Efficient resource allocation is another important function of banks.
Individual savers may not be able to collect and process information on a variety of possible investments. Consequently, the high cost of acquiring information could prevent capital from flowing to its most productive uses. For individual savers, it may be very expensive, if at all possible, to acquire the necessary investment evaluation skills to collect relevant information and to monitor the performance of a large number of investments. Taking advantage of specialization and significant economies of scale, banks are able to perform these tasks as a service to their clients. As a result, capital goes to those investors which are expected to give the best returns. To assess the performance of domestic banking in allocating resources the following indicators are selected:
• ratio of long-term loans to total loans
• ratio of long-term loans to total investments
• ratio of private sector bank credits to GDP
• variation in interest rates on deposits Figure 1
The ratio of time deposits in banks to GDP, percent, selected transition countries, end of year, 1999
Figure 2
The ratio of time deposits in banks to GDP, percent, end of year, Ukraine, 1995-2000
Sources: Web pages of the central
banks Source: Harvard/CASE database
In the macroeconomic sense, long-term loans support total investments, while short-term loans support (short-term) borrower liquidity. The term “investment” involves, among other things, the formation of new fixed capital (buildings and equipment); this is usually a lengthy process and requires a long-term commitment of capital and effort. Long-term loans are assumed to support this process. The ratio of long-term loans to total loans may be used as an indicator of the overall contribution of banks in allocating resources to total investments and growth.
The behavior of Ukrainian banks (Figure 3) does not show any significant changes in the crediting pattern. Although it is true that the year 2000 saw quite a substantial growth in the volume of loans provided by domestic banks,5 most of the funds were used for
5 In 2000 the credit portfolio of domestic commercial banks (stock) grew by about 64 percent (from UAH 14 billion to UAH 23 billion), which is a significant increase given that year-on-year inflation rate was about 25 percent.
0 1 2 3 4 5
95 96 97 98 99 00
%
0 10 20 30 40 50
Czech Rep. Slovakia Hungary Bulgaria Poland Russia Lithuania Latvia Moldova Estonia Ukraine Kazakhstan
term needs. Since 1998, the proportion of long-term loans in bank portfolios has been fluctuating in the 10–17 percent range. In 2000 the share of long-term loans remained at about 14 percent of the total credit portfolio. Thus, Ukrainian banks help enterprises with their liquidity needs, rather than with large investment projects.
Figure 3
Long-term loans and short-term loans, percent of total credit portfolio, Q4’97-Q4’00
Source: Harvard/CASE database
At the same time, according to another important indicator – the ratio of long-term loans to total investments6 – the role of banks in supporting the country’s investment activities has strengthened over the past several years (Figure 4).7
6 Here, the term “investment” is used in the macroeconomic sense: GDP minus total consumption minus net exports.
7 However, this ratio should not be interpreted as a percentage of total investment financed by bank loans. Long-term loans, according to the classification used in Ukraine, are those maturing in more than one year. Whereas total investments cover only a one year period.
0 10 20 30 40 50 60 70
Q4’97 Q1’98 Q2’98 Q3’98 Q4’98 Q1’99 Q2’99 Q3’99 Q4’99 Q1’00 Q2’00 Q3’00 Q4’00
%
Short-term loans
Long-term loans
Figure 4
The ratio of long-term loans to total investments, percent, 1991-2000
Source: Harvard/CASE database
The industrial structure of long-term loans was the following: about 32 percent were lent to Trade, 9 percent to Food, 6 percent to Agriculture, 8 percent to Machinery, 6 percent to Transportation, and 5 percent to Ferrous Metals. The remainder (about 34 percent) were dispersed in small amounts among all the other industries (Bulletin, 2001/2). In some industries - for example, in Food Processing - long-term loans seem to be used relatively efficiently.
Investment in Food Processing is done on a competitive basis: there is a low level of government intervention, and the banks allocate credit according to economic rather than political criteria. On the other hand, the Machinery and Metals factories are, as a rule, state-run and inefficient in the use of their capital.
There is empirical evidence suggesting the existence of a positive relationship between lending to the private sector and economic growth: countries in which private lending is high and expanding have higher levels of growth.8 This finding appears to be quite logical given that lending to the private sector is usually driven by economic rather than administrative levers. Moreover, private enterprises – rather than consuming borrowed funds - usually invest in projects, which generate economic returns. Thus, a high volume of credits directed to the private sector can be viewed as an indication of the significant contribution of banks to allocating resources that support economic growth. In Ukraine, the ratio of
8 See “Finance and Growth” in this volume.
0 5 10 15 20
1991 1992 1993 1994 1995 1996 1997 1998 1999 2000
private sector bank credits to GDP has remained low, although its level increased quite substantially, from 3 percent in 1995-96 to 11 percent at the end of 2000 (Figure 5). In countries like Poland, Hungary, and Slovenia this number approaches 30-40 percent.
Figure 5
The ratio of bank credits to the private sector to GDP, percent, 1995-1997, annually, end of year, and 1998-2000, quarterly, end of quarter
Source: Harvard/CASE database
The interest rate is the price of borrowed funds. In accordance with economic theory, a large discrepancy in the price of similar (homogeneous) goods or services indicates an allocative inefficiency.
Hence, a large variation in interest rates on deposits suggests the inefficient allocation of financial resources. Poor accounting and auditing standards, high market segmentation, and frequent nontransparent transactions between lenders and borrowers are important factors contributing to these differences. Some banks only “specialize” in servicing a limited number of specific enterprises, and behave as book-keepers for their clients, rather than as commercial banks operating in a competitive market.
Moreover, the banking industry is subject to various pressures from the central and local authorities. While all these market distortions were present in the Ukrainian banking industry in 1998-2000, the rapid convergence in interest rates (Figure 6) suggested that the situation was improving and resource allocation was becoming more efficient.
0 2 4 6 8 10 12
1995 1997 Q2’98 Q4’98 Q2’99 Q4’99 Q2’00 Q4’00
Figure 6
Variation in interest rates on deposits, percent, Q1’98-Q4’00
Note: The variation in interest rates is the spread of the interest rates, offered by various banks, around the average rate for the banking system. It can be measured by the variance defined as
N i i rate
Interest Var
N
n
n
∑
av=
−
= 1
)2
( ) (
where iav – average interest rate, in – interest rate offered by bank n, and N - number of banks analyzed. The variance was calculated for interest rates on term deposits of individuals for 6-12 months. As these services are available in all commercial banks, they can be viewed as homogeneous goods and their prices can be compared.
Source: Harvard/CASE database
3. Monitoring managers and exerting financial control