Repression is a form of direct intervention in the price and output of the banking service market. The price of banking services is the interest rate, while the output is the credit room.
With intervention, banks don’t have to compete too strongly with each other. They don’t have to run fierce race to raise deposit interest rates and lower lending interest rates. All banks can be sure that they will have certain profit margins and less likely to go bankrupt.
This kind of management is easy to do, but it brings a negative impact. Resources cannot be allocated in an optimal way. Even banks with low competitiveness won’t be eliminated from the market, while good banks will find it difficult to make a breakthrough in the market.
This way of management doesn't optimize economic growth.
The second way, prudential, is intervention based on financial safety rules, which include micro-prudential regulations and macro-prudential regulations. Capital adequacy ratio, bank risks management and Basel are some examples.
This management way helps banks stay safe and avoid bankruptcy thanks to the required capital adequacy ratios and the resistance against macro fluctuations, and it will not deprive banks of competitiveness momentum. But this way takes much more time.
He said in theory that central banks of emerging economies choose repression because it is easier to do and safer. However, they later gradually build competitiveness in a prudential way, and build society’s confidence and the market, ending up gradually loosening and removing repression regulations. However, the most important thing that determines whether a country chooses ‘repression’ or ‘prudential’ is the success of the liberalization process, depending on political reasons.
Under the ‘repression’ scheme, central banks have a lot of power in granting establishment of banks and allocating credit room to banks. And power is always associated with benefits.
He said, both in jest and earnestness: “I know many students in the class are officials of central banks in developing countries. Could you please tell us the reasons for those benefits?” No one said anything. “Could you please tell us about this?”
A medium-level official of a central bank of an emerging economy laughed loudly and said “I take the Fifth.” (The US’s Fifth Amendment allows people to refuse to answer questions and protects their right to keep silent; it is used when someone doesn’t want to reveal information that could incriminate them).
All of us burst into laughter.
Credit room in Vietnam
In Vietnam, the credit limit began in 2011 and it caused many problems to efforts to modernize the banking system.
As for banking services, we can use the simple supply-demand model to explain. The product of banking service is credit, while the input material is the capital mobilized from the public and other sources. The price of goods is the interest rate, while outstanding loans are the output.
Credit room is the limit of the output provided in the market. If the market equilibrium point has an output smaller than the total credit room, the policy, in general, won’t have a big impact. But if the market equilibrium point has an output bigger than that set by the central bank, a goods shortage will occur.
The lack of credit will increase the lending interest rates and decrease deposit interest rates. If the supply is short, commercial banks have to raise the interest rates to reduce the number of people who want to borrow money. They also lower deposit interest rates so that input capital is just enough for their credit room.
As a result, deposit interest rates decrease and lending increases. The widening of the gap between deposit and lending interest rates helps to increase the profit margin of the whole banking system. As such, banks get higher profits.
The question is why banks don’t want the credit room policy, even though they benefit from it.
The answer is that the whole banking system can benefit, but the benefits received by every bank are different. The best scenario for a bank is that the credit growth limit for the whole banking system increases by a little, but a bigger portion of the credit room is allocated to it.
However, economic laws show that the quota scheme which sets limits on the output of the market or allocates output for every supplier will cause damage to customers and society.
Another problem is that Vietnam not only sets limits on credit room, but also on the short-term lending interest rate.
In principle, the credit room policy will cause lending interest rates to increase and if the interest rates exceed the ceiling levels, under-the-table transactions will be made. In order to borrow money, businesses will pay under-the-table fees.
Nguyen Minh Duc