Download Information, Power, Credit Restrictions and international banking

Information, Power, Credit Restrictions and international banking
Version 0.4.
Paul Ramskogler
Abstract:
The paper aims at explaining structural biases against SMEs within the credit
granting process from a Post Keynesian perspective. New Institutional and New
Keynesian approaches are evaluated and rejected on the grounds of fundamental
uncertainty. An extended synthesis of earlier Post Keynesian approaches is
presented as an alternative explanation. On this basis, power and institutionalized
differences in working relations in larger and smaller enterprises are identified as the
major sources of a structurally biased access to credit for SMEs.
JEL code:
Keywords: Fundamental Uncertainty, Credit Restrictions, Power, Information
Information, Power, Credit Restrictions and international banking
Introduction
The purpose of this paper is to contribute to the understanding of biases that
discriminate against specific groups of lenders in the credit markets. The discussions
concerned with the Basel II accord have led to pertinent political concern with regard
to the availability of credit for small and medium sized enterprises (SME). Political
discussions have evolved in many countries over the last years that ask for
redemptions of the structurally biased access to credit of this group. For theories
aiming at participation in public policy, developing recommendations concerning the
credit availability of SMEs therefore seems especially fruitful. This particularly is the
case as SMEs hold an increasingly challenged position within a globalised economy.
In predominant theories of credit restrictions usually informational deficiencies that
prevent maximizing behaviour are made responsible for a limited access to credit of
specific groups. These streams of thought – New Institutional and New Keynesian
economics – are embedded in an immutable world in which complete information is,
in principle, achievable. Such approaches conflict with the Post Keynesian concept of
fundamental uncertainty. Approaching this problem from a Post Keynesian
perspective might offer a richer scope of explanations.
These aspects lie underneath the motivation of this paper. In order to achieve an
alternative approach, earlier Post Keynesian concepts will be combined and
extended. In so doing especially the concept of asymmetric expectations developed
by Wolfson (e.g. 1996) and the information-knowledge distinction developed by Dow
(e.g. 1998) will be of interest. Also a more distinct role of information as claimed by
Dymski (e.g. 1994) will be considered. It is aimed thereby to contribute to a deeper
Post Keynesian understanding of credit restrictions.
The paper is divided in four sections1. The first section presents empirical evidence
and evaluates the standard background of the majority of the empirical surveys that
are concerned with credit restrictions against SMEs. The second section deals with
the New Keynesian view of credit rationing that in the meantime pretty much can be
regarded as the mainstream’s explanation of the problem at hand. The third section
aims at creating a synthesis and extension of current Post Keynesian views on credit
1 On a higher level of aggregation the paper can be seen as being divided in two parts. The first part – including
the first two sections – deals with non-Post Keynesian contributions. The second part – including the last two
sections – aims at developing a Post Keynesian approach towards the explanation of credit restrictions.
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restrictions. Building on the results the fourth section investigates structural forces
that exert influence on credit restrictions and account for biases within the credit
granting process. Finally the results are summarized briefly and conclusions are
presented.
Evidence and New Institutionalist explanations:
To start with, it seems appropriate to briefly review recent empirical findings
considering credit restrictions of SMEs. The vast majority of the empirical literature is
– surprisingly – inspired by New Institutional economics. Probably an explanation for
this finding is that New Keynesians tend to emphasise the bank lending channel of
monetary policy in their empirical research.
A group of unsatisfied borrowers
The empirics display the following situation: Representative for most of the recent
surveys concerned with credit availability for SMEs are Cole et al. (1999). They base
their study on a representative sample concerning the credit availability of SMEs in
the US. Based on earlier arguments developed by De Young et al. (see e.g. De
Young et al. 2004) they test the hypothesis that larger banks apply a cookie cutter
approach – i.e. they supply credit mainly based on key financial ratios – whereas
small banks rely on relationship lending. Relationship lending thereby indicates that
banks put more emphasis on establishing longer relationships with a lender and rely
on the lending history of borrowers to overcome informational problems. As SMEs
are regarded as being informational opaque a shift from relationship lending to
cookie cutter lending is seen as being restrictive for the credit access of SMEs.
