Notes From a Native Son – The Case for a Post Office Bank
Ryan Straughn, Economist and BLP candidate for Christ Church East Central delivered the Eight Tom Adams Memorial Lecture this week. Interesting was the central point to his address reported in the Barbados Today extract and mooted in the Hal Austin article posted to BU in 2012.
– Barbados Underground
As we enter the New Year, Barbados continues to be in the grip of a serious economic crisis, which, whatever the macroeconomic hurdles, is manifested in the effective withdrawal of the financing of job-creating small and medium enterprises by the major banks.
It is manifestly clear that the foreign-owned banks based in Barbados, either as branches or subsidiaries, are not lending would-be young business people any money. Reasons may vary, but the outcomes are always the same, the rejection of loan applications.
It is even clearer, judging from the long queues that form from opening to closing hours in most of these banks, that the customer service propositions are disgraceful. Ordinary people are forced to endure this inferior service because there is no real alternative. The banks have become complacent. Access to finance is a massive problem in Barbados and government, the wider public sector and the non-banking sector are unable to fill this gap.
In the fog of all this global banking and sovereign crises, there is a positive banking model just struggling to show its head. As Andrew Haldane, the executive director of the Bank of England for financial stability, recently reminded us, perverse incentives, excessive gearing, tax benefits for debt and government insurance all combined to create a financial environment of moral hazard.
Barbados, a micro-jurisdiction, can avoid all this by legislating out perverse incentives, restricting gearing as a ratio of a company’s total assets, reducing or totally eliminating tax benefits in certain circumstances and forcing the industry to fund a deposit and investment insurance scheme.
Part of this proposed new regulatory regime is that home-based banks should not be allowed to engage in off balance-sheet lending or borrowing, or any other form of securitisation without central bank approval.
Community banking is important, not only for the generation of jobs, thereby fuelling consumer spending, that SMEs be funded, but moreso because these firms provide vital goods and services to ordinary consumers and, in so doing, go a long way towards improving the quality of life in Barbados.
The case for a post office bank, operating on the principles of mutuality, to meet this shortfall is powerful and it is one that government should give serious consideration to.
A community bank would not pose any systemic risk to the economy due to macroeconomic shocks; or other endogenous threats. So, its business model removes a serious risk. But, it would be at the centre of government’s drive to grow the economy through the financialisation of the small business sector, which in all liberal democracies, has been the backbone of job creation and economic growth.
The great operational challenge to a community bank will be the threat of default-risk, rather than liquidity shortage, but default risk can be priced. In any case, if a liquidity problem does occur, this can be controlled through allowing the community bank to enter the overnight interbank loan market, or through a short-term cash flow injection from the central bank as lender of last resort. But this is a worst case scenario.
Another worst case risk is a bank run if interbank lending is withdrawn. But, as has already been pointed out, any such void can be filled by the lender of last resort. We all know the dysfunctional way in which the mortgage market operated leading up to the 2007/8 mortgage crisis, with securitisation out of control, cheap mortgages and loan to values of 100 per cent – and in the case of Northern Rock, 125 per cent.
However, one way of avoiding such risk for the entire banking system is the introduction of a deposit insurance scheme, funded through a levy on bank’s and insurance companies’ profits, and either managed independently or through a government agency, such as the Financial Services Commission. Deposit insurance will be risk-free and, in time, cash rich, which will provide the regulators with the means of meeting reasonable demands by savers.
It is arguable, in the final analysis, that retail banks are not just commercial businesses, they perform an important utility service to local communities.
To build a dynamic entrepreneurial sector there must be an improvement in financial intermediation, the vehicle for channelling domestic and commercial savings in to investments.
Traditionally, this is the role of the retail banking sector, providing external finance, but we have seen since the 2007 banking crisis that most banks have embarked on a policy of deleveraging, rebuilding their Tier 1 capital, and imposing stricter conditions on lending.
The outcome is that small and medium enterprises which are badly in need of funds, either for cash flow or to grow, and are finding themselves lockout out by current banks’ lending policy.
