to make all banks operate in the same way and follow the same guidelines (see box). Herd behaviour will always compound excesses, both in terms of irrational exuberance and, more recently, frantic de-leveraging.
Dwindling financial diversity means less resilience everywhere. In the developing world, however, there are some additional serious consequences. The ability of financial systems to channel domestic savings into investment has been reduced. In particular, banks are now less prepared to lend money to small and medium-sized enterprises, co-operatives and other businesses that drive local economies though they do not come up with huge figures on their balance sheets.
Historically, these smaller-scale producers used to be outside the reach of formal finance, and things have lately become tougher for them once again. They deserve to be properly covered by institutional finance instead of having to rely merely on expensive and short-term microfinance.
For that purpose, some forms of subsidy may be required. Moreover, central banks and regulators should take creative and flexible approaches to ensure that different banks (commercial, co-operative, development, et cetera) reach SMEs, self-employed workers, peasants, women and those without land titles or other collateral.
Developing countries need a broad variety of banking institutions to boost growth and foster business in different areas and sectors. Today, global homogenisation and increasingly standardised regulations are thwarting the scope for different types of banks to emerge and/or survive. This trend is reducing the diversity needed to expand access to financial services in developing countries.
The rules that apply to multinational investment banks and national-level commercial banks cannot and must not apply to government-run development banks, local savings banks or co-operative banks. Instead, diversity in the financial system can and should be encouraged at several levels and by several means. Central banks and regulators should focus on aspects such as:
- encouraging or even requiring financial institutions to specialise in different activities,
- reducing or even eliminating the convergence of risk management systems across different financial institutions, by emphasising different ways of modelling risk for different kinds of financial institutions,
- encouraging the creation and expansion of development banks that are subject to different regulatory requirements from normal commercial banks,
- creating and expanding national networks of community development banks that serve financially underserved communities, whilst allowing for cross-subsidisation and synergies, and
- ensuring that sector-specific banks and client-specific financial institutions operate under prudential norms and other regulations that are sensitive to their specific areas of business (agricultural banks or cooperative banks, for instance).
If the G20 is to fulfil its role of adequately representing the needs of the majority of the world population, it needs to take these concerns on board. Global leaders must consider developing an international financial architecture that recognises the need for diversity in finance even as it prevents or at least reduces institutional fragility and market volatility.
So far, the G20 has not risen to this challenge. It is too early to tell the reason. Perhaps the structure of this informal global-governance body is to blame. Perhaps domestic politics in member countries is blocking progress. It is obvious, however, that global leaders have been doing more to promote the interests of finance capital than to serve the interests of their peoples ever since the global crisis broke out in 2007/2008.
Jayati Ghosh is an economics professor at Jawaharlal Nehru University in Delhi.