The findings of Cole et al. seem to support this view, as the larger banks are the
larger their propensity to “go with the figures” becomes and this adversely affects
credit availability for SMEs. Similarly Berger at al. (2005) find – relying on data of the
Federal Reserve’s 1993 National Survey of Small Business Finance – evidence that
large banks concentrate mainly on “good accounting records” whereas smaller banks
concentrate on “difficult borrowers”. Building upon the same hypothesis Rauch and
Hendrickson (2004) investigate data on the availability of loan maturity extensions for
the US from 1991 to 2001. They primarily are interested in the effect of bank size on
interest rates. The results whatsoever fit into the picture. Bank size negatively affects
the interest rates that SMEs have to bear. These findings also are supported for the
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case of Italy by Sapienza (2002) who investigates data about credit contracts and
balance sheets for the period of 1989-1995. He concentrates on post-merger effects
of banks on the credit availability of SMEs. An important observation of Sapienza is
that with a post-fusion market-share of a bank in a region being bigger than 6.15%
market-power effects have in general adverse effects on the price terms in customer
relations. Additionally there is a significant probability that banks will reduce lending
to SMEs after being subject to a merger. Finally a study conducted by Wagenvoort
(2002) is based on the analysis of balance sheet and credit data for the EU from
1996-2000. This study comes to the conclusion that in general growth of SMEs is
hampered by external finance constraints, which mainly indicates a restricted access
to credit according to the author. Wagenvoort also finds that within each size class
non-quoted enterprises suffer from a more restricted access to credit than quoted
enterprises.
To summarize the picture that arises is the following: SMEs do suffer considerable
credit restrictions. The larger the concentration of the banking industry is, the
stronger the restrictions for SMEs become as compared to the credit availability of
larger enterprises or corporations. With a given concentration of the banking industry
the availability of non-quoted enterprises to credit is worse than that of quoted
enterprises.
The New institutional explanation: friend or foe?
Given the New Institutionalist background it will be hardly surprising that the principal
agent problem locates at the centre of the theoretical considerations. The standard
explanation of credit restrictions is usually a variation of the following:
“The operational differences of small and large banks with respect to lending can be explained by the
theory of hierarchical control as contained in Williamson. As the size of an organization increases, loss
of control occurs between successive hierarchies. Consequently a large bank needs explicit rules in
the lending process in order to avoid distortions. Because there are fewer intermediaries between top
management and lending officers in small banks, the small banks officers can be granted more
discretion in the lending process (…).” (Cole et al., p.366)
The argument is standard New Institutionalism. The environment is complex; to attain
full information therefore is costly. This also holds true for working contracts, which
cannot be fully specified in advance. In smaller entities the principal is able to
supervise and control agents more thoroughly. In larger entities this is not attainable.
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Agents however, when not being under restrictive controls immediately start to
maximize their own preference functions. This unfortunately interferes with the
objectives of the firm. To therefore restrict the activities of agents to the maximization
of the firm’s objectives ‘explicit rules’ have to be imposed.
It seems that the picture that is drawn of agents by New Institutionalists (especially
their opportunistic preference function) is hard to be reconciled with Post Keynesian
theory (see e.g. Dunn 2001). The more severe problem from a Post Keynesian point
of view, however, comes with the way New Institutionalists use information. As a
matter of fact New Institutionalists do not deviate from the proposition that complete
information – in principle – does exist. They only claim that it is not attainable as the
cost of further information gathering might be too costly as compared with the
improvement of a decision. Therefore with regard to decisions rules of thumb are
developed with regard to which information is useful and which is not (see e.g. North
1995). An evolutionary process on the market guarantees that the rules that survive
employ those informational samples that most efficiently can be used for close-toaccurate forecasts. The ‘explicit rules in order to avoid distortion’ mentioned by Cole
et al. therefore are nothing but the outcome of such a process. This also restricts the
scope of the conclusions of the mentioned studies that collectively fail to
acknowledge the possibility that the rules themselves could be the distortions.
