Free market (8) - Access to credit

Banks provide credit to businesses. They charge an interest rate comprising of the cost of funds (i.e. the interest that they pay to deposits) and the credit spread (i.e. the additional fee to cover the risk of default by the borrowers, expenses and profit).

In a competitive environment, the credit spread narrows and banks make a modest profit. Under volatile market conditions, the credit spread can increase sharply as the banks take advantage to increase their profit margins.

Some banks take advantage of the market volatility to recall loans and increase the interest sharply. The borrower has no recourse, but to pay the high interest rate, as this is a commercial term.

The banking industry is able to make huge profit at the expense of the business and consumer sectors. Some lawmakers have described the practice as predatory or usurious.

During an economic crisis, the Government has to step in and guarantee the credit for small businesses, as the banks are not prepared to take the risk. Some people refer to this practice as "lend you an umbrella during the sunny days and take it back when it rains".

Is there a better way to provide credit for businesses, rather than rely on the banking industry, especially if the banks do not have a social conscience and exploit the situation to make huge profits?

In my view, there should be a state owned development bank that is willing to offer financing on fair terms to the essential sectors of the economy, i.e. those that meet the needs of the population for their day to day living. These loans are for small businesses to buy the tools, equipments and stocks to run small businesses to provide goods and services for the population.

It is also possible to have large numbers of community or cooperative banks to provide the lending to the small businesses. These banks can draw their funds from the state owned development banks on fixed terms.

This type of structure ensures that there is healthy competition among the large number of banks. The lending should be restricted to the cost of running a business, and not for speculation in properties, including commercial properties.

If businesses have access to credit on fair terms and are not subject to exploitation by the banks or by speculative forces, they can provide their goods and services at fair prices, stablilise the cost of living and increase their economic efficiency.

A large source of economic instability and crisis in past years is due to speculation in property and cost of credit, and in exploitation by the owners of these resources. It is better for these two key sectors to be controlled (and still reflect the market) but to remove the exploitation of the market.

Tan Kin Lian


Tan Kin Lian