—Tim Worstall—

The banking system is in crisis — just as I’ve said for many years. Well, banking systems often have problems and it’s simple to claim that one of those is a crisis. But I went one step further — I said what the problem was and also why it had happened. Even, said that there’s a perfectly sensible and reasonable solution — which is to close down or sell off the state owned banks. All of them, at whatever price anyone will pay. If that price is nothing then close them.

The crucial line is in this newspaper’s reporting of the current problems: “Politically motivated loan distributions.” Now clearly, that’s referring to the last government and so on but we do need to think about this, so let’s look at it more generally.

Why would a government desire to have state owned banks? So that there can be political control of who gets to borrow money. Obviously.

Now, sometimes this can be a respectable directive. We might think that the standard commercial banks are far too interested in big corporations and no one is thinking properly about the seasonal needs of small farmers. Or even, is willing to deal in the small sums that small farmers might want to deposit, or borrow, over the cycle of the seasons. Thus we should set up a bank specifically to operate with these sorts of sums, with branches across rural areas and so on.

I can think of other ways of achieving the same goal, but I agree that it’s a respectable goal. We can all come up with similar arguments — we want a low value deposit system for the savings of poor people perhaps? Probably a very good idea too, for one of the grand findings of the MPESA banking system in East Africa was that the poor want secure savings opportunities even more than they want to be able to borrow as with Grameen Bank.

We could even note that both Grameen and MPESA were not government banks of course, so it’s not true that government is the necessary solution.

But if we see the government setting up commercial banks, operating on the same structures and lines as the private sector ones then yes, we can indeed claim that the reason for doing so is that politics likely directs who gets the loans.

As ever with political direction of money,who the money gets directed to will be a function of politics. Not necessarily who is a good risk for a loan, possibly even loans offered without any real expectation that there will be an economic return even while there will be a political one.

We now observe the results. As those loans books, capital bases, of those state banks are looked at we find very large levels of non-performing loans. That is, money was lent upon political grounds, not on the basis of who was a good risk and would repay. Therefore the money isn’t being repaid, and aren’t we all surprised? This then means that the same banks cannot lend in this new political world as they’ve not any money left.

At which stage we’ve got to decide what to do. The first thing is unfair, unkind, and also very annoying. But we’ve got to subsidise those banks. Yes, we shouldn’t have to and all that but a great gaping hole where we used to have a financial system is not a good idea. We’ll have to recapitalize, at least plug the holes where the losses are.

The second thing is of course to make sure it never happens again. This means not having state banks — not having banks where the lending of money is subject to political forces. Yes, yes, of course the current government would never do so but, you know, elections can mean other guys come to power. So, sell off the state banks at whatever price anyone will pay. If the buyer will plug the capital hole then all well and good. If not and we have to, well, sad but there we are. If no one will buy at all, then simply close the bank down.

The argument against state banks is that politics will rape and pillage them by directing lending upon political grounds. And that’s what happened.

Once we’ve cleared up the mess — which will cost money — then the important thing is to make sure it doesn’t happen again. That means no state owned banks. So, having learned our lesson — as I warned over the years — let’s not have state owned banks.

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Tim Worstall is a senior fellow at the Adam Smith Institute in London.