Consequently the recommendations are often fatalistic. New institutional economists
argue that subsidised loan programs due to their bureaucracies are not able to
redeem the problem. The general tendency of the studies implicates that if SMEs
have anything to offer in terms of efficiency new types of credit institutions will arise
anyhow that cope with their informational problems.
Post Keynesians do not hesitate to acknowledge that SMEs might be ‘special’ with
regard to their informational structure (see Dow 1996) and might therefore pose
special problems to banks. Still the implicit assumption of in principal attainable
complete information interferes with fundamental uncertainty that is central to Post
Keynesian theory. Post Keynesians insist that in many situations – investment and
therefore credit granting situations amongst them – the future is created by the
agents’ very own actions. Information that completely reveals the future course of
events therefore does not exist. In situations of fundamental uncertainty the future
cannot be revealed before action takes place. ‘Explicit rules’ that make semi-correct
predictions possible by drawing on reduced sets of information in an efficient way as
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New Institutional economists suggest cannot exist. Even if rules are employed and
information is used there is nothing that guarantees that the most ‘efficient’
behavioural rules survive. It seems that a Post Keynesian approach should have a
richer variety of explanations to offer.
New Keynesian explanations and incompatibilities with Post Keynesian theory
Before proceeding to Post Keynesian views another stream of the literature shall be
briefly considered: New Keynesian credit rationing. Given the prominence of New
Keynesian literature in the meantime this position arguably can be interpreted as the
mainstream explanation of credit restrictions. This section briefly evaluates the New
Keynesian arguments from a Post Keynesian point of view.
The New Keynesian explanation
In its simplest form the starting point of a New Keynesian investigation of credit
rationing is an analysis of the specific characteristics of credit contracts (see e.g.
Jaffee and Russell 1976, Stiglitz and Weiss 1981 or Mankiw 1986). The highest profit
a bank may gain through the granting of a credit is ceiled by the interest stipulated on
that credit. If a borrower earns less than what is necessary to pay back the principal
plus the loan rate, the bank does not earn a profit. If the borrower’s earnings are
even smaller than the (inflation adjusted) sum that was lent, the bank makes a loss. If
on the other hand the earnings of a borrower are higher than the credit plus the loan
rate the bank does not get more than the backpay plus interests. As a consequence,
at a given loan rate, out of two projects a bank will always favour that project whose
propensity to default is smaller, even if the other project promises more-than-normal
profits when being successful. A bank would not benefit from more-than-normal
profits due to the credit contracts features. In statistical terminology this means that
out of two projects whose prospective earning distributions have identical means but
different variances a bank will always favour the project with the smaller variance for
a given interest rate. A bank will always favour the least risky project. New
Keynesians allow for borrowers with less risky projects as well as for borrowers with
riskier projects to apply for credit. From the banks’ point of view the latter group of
borrowers should be charged with higher loan rates to account for their higher
propensity of default.
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Unfortunately New Keynesian banks are not able to identify the variance of the
earnings of the respective borrowers but only the mean of these projects. The bank
faces a situation of asymmetric information. Thus banks are not able to form riskhomogenous creditor groups which may be charged with different risk-spreads. The
pool of applicants therefore is heterogeneously constituted including high and low
risk projects. An increased loan rate can lead to a situation where low risk investors
judge their projects as being unprofitable but high risk investors – being able to
pocket higher earnings “if everything goes well” – still are willing to undertake their
projects. Therefore increasing the loan rate can change the average risk of those
borrowers. Raising the loan rate can raise the average propensity of default. This can
be due to adverse selection, i.e. inducing low-risk investors to withdraw their credit
applications or to moral hazard, i.e. inducing low-risk investors to undertake riskier
projects. Through raising the loan rate thereby a situation can accrue where the
negative substitution effect that leads to more defaults as the share of riskier projects
in the distribution increases, overweighs the positive income effect of the increased
interest earnings.
