How can something as simple as a bank savings account bring about economic reform in Ukraine?
As I spend time here in Kyiv getting to know the savings and spending habits of Ukrainians, I notice there are very big differences with regard to savings compared to most Westerners.
Most Ukrainians I have met are very averse to saving for a rainy day. When I ask why that is the usual response is that the banks cannot be trusted. I often hear Ukrainians tell me about the direct or indirect experience of people depositing their lives’ savings into a bank and then one day see the bank has closed its doors, leaving the depositor with no recourse.
So, none of this is news and what does any of this have to do with economic reform? Everything, if you believe that prosperous economies are demand driven. Let’s suppose depositors could rely on the safety and security of the Ukraine banking system and the banking system is a competitive efficient market.
How would banks compete for depositors and remain a good investment for shareholders? The banks would have to offer security of capital and returns for depositors while at the same time manage the reserve requirements and loan portfolio to be profitable for shareholders.
OK, this sounds reasonable but how does that create economic reform? The answer is investments!
If the banks were forced to offer a competitive return for depositors, the resources for those returns would have to come from investments in loans. The more deposits a bank takes in the more the bank must lend. If the banks do not lend, then it could not offer competitive returns to depositors.
The bank soon would have few depositors and close down. Competitive banking would drive a market for lending and a market for lending would bring about economic reform.
Most Ukrainians I have met are very averse to saving for a rainy day. When I ask why that is the usual response is that the banks cannot be trusted.
How does a market for lending bring about economic reform? As depositors see their assets rise they will want to invest and diversify into real estate and other commercial ventures.
The banks would then lend to satisfy this demand, increasing their investment portfolio and brand. Both the banks and depositors would want to see that their investments are safe and stable.
We would soon see the following reforms:
Clear and transparent ownership of real and trade property;
Clear and transparent assignment of liens and security interest in property;
A swift, predictable and accessible legal system;
A crackdown on cyber crime;
A tax system that encourages small and mid-sized business;
A reliable auditing industry;
An efficient and transparent secondary market to provide liquidity; and investment.
Yes, all this sounds wonderful so how do we get there? We would need the backing of the Ukrainian government and perhaps the International Monetary Fund. In America we have a few public-private institutions that assist the above model.
The Federal Deposit Insurance Corporation guarantees depositors the security of savings in bank accounts. In the U.S., the deposit insurance amount is $250,000 per bank. I personally feel this amount of insurance is needlessly high and should be about 20-25 percent above the average savings amount per household in total.
If the Ukraine government insured deposits to qualified banks up to 125 percent of the average estimated saving amount per Ukraine household, let’s just say $20,000, Ukraine banks would see a flood of deposits. Two changes would happen rather quickly.
Depositors, banks and the government would very quickly demand the police put an end to cybercrime as loses would not be tolerated by anyone.
The banks would then have to find the resources to pay returns to depositors or risk losing depositors and going out of business. Lending starts.
Housing is generally the first place depositors want to invest to diversify and is also the first place banks want lend to generate resources and build a portfolio.
The Federal Housing Authority (FHA) establishes guidelines of how banks should lend to homebuyers and insures loans that are FHA compliant. Because the lending standards are the same from region to region the loans can be traded on a secondary market among banks to diversify the bank’s portfolio and provide liquidity.
The secondary market would require a number of reforms related to ownership of title, transparency of liens secured by real property, reliable Auditing and a predictable legal system.
Now imaging we got all this working, what’s next? Small and midsized businesses start to flourish. As depositors diversify through investment in real estate, demand for skilled labor and materials will increase. Some depositors will want to diversify beyond real estate and take advantage of housing demand by opening construction and other businesses.
The Small Business Administration works the same way as the FHA only they insure commercial loans to new or expanding businesses. The SBA has a set of standardized lending criteria for different industries and company sizes. This standardization of SBA lending requirements would reform how businesses use credit to buy and sell capital equipment and inventory. It would also lead to standardization of accounting practices and reliable auditing.
One point that is distinct for the SBA is that is usually requires that the business hire and retain a certain number of employees as a condition for the loan in order to reduce unemployment.
The way I see it is that Ukraine economic reforms will have to come from the bottom up. Individual depositors looking to diversify their portfolios and banks looking to secure their loans will have a grassroots effect stronger than any political slogan.
But to get this started the Ukraine government will have to get behind the banks and guarantee the security reasonable amount of savings to encourage depositors. To do this the IMF may need to get behind the Ukraine government.
Eugene Harrison, an information technology architect, can be reached at [email protected].
