Opinion | Bank reforms touted by Georgia’s Prime Minister–to-be could spell the end of predatory lending

Just two months after announcing sweeping reforms of Georgia’s banks, 36-year-old Finance Minister Mamuka Bakhtadze looks set to become the new Prime Minister. While the country’s banks have become among the most profitable in the world, they have done so at the expense of ordinary Georgians. If Bakhtadze and his replacement at the finance ministry follow through on these reforms, they could be the first step in addressing some of Georgia’s most pressing economic woes.

The remarkable rise of Georgia’s banks has not translated into an improved economic situation for most of the population. Despite the banks getting richer, the levels of poverty and inequality remain unchanged.

Hoping to address these issues, at a meeting with young entrepreneurs at Tbilisi’s Tech Park on 12 April, Georgia’s new Finance Minister Mamuka Bakhtadze unexpectedly declared that Georgian banks are an impediment to the economy. Bakhtadze, just eight months into his professional political career, said the banks are fueling over-indebtedness instead of helping the economy to grow.

So unexpected was the announcement, that initially, some economic commentators claimed Bakhtadze hadn’t meant to say the sector needed reform. Members of Georgia’s central bank — the National Bank of Georgia — were also reportedly caught off-guard, given that regulating the banks is the task of the National Bank, and it is they who are supposed to initiate reforms to the financial sector, not the Finance Ministry.

Two months after the announcement, Georgia’s Prime Minister Giorgi Kvirikashvili resigned over economic differences with others in the ruling Georgian Dream party. Given that the party has selected Bakhtadze to replace him, regulating Georgia’s banks could well be at the top of the agenda.

The banking system hinders business

Commercial banks in Georgia have the highest profitability rate among Europe’s banks, and are among the top 20 most profitable worldwide, ranking alongside banks from developing countries in Africa and Latin America. Last year profits from Georgia’s banking sector exceeded ₾869 million ($350 million). This extraordinary expansion in profits has been on the increase especially since 2012, when the newly elected Georgian Dream Government decided not to employ intrusive actions against businesses.

While in 2001–2013 the total sum of  Georgian banking sector’s profit equalled ₾1.119 billion ($453 million), since 2013, profits from the sector have more than doubled, reaching a total of ₾2.561 billion ($1 billion). However, the apparent success of the Georgian banking sector has not translated into success and wealth for the Georgian economy and its citizens.

Economists and banking lobbyists frequently claim the banks are the strongest element of the Georgian economy, and as such, the government should allow the sector to flourish without state interference. In fact, just two major banks have achieved long-term growth.

In theory, the banking sector should function as the engine of the economy, providing businesses and households with the money needed to expand. but retail credit has dominated banking sector loans, while loans for Small and Medium Enterprises (SMEs) are falling short.

Consumer loans and retail financing tend to promote imports rather than encouraging local production, which would create employment and bring added value to the economy. Research by the World Bank and EBRD puts access to credit as the third biggest obstacle to Georgian businesses; the Global Competitiveness index puts it in second place. This means that Georgia’s ‘successful’ banking sector is much more effective in extracting profit than fulfilling its what it’s primary goal should be: providing loans to businesses.

Trickle-up economics

According to IMF research, Georgia has the one of the highest number of individuals in debt, with 680 out of every 1,000 adults having loans in 2015. The number of individual loan contracts  reached 2.4 million at the end of 2016. Those in favour of deregulation argue that by issuing loans, Georgian banks are increasing citizens’ purchasing power and contributing to an overall increase in aggregate demand, which is good for the economy.

Advocates for the banking industry frequently tout Georgia’s low percentage of non-performing loans, but in reality this is due to extremely harsh penalties for those who fail to repay on time.

According to current regulations, failing to keep up with loan repayments can mean the banks have the right to seize property and sell it, even if this property is not listed as collateral in the loan agreement. In effect, someone who fails to pay their credit card bill may end up losing their home.

The roots of the issue lie in the neoliberal revolution and ‘Reagonomics’ which became popular in the 1980s. Since then, the idea of trickle-down economics has dominated both the political and economic agenda around the world.

In young democracies like Georgia, where social institutions were much weaker following the collapse of the Soviet Union, this ideology took more radical forms — the banks were free to maximise profits and  socially oriented redistributive policies of government were also absent.