Launching the Banks:
There are eighteen post offices in Barbados, offering various services to the public, from full postal services such as the sale of postage stamps, money transfers and other traditional goods and services, to other soft banking services.
These post offices, well-staffed and geographically much better distributed throughout the island than any of the existing foreign-owned banks, can be transformed in to ordinary community banks, offering a range of balance-sheet services at minimum cost and meeting the basic needs of thousands of customers.
The primary tool to make this transformation will be technology and the retraining of staff, neither of which would exorbitantly expensive.
The technology can be bought off the shelf for under Bds$25m dollars; and with a soft-launch – opening branch by branch – staff can be trained and initial teething problems ironed out with minimum problems.
Capital adequacy, of no more than Bds$50m, in addition to the cost of the enabling technology, will be an early challenge but this can be met through a number of ways, from a basic loan for the technology from the national insurance, repayable within two years at a market rate; a loan from the central bank; a one-off print run; selling the equity government holds in the BNB; selling the equity government holds in LIAT; or a joint equity share with trade and credit unions.
The initial capital could also be raised by the issuing of a corporate bond to retail investors, or even shares in the new bank.
One source of possible funding is the Bds $10m presently in dormant bank accounts not being fully used.
That money could be loaned to a post office community bank for basic funding, for a period of not more than five years, at a commercial rate.
Afterall, the current government has been reported as giving $10m to the Turf Club and has given guarantees for various loans to a number of organisations. Funding the start-up costs of a post office bank will be money better spent than many of the current capital expenditures.
It will also be the biggest show of confidence that the government and small business community could expect in the current economic circumstances.
Once the bank begins trading, the aim should be a minimum capital buffer of between fifteen and eighteen per cent, far in excess of that required by the Bank for International Settlements and the European Union, which is about eight per cent.
Apart from the basic technology, the other moderate cost will be staff training, which, given their existing skills set, again will be minimum, in terms of familiarising them with the software.
It will also mean training senior managers and specialist loan staff in risk management and analysis. Again this can be provided by specialist trainers at a minimum cost.
There are numerous models of post office banks that can be used: the French, Italian and German postal services, all have successful banking arms.
A post office bank operating on balance sheet principles, will offer a range of services, all of which will be based on sound risk perception and risk management.
These will include:
savings (notice) accounts;
Land tax payments;
Safe deposit boxes;
Children’s Saving Account;
Other Options include:
This list is by no way exhaustive, but gives a clear indication of the services that could be offered by a good community bank.
Relationship banking, with lending decisions based on the bank’s detailed knowledge of its clients and of the business climate and demand for the specified products and services, is another key aspect which could be exploited by a community bank.
But over and above this, a post office bank will play a key role in the creation of an entrepreneurial and savings culture, in job creation and, overall, in lifting the financial and non-financial sectors in Barbados to the top of the regional banking and financial intermediation.
Managing risks will be the real challenge for the new bank, but with proper credit underwriting training, again this should not pose any problem, as risks would be factored in to the credit spread.
For example, in simple terms, savings account would pay X per cent in interest, therefore lending would be at X per cent plus however many basis points in mark ups the bank wants to impose.
Equally, the same goes for mortgage loans. If, to give another example, the bank launches with a very cautious approach, the management of loan behaviour should not pose an undue risk.
For example, would-be borrowers should be compelled, at least in the early months, to have an account with the bank to be eligible for what would be a standard 75-80 per cent loan to value of the property under consideration.
Any borrower taking out a 75 per cent loan, with adequate protection cover, would hardly default on that loan unless something extreme were to take place.
In any case, credit rationing is a key part of sound risk perception, along with collateralised lending, which could vary from 100 per cent to a percentage of the loan.
And even then the comprehensive protection cover would provide the surety that the investor/homeowner, and the lender, would need.
Such protection cover would include life cover, whole of life or term assurance, which will cover the mortgage, and in the case of term assurance, reduce annually as the mortgage payments are made (I am aware that there are different kinds of mortgages, but the principle holds) and written under trust law so as to avoid unnecessary delay on the death of the borrower.
