Jayati Ghosh

International Seminar on

“Central Banks: Systems of payment and financial inclusion”

Central Bank of Ecuador

Quito, Ecuador, 2 August 2012

Ecuador as a model for other countries

Ecuador already offers the rest of the world many lessons in terms of how much can be achieved for positive transformation by a progressive government intent on change, even in a global context that looks increasingly gloomy.

Many positive economic changes in the past five years.

Focus on “sumak kawsay” and quality of life rather than only GDP is particularly important.

Eccaudor can also engage in innovative strategies of development banking developed by a central bank inspired by democratic and egalitarian priorities.

This requires more emphasis on different goals of the central bank.

State intervention in the financial system

Global financial fragilities and vulnerability to crisis make it imperative for governments to impose stricter financial regulations and for central banks to exercise their regulatory and supervisory functions more closely.

But it is not only the possibility of financial crisis that requires a more proactive role of central banks – there are also the critical issues of employment and growth.

These require central banks to move beyond inflation control as the only goal. Instead this must be combined with the goals of employment generation,

economic diversification and

achieving a sustainable economy.

What does this mean for central bank strategy?

Financial regulation – and particularly the prevention of risky activities of commercial banks and pension funds.

Control and monitoring of “financial innovation” and new financial instruments.

Setting of interest rates must take into account not just inflation but economic activity and employment.

Other instruments must be used to direct credit into socially desired channels, and to provide access to institutional credit to those who are normally excluded.

Dollarisation and the constraints on the central bank in Ecuador

Dollarisation means that the exchange rate as a macroeconomic instrument is no longer available and monetary policy is severely curtailed.

Even so, there are possibilities of countercyclical monetary policies through creative means of expanding liquidity during slumps and controlling excessively “euphoric” investment and consumption behaviour during booms.

And the developmental role of the central bank is still very important and can be fulfilled even with dollarisation.

One important aspect of this is financial inclusion to ensure access to institutional savings and loans instruments to those who are still left out of the formal credit system.

Why not rely on the market to deliver finance for development?

Private financial markets do not provide enough long-term finance to undertake the investments necessary for economic and social development.

This reduces or removes access of many firms, especially small enterprises.

It also means firms in developing countries hold more short-term debt than long-term debt.

It also excludes potential savers and borrowers in low income groups or remote areas.

This is because of perceptions of high default risk, high transaction costs in many cases, and when anticipated returns to private agents are lower than the social returns in the investment concerned .

Financial systems need to be diverse and cater to different groups of borrowers

Commercial banks Co-operative banks Housing banks Regional banks Sector-specific and size specific banks Development banks With a variety of banks, possibilities of cross-subsidisation

of activities have to be explored through different forms of co-ordination that central banks can promote.

Regulators should have different approaches to different types of banks.

Development banking

Necessary because market forces do not address mismatches in the expectations with regard to maturity, liquidity, risk and interest rates between savers and investors.

Development banks provide long-term credit at terms that render such investment sustainable.

They lend not only for working capital purposes, but to finance long-term investment as well, including in capital-intensive sectors.

They lend long and are often willing to lend more in the future.

Supervisory role of development banks

Close monitoring of firms they lend to, resulting in a special form of “relationship banking”.

Involved in decisions such as choice of technology, scale and location.

This require more than just financial expertise, so that development banking institutions often have to build teams of technical, financial and managerial experts, who are involved in the decisions related to lending and therefore to the nature of the investment.

This requires a different (more flexible, forward looking and innovative) approach on the part of the central bank towards these institutions.

Other measures for financial inclusion

Microfinance is NOT the same as financial inclusion ensuring access to institutional finance.

Microfinance is more important in consumption smoothing – it does not really address fundamental issues of poverty reduction and asset creation by the poor.

Proper financial inclusion into institutional finance may require some forms of subsidy as well as creative and flexible approach on the part of the central bank, to ensure that different banks (commercial, co-operative, development, etc) reach excluded groups like SMEs, self-employed workers, peasants, women and those without land titles or other collateral.

Secure savings function is also important and may require deposit guarantees and other measures.

Ecuador’s progress in financial inclusion

National Low Income Housing Project , which seeks to strengthen Banco Ecuatoriano de la Vivienda and Junta Nacional de la Vivienda

Financial inclusion of beneficiaries of Bono de Desarollo Humano , through access to banks and credit cards.

Importance of efforts to increase financial literacy and awareness among citizenry to be able to handle new instruments.

With credit cards and other such instruments, need to incorporate concerns about fraud as well as implications of income volatility of low income households.

Potential areas of banking strategy for inclusion

Credit for agriculturalists : ensuring access, dealing with transaction costs, timing and flexibility of repayment, risks of volatility in farm incomes.

Credit for small scale providers of goods and services, with a focus on building assets to counter existing asset inequalities.

Credit for innovations.

Building viable and autonomous co-operative savings and loan institutions.

Particular measures for the inclusion of women, recognising their specific constraints.

Thank you for your attention!