The core tenets of neoliberalism are that regulations should be minimised, taxes should be lowered, and government bureaucracy should be reduced in an effort to increase competition and stimulate growth. The Georgian banking sector has benefited immensely from this type of economic approach, giving it free rein to engage in predatory and irresponsible lending practices. This has led many Georgians to end up trapped in a cycle of debt and poverty from which they can never escape. Instead of trickling down, the wealth has trickled-up, meaning the banks have got richer while the rest of the population loses out.

Instead of fulfilling their wealth-creating function — a role that banks traditionally play in a healthy economy — it seems that Georgian banks have become rent-extracting enterprises preying on a population where many still live in poverty.

Additionally, a highly concentrated banking sector has driven up the price of money i.e. interest rates. Two banks — Bank of Georgia and TBC — hold 72% of the total assets in the country’s banking sector. The level of concentration has increased since 2014, with the number of banks decreasing from 21 to 16. This suggests that the profitability of Georgia’s banking sector is underpinned by oligarchic trends, rather than a system which encourages efficiency.

The winds of change

The dramatic changes in banking regulations announced by the PM–to-be surprised most observers and commentators. Bakhtatdze’s reform package incorporates the following major changes in the banking sector:

• The effective annual interest rate ceiling on loans will be 50% instead of 100%;
• Fines for late repayments of loans will be calculated differently and will be much lower;
• The banks will no longer be able to seize property not listed as collateral in a loan agreement.

The second part of Bakhtadze’s plan aims to address the imbalance in loans to Georgia’s corporate sector. While large companies can easily access credit, Georgian start-ups so far have no access to cheap and reliable sources of investment to establish small and medium businesses. Nor has the Georgian government so far developed any substantive financial instrument to support infant enterprises.

Bakhtadze has announced a plan to create a ‘financial arm’ of the Georgian Government which would enable it to spend up to 1% of GDP supporting Georgian start-ups.

After years of failed ‘marketisation policies’ and ‘social engineering’, it looks like the National Bank of Georgia and the Ministry of Finance may finally be taking steps in the right direction in terms of reforms. The National Bank has already proposed draft regulations which would put caps on lending for certain groups and introduce debt-to-income ratios for different income groups. However, much more has to be done to regain public control of the banking sector.

A radical agenda for transforming Georgia’s banking sector

In considering regulations over the banking sector, the government needs to understand that the National Bank — the institution responsible for regulating the banking sector — is itself in urgent need of reform. A key step towards making this regulatory mechanism more accountable to the public would be to abolish revolving door practices, whereby directors of commercial banks go on to work at the National Bank and vice versa.

The current president and vice-president both previously held positions in Bank of Georgia, the second largest commercial bank in Georgia. Moreover, vice-president Murtaz Kikoria also held an executive position in the Bank of Georgia, for which he received several million lari in remuneration. Since the global economic crisis of 2008, these revolving door practices have been condemned in in both policy making and academic circles.

Furthermore, the Georgian government and National Bank should take further steps toward stimulating competition in the banking sector. By levying a progressive corporate income tax on the sector, the government could both generate revenue while discouraging banks from over-expanding and becoming ‘too big to fail’.

The Georgian government, and whoever is chosen as the new Finance Minister in particular, have an important role to play in bringing order and stability to the country’s banking sector. If reforms are successfully implemented, it would reduce the number of citizens falling into unmanageable debt and losing their property as a result.

However, these regulations will not go as far as addressing the core issue that fuels predatory lending practices, which is that Georgians end up borrowing money from banks because they simply don’t have it. According to national statistics, the share of working people earning a wage is 42.5%, while 57.6% of Georgians are deemed to be self-employed. Precarious self-employment and high structural unemployment, especially among young people, drives many Georgians towards risky debt practices.

With these statistics in mind, the government should design an effective industrial strategy to create jobs and utilise the potential of its human capital to boost the economy. Such an industrial strategy would incorporate tax incentives, subsidies, and technical assistance to local producers.

The creation of a State Development Bank would fit this agenda and it could go towards filling the financing gap for Georgian industries, which are suffering from a shortage of ‘cheap’ and ‘patient’ credit. By doing so, the government would address the root causes of debt and poverty, and not just the external symptoms of this social disease.

This article was prepared with support from the Friedrich-Ebert-Stiftung (FES) Regional Office in the South Caucasus. All opinions expressed are the author’s alone, and do not necessarily reflect the views of FES or OC Media.