1 Paper submitted to the Savings Banks Academic Award 2008 Savings and Cooperative banks: Social Approach to Credit Rationing Nazik Beishenaly PhD student at the Grenoble-II University (France) & at the National University of Kyrgyzstan Adress: 64, av. Prekelinden, 1200 Woluwé St. Lambert Belgium E-mail: nazik_beishenaly@yahoo.com December, 2007 2 Nazik Beishenaly SAVINGS AND COOPERATIVE BANKS: SOCIAL APPROACH TO CREDIT RATIONING Abstract The main purpose of this work is to investigate reasons of cooperative and savings banks’ capacity to reduce problem of credit rationing within the theoretical framework of post- Keynesian uncertainty. We have also proposed the notion of social approach as an alternative to traditional and relational approaches which only remotely describe cooperative and savings banks reality. Social approach seems not only to better describe the relationship with their members but also appears to be positive constraint that the cooperative and savings banks’ organizational structure puts on their performance. In fact the confusion between owner- customer functions of cooperative banks’ members and public interest assignment of most European savings banks make clear that these banking institutions’ finality is to offer services to the community. Loans to SME reveal this finality. 3 Introduction Despite the fact that savings banks vary significantly from country to country in their structures and the roles they play in their local markets, savings banks in Europe are progressively becoming universal banks. The question arises about the particularity of savings banks with this evolution: if they still have a separate identity or if “it is already diluted in wide institutional variety on one hand and in universalized operations on the other” (Wysocki, 1995, p.27) 1 . According to the European Savings Bank Group, today’s savings banks stand out first and foremost for their “close local and regional ties and proximity, the will and vocation for socially responsible behaviour and a comprehensive range of financial services for private and corporate customers with a special focus on small and medium- sized enterprises” (ESBG&WSBI, 2006, p. 35). The last statement presents several questions in view: can savings banks’ focus on SMEs secure their particular position in banking industry? Why savings banks would be a better fit when it comes to supplying credit to “risky” borrowers as compared to commercial banks? How do they protect themselves from hazards associated with lending to micro and small enterprises? In our paper we argue that savings but also co-operative banks are the most efficient banking institutions offering credit to SMEs as a result of better capacity to reduce credit-rationing problem. 1 In Brück et al. (1995) 4 It is a well-known fact that SMEs are unanimously considered by economic researchers and policy makers as a group most exposed to credit rationing problem. This opinion is traditionally explained by information asymmetry within new-Keynesian theoretical framework (Stiglitz and Weiss, 1981). However, in this work we adopted a different approach, the one based on post- Keynesian anticipation asymmetry (Wolfson, 1996). We will discuss both theories and their impact on “savings and cooperative banks- SMEs” relationship in the first part. Our study is based on the presumption that the capacity of banking institution to reduce credit-rationing problem would not only foster access to finance for SMEs, but it can also represent a competitive advantage for the bank. Therefore in the second part of this paper we will analyze the factors of lenders’ anticipations that affect credit rationing. Our hypothesis is that these factors are specific to savings and cooperative banks and thus can be considered as intrinsic forms of competitive advantage. In the new environment where savings and cooperative banks have become important actors of European banking industry perfectly capable to compete with commercial banking, this advantage can serve as a crucial feature distinguishing them from other banking institutions. Credit rationing theory Traditionally credit-rationing problem is represented within new-Keynesian (Stiglitz and Weiss, 1981) analytical framework based on asymmetrical information. The latter explains why economic agents have conflicting relations where borrowers mislead lenders, obliging them to take measures such as credit rationing. We consider that interests of the bank and the borrowers are not always conflicting, especially in case of cooperative and savings banks, given their ownership structure and historical background. This fact allows us to employ alternative post- 5 Keynesian (Wolfson, 1996) framework where it is believed that uncertainty does not allow overcoming informational opacity in ultimate terms. Thus instead of asymmetry of information one can think in terms of asymmetry of anticipation. In fact cooperative and savings banks’ lending activities are characterized by their will to approximate