The homeowner should also be encouraged to take out income protection, in case of loss of occupation, obviously home insurance, and most of all, mortgage payment protection, but with the homeowner being the principal beneficiary in case of default.
In such cases the re-possessed home should be sold at market value, if possible, with any remaining cash going to the mortgage borrower.
Making efficient and speedy payments are the lifeblood of modern retail banking.
This entails having the technology and management competence to cope with local, regional and international payments, from weekly and monthly salaries and pensions to cheque payments.
It also involves the payment of pensions and other forms of income for residents who have moved to Barbados or re-located after working for a number of years overseas.
In a world already used to instant money transfers from barber shops and corner shops, and payment by Paypal and other non-banking institutions, any community bank, even if operating on balance sheet principles, must still be up to speed in terms of new globally compatible technologies.
Therefore, payment infrastructure and low-cost processors are therefore going to be very important in getting on top of new developments in banking, such as internet, mobile contactless, cloud computing, payment apps, online, telephone, and new forms of banking, which have not yet come on stream.
This will necessitate real-time payments, whatever the geographical boundaries, and sound payment risk forecasting.
As the number of entrants to internet payments is growing, any new entrant, even a conventional bank, must compete on price, speed, security and efficiency.
The market is huge, with Paypal alone processing transactions north of US$100bn a year, and growing at a further $5bn a year.
What is important is that in the world of modern banking, as institutions banks may be important for deposit-taking, but not for payments.
The bottom line in retail banking, as in all retail businesses, is customer relations management, putting the account holder at the centre of the business and making him or her feel wanted.
As things stand, most Barbados-based banks do not understand, or just do not demonstrably care, about their customers.
Long queues, obstreperous staff, distant executives and unsympathetic loan officers, all combine to make the customer experience an unnecessarily difficult one.
As has already been stated, a post office balance-sheet bank should not pose any systemic risk, either from external shocks, or from recklessly entering the securitisation market. In fact, it should be prohibited from doing so through legislation.
This should not, however, prevent the bank from selling off its mortgage book when necessary to raise additional funds to continue lending, as this would be necessary to meet continuing demand.
Equally, retail savings will be under-written either by the state or through an appropriate deposit insurance policy, as suggested.
On the supply side, a community bank will meet many of the pressing cash flow and policy needs of the government by providing the financial backing for SMEs.
As has been pointed out, default risks pose the real danger, but these cannot be predicted with any accuracy, even if with good risk perception and management they could be planned for.
In the final analysis, a post office community bank would not only correct the massive error committed by the Arthur government in selling the Barbados National Bank, it would in time prove to be the bank of choice for ordinary people.
Barbados must have a retail bank domiciled in its jurisdiction, despite the irresponsible claims of senior regulators.
And with a carefully managed balance sheet – cash plus credit – such a development could prove the driver of the creation of the biggest small business sector since the end of the Second World War.
Barbadians need a decent banking system, one that they can trust, and one that they can call their very own.
More importantly, for the firs time in the history of banking in Barbados, local communities will have a national bank which is closely identified with their neighbourhoods, supporting local tradespeople and businesses, with a range of saving products which will encourage ordinary people to put aside some of their money for a rainy day.
It will be based on published governance principles which will form the basis of their relations with customers, including a clearly publicised complaints system.
There is also another important role a post office bank could play: being the communicating nerve centre for local communities, with notice boards and other forms of information displays.
It could also be used by government to advertise public sector vacancies, public announcements and other community notices.
As long as the executive team avoids venturing in to the leveraged banking sector, a community bank should do well in Barbados and provide an invaluable public service.
However, it is important to remember that the regulatory and supervisory structure of banking, and ownership, affects economic growth, since it directly affects access to capital.
The efficient allocation of capital determines the rate of returns, impacting on savings and economic growth. Financial markets feed in to the real economy, helping firms to avoid short-term crises, such as cash flow and funding growth.
It is this link between finance and development has been clearly pointed out in the literature.
Finally, one feature that should be a characteristic of a post office bank is that individual branch managers should have greater autonomy for making key decisions and all the important decisions should not centralised.