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BUSINESS WORLD

The Role Of Commercial Banks In Economic Development
Posted by on May 15, 2008, 01:33

Before we initiate a well articulated and meaningful discussion on the subject, it would, in my view be befitting to clearly understand the theoretical underpinnings underlying the role of finance in the process of growth. Views of economists on this important issue viz. the inter-relationship between finance and growth, however, diverge. While some economists feel that finance drives the wheels of economic growth, others opine that the process of economic growth itself induces financial development.

 

The available evidence seems to strongly suggest a bi-directional relationship between finance and development. In other words, growth drives the evolution of the financial super structure and the financial super structure, by meeting the financing requirements of the economy, facilitates the process of growth. In the latter case, it is well appreciated that if the financing requirements of the economy are not adequately met and in time, it would affect the growth process adversely. As it is known, financial institutions, of which the banking system is an integral part, play the major role of financial inter-mediation. In this regard, their traditional role consists of mobilizing resources from the sectors generating surpluses and channeling them to the sectors that need them. Thus, by meeting the investment requirements of the economy, they facilitate the process of capital formation.

 

When domestic savings fall short of the investment requirements of the economy, the gap is closed through net capital inflow i.e.; the gap is met by way of borrowing from abroad. Banks play an important role in this sphere too by facilitating international trade and service payments. In recent years, however, the conventional view that financial intermediaries should confine their traditional role of mobilizing resources and attracting capital inflows seems to have lost much of its ground. A global perspective on the role of banks reveals a more pro-active and positivist approach to the bank’s role in facilitating the achievement of broader goals of economic development and making them a matter of reality.

 

 In the words of King and Levine, “financial intermediaries determine which economic organizations will survive and which will perish, which entrepreneurs will control organization and which will not, which types of investment can be made and which cannot, and which new economic products can be introduced by firms and which cannot”.

 

This statement is very much relevant to our situation here in Sierra Leone and hence there is good reason for the public to be concerned about the role and behavior of those who are in charge of the financial sector in general and the banking industry in particular. It is also pertinent to examine as to the precise role and responsibilities of banks in the economy in general and in the specialized function of credit extension, in particular. A pertinent issue that has often been discussed in the literature and policy circles in this regard is whether the focus on the mode of financing should be bank-based finance or market based finance. There is no precise answer to the issue as to the relative preference of one to the other.

 

Nevertheless, a pragmatic evaluation of this issue could only be made after taking note of the state of development of the economy, and a critical assessment of the emerging credit requirements not only in terms of quantum but also in terms of their diversity and priority. It may be noted that the credit requirements of the economy are dynamic in nature and are basically a function of the way the economy expands in terms of infrastructure development, commodity specialization and productivity gains.

Further, as development gains momentum, there is a need to step up the resource mobilization process as well. The structure and level of interest rates and the level of ‘efficiency’ (as measured in terms of the spread between the lending and deposit rates) achieved by the banking system thereof gains utmost attention of policy makers in this regard.

 

The Role of Commercial Banks

 

Before we examine the role of the banking system in Sierra Leone against the above backdrop let me briefly review the primary functions of commercial banks. The main traditional function of a commercial bank is that of accepting deposits and granting of loans. They accept deposits of various kinds ranging from demand to fixed deposits, and lend this money to those who are in need. That’s being a broker and a dealer in money. It should also be noted that, a banker is a custodian of others surplus funds, so while earning a profit he should not forget that he is doing business with other people’s money. He must always be ready to meet his liabilities at all times. In case of a banker not able to honour his commitment, he will not only suffer a shock of such a failure, but the shock will also be transmitted to the rest of the economy very quickly.

 

The systemic risks arising from that need to be eliminated or minimized. Besides, bankers are creators of money in the sense that credit creation leads to deposit generation, which, in turn, leads to credit creation, and the process ultimately would have implications for the monetary framework.It’s therefore important that, a banker should always and at all times bear in mind that, he is a guardian of a very important mechanism. A mechanism, which not only bears relevance for monetary policy but also paves the way for future economic growth and development and any disruption or deviation in this regard, could create economic or financial chaos.

 

Do Sierra Leone Commercial Banks Play a Developmental Role?

The traditional functions of Commercial Banking in Sierra Leone have undergone rapid transformation since independence. The total assets of commercial banks currently operating in the system increased a great deal since 2000 with branches now spring up allover the country with a total number of employees exceeding 1500. Commercial banks real credit to the private sector is also growing at a very high rate.

 

As with real credit to the private sector, the total deposits, on an average, witnessed a higher growth rate since 1999. If the rate of growth of deposits is an indicator of the ability of commercial banks to mobilize deposits, the performance of commercial banks in Sierra Leone has been quite commendable in the recent past. However, it is worthy to note here that there has been a considerable shift in the structure of deposits particularly since 1996 with a noticeable slide in the growth rate of time deposits. This would tend to suggest, that despite the high growth in the overall deposits level, the commercial banks are no longer able to mobilize substantial long-term deposits particularly in the wake of competition brought about by the introduction of unit trust and other products of non-bank financial institutions.

 

As you all know the most important indicator of the soundness of the banking system is the bank’s operating efficiency. Recent studies on the banking system in Sierra Leone have shown that commercial banks in Sierra Leone are characterized by high gross margins, high return on assets, high cost-asset ratios and moderately high equity capitalization ratios.

 

Emerging Economic Paradigm - Need for Transformation of Banking

From the point of view of the central bank and based on a review of banks’ performance reflected through major indicators, one could conclude that Sierra Leone enjoys a robust and stable banking system. Having taken stock of the bank’s ability to perform in the emerging economic scenario, it is reiterated that this is the most appropriate time for us to reflect on some of the major issues as a matter of introspection and with a view to reaping optimal benefits from our strengths.

 

As it is pointed out, credit extension is very important for rapid economic development particularly in a bank-based economy like ours. The volume of credit as well as its allocation to key sectors of the economy can help to stimulate productive activities. Although statistics show that the ratio of private sector credit to GDP is encouraging high in Sierra Leone, more still needs to be done especially in the area of long-term loans.

 

There is a strong need to direct credit to the previously disadvantaged people who because of the accident of history may not possess the specified collateral required by banks. As a logical step forward towards transforming the banking system, there seems to be a greater need for a review of our lending procedures, practices and credit assessment mechanisms with a view to ensuring supply of credit to the genuine clients and particularly to the hitherto neglected sectors.

 

Available evidence shows that most of the credit extended by commercial banks is mainly used to finance properties and other personal items. There are also reports by loan applicants that banks do not carry out proper investigation on project viability particularly when this has to do with projects falling outside the purview of their traditional areas of financing. The application of venture capital gains relevance in this context. There is therefore, a need for both the commercial banks and the policy makers to explore ways of evolving appropriate assessment mechanisms and credit evaluation techniques with view to extending credit to all viable projects. These steps would result in deploying the high level of financial savings in the economy and reaping the best possible advantage in terms of gearing the economy towards the optimal growth path.

 






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