their anticipations to those of their borrowers. Moreover, according to new-Keynesian approach of exogenous money, banking institutions are conceptualized as pure financial intermediaries, while in post-Keynesian endogenous money perspective they create money by making loans. Given the fact that in Europe cooperative and savings banks are primary credit organizations(OCDE, 2005; Banque de France, 2006), their role is to some extent crucial as compared to commercial banks. However in present paper we focus mostly on ‘lender-borrower’ fragment of money-and-credit theoretical debate between new- and post- Keynesian authors 2 . Credit rationing - a consequence of asymmetric information? According to Stiglitz and Weiss (1981), credit rationing refers to a situation where within a group of loan applicants with equal characteristics, some of them receive a loan and some do not even if they offer to pay a higher interest rate. Still, some individuals could obtain a loan 2 Stiglitz J.E., Weiss A. (1981) “Credit Rationing in Market with Imperfect Information” in New Keynesian Economics, v.2: Coordination Failures and Real Rigidities, ed. by Mankiw N.G., Romer D., The MIT Press, Cambridge Wolfson M. H. (1996) “A Post Keynesian theory of credit rationing”, Journal of Post Keynesian Economics, Armonk, spring, vol. 18, iss. 3 6 under larger supply of credit even if they were unable to obtain it under more limited conditions (Stiglitz and Weiss, 1981; Greenwald, Stiglitz, 1987). This definition shows importance of supply which depends on availability of money in economy and which is a growing function of the bank’s expectation for the profit. In conditions of full transparency of information, demand and supply of money would be regulated by price mechanism. However, this mechanism fails when information is asymmetrical. In fact, in situation of asymmetry of information, higher interest rates will attract bad borrowers and therefore the system as a whole fails to efficiently reduce demand for credit. This process explains the existence of the equilibrium inferior to full employment 3 . Asymmetric information, key concept of New Keynesian approach, corresponds to the situation where the borrower knows the exact distribution of the probability of success of his investment project, but not the lender. In the situation where available offer cannot satisfy the demand for credit, bank will tend to raise interest rate in order to equilibrate the market. However, this increase will backfire by attracting risky projects as a result of the operation. In fact, 3 “What ensures that the number of individuals certified to be credit worthy, combined with those with cash resources, generates a demand for current resources equal to current supplies?… The answer provided by traditional micro-economic analysis is simple: if there is an excess demand for current resources, the real rate of interest will rise: as this happens, the demand for credit, i.e., the number of individuals seeking certification from the banking institutions is reduced until demand equals supply at full employment for current resources. Similarly, potential borrowers with high expected yield projects will bid more for resources, resulting in an efficient allocation of resources. We now argue that, in economies characterized by information imperfections the price system may well not serve the information-equilibrating role assigned to it by conventional theory ” (Stiglitz et Weiss 1990, p. 101) 7 asymmetry of information can cause situations of adverse selection (higher interest rates and collaterals attract riskier borrowers); incentive effect (higher interest rates encourage borrowers to choose riskier projects); moral hazard (higher interest rates encourage borrower to change his initial project); opportunism (when borrower communicates erroneous data on his project). In these conditions bank has limited capacity to correctly evaluate inherent risks of projects and thus practicing higher interest rates does not fulfill its expectations of higher profit. Bank is therefore obliged to ration credit demands on quantitative basis: some individuals obtain credit while others do not even if they are ready to assume the same conditions as accepted borrowers. …or a consequence of asymmetric anticipations? Post-Keynesian representation of credit rationing problem (Wolfson, 1996, Isenberg, 1998, Dow, 1998), which was elaborated upon based on the theory of endogenous money, differs and criticizes the previous theory. It cannot be accepted that information on success of the project exists and is known to one group of agents (borrowers) and is concealed from the other (lenders). This assumption would be in opposition with the notion of fundamental uncertainty of Keynes where the future cannot be known at any conditions. Given that economic system is under continuous structural change, uncertainty does not allow utilizing certain methods that would help to predict the issue of investment projects (Minsky, 1974; Basu, 2003). Therefore, borrower’s desire to borrow and to finance new investment “arises jointly from optimism about returns to the real investment and a need for financial capital, while lenders’ terms depend on the optimism of both potential lenders and wealth-holders” (Chick and Dow, 1988). 