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What does Nobel laureate Douglas Diamond think of dominance of PSBs?


Q: The global economy is again facing steep challenges and experts are beginning to worry that we might be looking at a recession in 2023. How can banks brace for something like this? Are there lessons from the 2008 financial crisis that they can draw from?


>Banks have pre-positioned themselves with bigger capital buffers over and above the amount they require

>Recent memory of a crisis gives individual institutions incentives to be a little more careful

>Regulations have made banks hold more capital. It means, they have fewer deposits and more equity

>Commercial banking sector is in a more resilient state than before

>Banks should consider raising credit standards a little bit, which may tighten things

>Banks can be more careful and have higher lending standards

>Being more transparent about their standards would help banks

Q: We have seen a tremendous rise in fintechs in the past few years. Are fintechs making banks less relevant? What kind of role and presence do you see banks having in the future?


>Fintechs do a lot of the things that banks do but use a different platform and different technologies to evaluate borrowers and lenders

>Fintechs are the shadow banks of the current times

>There is profit in borrowing short-term and lending long-term. If one institution is unable to do that, another institution will

Q: The Indian banking sector is dominated by public sector banks. They control about two-thirds of the market share. Do you think this kind of dominance by state-run lenders is healthy? Or is it time the government privatised its banks?


>Govt banks around the world tend to do more politically-connected lending than fundamentals-based lending

>When a bank lends money for a bad business, it is a thing about politically-connected banks

>PSU banks could also be lending to parts of the economy that need more encouragement or development

>PSU banks don’t have to maximise profit. If the govt has a goal, PSU banks can allocate capital a little bit

>But there is no way to leave capital allocation at a little bit. Once the govt (or a govt official) is allocating the capital, you get this sort of crony capitalism

Q: Now again, in Indian context, we are heavily dependent on the weather which plays a critical role in price movements. Do you think inflation targeting as a framework for the monetary policy works in countries where external factors significantly influence the price?


>If a central bank wanted to ensure inflation and inflation expectations don’t get out of control, the natural target is actual inflation

>If you have an inflation target, you need your own version of core inflation, which is like wages and the prices of crops that don’t change with the weather

>Look at what’s called ‘headline inflation’ and also look at the ‘long-run moving average’

>If prices jump 10% today, goes down 12% tomorrow if the weather gets better, that’s not inflation. That’s price movements.

>If you want central banks to do their job, you have got to give them some kind of a goal


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