In guest article in The Economist, health Justin Lin, chief economist at the World Bank recommends that developing countries take a different approach to banking than the developed countries. Instead of focusing on building out advanced stockmarkets and encouraging large diversified global banks, developing nations should instead focus on encouraging small, local banks which focus on providing financial services to small businesses and households.
He sites the success of countries moving from low-income and middle income which focused on more simple banking systems and only gradually liberalized their capital markets as their GDP per person grew. He also sites how attempts in sub-Saharan Africa to create stockmarkets have largely not got much traction.
He suggests that local, smaller banks focus on serving industries for which the country has comparative advantage … that is, something they do well compared to other countries … which has been the strategy successfully employed by South Korea, China, Malaysia and others.
He also calls on the need to create credit and collateral registries along with reasonable legal systems for dealing with the inevitable failures. For instance, banks will be much more willing to lend to a manufacturing business if they know the collateral pledged is that already pledged to someone else. Also, when banks or businesses fail, there needs to be a timely process for liquidating in order to enable capital to flow to the successful businesses in the economy.
He identifies microfinance banks and other non-banking financial companies as being critical to developing countries financial systems inferring that these institutions should get more support from governments to expand their operations.
One thought on “Small, local banks are better”
Micro finance groups have been successfully established by NGOs working in developing nations for decades. Indeed, this is a proven way of helping the rural and urban poor have access to credit without the high interest rates of corrupt money lenders.
Additionally, the poor learn new skills when setting up a micro credit program. Financial skills and accountability in particular, provide the basis for successfull small revolving loan funds. The monies accessed by the poor are turned back into the community through micro enterprise businesses. Farmers have access to agricultural inputs that allow them to provide food and income for their families, as well as food for the community.
Small local banks protect the interests of the poor when it is the poor themselves who own the interests of the bank. Along with Justin Lin’s recommendations, I would like to add that governments should look at ways to strengthen the work of NGOs in developing countries, who are helping the poor to establish micro finance cooperatives.