8 Credit rationing appears whenever “bank refuses to lend to particular borrower despite his will to pay higher interest rate” (Wolfson, 1996, p. 463). This definition results from distinction made by Wolfson (1996) between notional demand (all demand in economy for bank credit) and effective demand (demand of borrowers considered creditworthy). Banks produce credit in response to the effective demand, while the difference between notional and effective demand represents rationed part of credit demands. Asymmetry of information thus does not play crucial role when efforts are made to explain credit rationing. In fact ex ante asymmetry, as adverse selection and incentive effect, are not regarded as decisive factors of credit rationing. However, the concept of asymmetry of information as such, is not contradictory to this analysis: in case where the relationship between bank and its customers is deficient, ex post asymmetry as moral hazard or opportunism can emerge describing the situation of voluntary risks (Lavoie, 1992). Bank can refuse credit for two main reasons: 1. because bank does not believe in successful issue of the project at any interest rate even if it is not constrained by the money supply limits; 2.because potential borrower does not satisfy bank’s conditions (Lavoie, 1992). In both cases, credit demand is not considered effective. Only demand judged as effective can determine the volume of bank credit. In post-Keynesian perspective, bank appears to be the one who decides the volume of credit in economy in contrast to its traditional representation as a simple financial intermediary. The bank’s choice between effective demand and rationing is function of mutual knowledge between bank and its customer (Dow, 1998). The concept of knowledge is thus opposed to the 9 one of information which corresponds to the set of empirical data, while knowledge describes a more dynamic process. Thus the volume of credit supply reflects the state of knowledge between borrowers and lenders (Dow, 1998). The problem of credit rationing emerges consequently from anticipations asymmetry (Wolfson, 1996), which is legitimate with regard to the concept of uncertainty. These anticipations correspond to the differences in perception of the future by different groups of agents. In fact, lenders and borrowers can have different anticipations of the success of the project on the grounds of the same available information. Investment projects are therefore double- constrained by the choices of both borrowers and lenders. Credit rationing results then from the situation where projects are considered successful by borrowers but not by banks. In fact, borrower might believe in success of his project but it does not connote the project’s successful realization. The level of credit rationing depends on bank’s subjective evaluation criteria based on its confidence and not only on probability calculations: « The state of long-term expectation, upon which our decision are based, does not solely depend, therefore, on the most probable forecast we can make. It also depends on the confidence with which we make this forecast-on how highly we rate the likelihood of our best forecast turning out quite wrong” (Keynes, 1936, p. 148). Bank’s confidence is related therefore to the asymmetric anticipations, which can modify the level of credit rationing. At some point of confidence level, bank tolerates risk and grants credit, but once the limit of its confidence is touched upon, credit rationing takes place (Wolfson, 1996). 10 In resume, for New Keynesians asymmetrical information reflects the situation of unequal distribution of information, which could benefit from a more efficient allocation of resources if client relations would be better developed. In fact, transparency of information would let banks select good borrowers. In Post Keynesian analysis, even with transparent information uncertainty excludes any attempt to know the future. Only concordant anticipations can reduce the problem of credit rationing. We can conclude this assumption by the following logical statements: 1. good “lender-borrower” relationship makes it possible to develop mutual knowledge; 2. mutual knowledge facilitates establishment of confidence; 3. confidence can reduce asymmetry of anticipations and thus credit rationing itself. Common conclusion to both approaches is the importance that needs to be attached to the relationship between bank and its customer as the decisive factor of reducing credit rationing problem. However, there is a difference in the approach to the banks’ customers: information asymmetry supposes that borrowers continuously seek to deceive lenders while the practice of relational banking would help the financial institution to monitor and to distinguish “good” borrowers. Anticipation asymmetry does not consider borrowers as a group with interests opposite to lenders’ since even their honest behaviour does not prevent from their “naïve” anticipation. “Fringe of unsatisfied borrowers”: micro, small and medium enterprises As stated in recent OECD’s study on SMEs’ financing gap, policy makers are aware of great importance of funding and acknowledge that the lack of finance in appropriate forms may be serious barrier to the development of this sector (OECD, 2006). While bank credit programs [...]... features of cooperative and savings banks which are able to impact these banks’ capacity to increase credit offer to SME We argue that these historical and structural features originate proximity and explain social approach in the relationship between cooperative and savings banks and SME In fact geographic and socio-cultural proximity contribute to the development of mutual knowledge and thus to the establishment... certainly demands to be investigated with appropriate tools however these results conform to the general statement that cooperative and savings banks are mostly developed in rural agricultural regions ignored by commercial banks Proximity and social approach The proximity in the relationship between banks and their customers resulting from the historical and structural particularities of cooperative. .. for SMEs, just as other cooperative banks We explain savings and cooperative banks particularities in SME loan market by identifying two major groups of factors- historical and structural- which are at the origin of their specificity Historical and structural factors Historical factors play important role in present credit activities of savings and cooperative banks, probably for the same reason as ruins... exclusive position of cooperative and savings bank in loan market? Social approach in savings and cooperative banks’ credit making We are going to consider French savings banks, namely their positioning in banking market so that we can observe their specificity comparatively to commercial type of banks In France, the case of Caisses d’Epargne is interesting for its transition from public to cooperative form... solution to the losses of profit from operations with “good” borrowers rationed wrongly Alternatively we suggest that savings and cooperative banks already possess tools which can serve to reduce credit rationing for the benefit of both lenders and borrowers In fact cooperative and savings banks where owners are also borrowers (ex., cooperative banks) or the owner is the State (ex., public savings banks)... customers and locality The term social approach is employed to describe neither altruistic behaviour nor solidarity finance Since transactional and relational approaches have for their ultimate purpose bringing more profit to the owners of the firm, in cooperative, where owners are also members, social approach is constrained by its ownership structure and statutes In fact, despite the fact that cooperative. .. during these years, cooperative and savings banks could benefit from building solid network and gain significant part of banking market, which are their strong sides today They are also remarkable for their social engagement which translates their will to give access to finance to non-profit sector Moreover, cooperative banks are well-known for their cooperation with numerous micro -credit and other public... institution and beneficiaries typical of other banks Summarizing it, both asymmetries related to the information and anticipation will be reduced: generally speaking, borrowers do not have opposite interests with their cooperative or savings bank so they will not try to mislead it on permanent basis; cooperative or savings banks are aware of this and will ensure more responsibility in credit demand treatment... institutions represented to the State, as potential channels of state aid to selected sectors of economy Agricultural sector was the first to host considerable sums of subsidized credits channelled by cooperative banks while housing and other sectors of public interest were financed through savings banks (Law of 5.06.1835) Later, in the context of post-war reconstruction, the State counted on cooperative banks... while savings banks were authorized by Minjoz law to offer credit to public administrations and municipalities As a consequence, French cooperative and savings banks could benefit from public subsidies, tax exemption and favourable legislation 6 Catholic Church considered these institutions as a mean for supporting certain social categories In 1891, the encyclical Rerum novarum of Leon XIII explained social . SAVINGS AND COOPERATIVE BANKS: SOCIAL APPROACH TO CREDIT RATIONING Abstract The main purpose of this work is to investigate reasons of cooperative and. 1 Paper submitted to the Savings Banks Academic Award 2008 Savings and Cooperative banks: Social Approach to Credit Rationing Nazik