Thus far, however, the story only tells us that banks are not able to properly optimize.
To come to a credit rationing equilibrium, New Keynesians necessarily need to
provide banks with additional information. Despite their asymmetric information
problem New Keynesian banks posses perfect information of the risk-distribution of
the entire population of potential borrowers; i.e. they know the mean as well as the
variance of the aggregate of all borrowers2. This information is the crucial ingredient
that leads to a situation where banks are once again able to depict their profit
optimizing loan rate. Through this information banks are able to identify the mean
return on loans for each loan rate. Therefore they are able to exactly depict the very
loan rate where the positive income effect is neutralized by the negative substitution
effect. Put in the words of Crotty: “… lenders must possess all the information that is
required to solve the borrower’s optimal choice problem in order to solve their own.
(…) So, if the Neoclassical lender can be said to have “perfect” (though stochastic)
information, then the New Keynesian lender must posses information that is in some
sense beyond perfect, yet inadequate.” (Crotty 1996 p. 336f.) Still, individual projects
2 This information – as in neoclassical economics – is based on objective probabilities. If it was based on subjective probabilities
– as for instance Stiglitz and Weiss 1981 claim – there would be the need for a mechanism that assures that all banks come to
the same assumptions about the future. Otherwise New Keynesians would only explain why a borrower is “rationed” by one
specific bank but not by the entire banking sector.
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cannot be identified as being riskier and are provided with credit but the banks are
able to (second-best) optimize their own profits again.
Whatsoever, even this is not sufficient to produce an equilibrium that is creditrationed. To do this the New Keynesian decisional apparatus (including asymmetric
information) has to be based on the loanable funds theory. Banks need to obtain the
funds that they lend first and have to obtain hoardings (held by wealth owners) say
for instance on the bond-market. Usually they would raise the interest rate offered to
“hoarders” in line with that charged on credits until the market is in equilibrium. Yet,
the asymmetric information problem prevents banks from proceeding like that.
Therefore a situation can occur where banks can only pay an interest rate on the
hoardings market that is too low to attract sufficient funds to satisfy all demand for
credit that occurs at the bank’s optimal loan rate. To make this theory consistent with
the above mentioned evidence it would be necessary to imply that it is mainly SMEs
that are informational opaque and therefore cause asymmetric information problems.
Post Keynesian Theory and the New Keynesian Story
Still, there are two crucial aspects in the New Keynesian story that make it
irreconcilable with Post Keynesian arguments3. Firstly New Keynesians implicitly
assume objective probabilities. Given the prominence of fundamental uncertainty
within Post Keynesian theory the New Keynesian position can not be hold from a
Post Keynesian point of view. In situations that underlie fundamental uncertainty the
future cannot be revealed before human actions have taken place and objective
probabilities that govern the fate of actors do not exist. (see e.g. Davidson 1991). In
the New Keynesian world however, banks – all banks – have access to identical and
correct information about the risk distribution within the entire population of
borrowers. This sort of supra-information simply could not exist in a Post Keynesian
approach, at least not for the decisional situation at hand, due to its ex ante (arguably
even its a priori) correctness. The credit market is concerned with and influenced by
the overall economic development as well as with the specific situation of a certain
firm. If correct (even though stochastic) knowledge about this could be achieved
there would be little place left for fundamental uncertainty to be relevant. Additionally,
even if the credit market was ergodic, the way in which banks achieve this
3 A broad debate about the consistency of New Keynesian approaches with Post Keynesian theory has been led e.g. in the
JPKE throughout 90ies: Dymski (1992) and (1993); van Ees and Garretsen (1993); Fazzari and Variato (1994) and (1996);
Crotty (1996); See also Rotheim (1998) for a book length discourse or – in German language – Hein, Heise and Truger (2003).
Additional contributions can be found in Dymski and Pollin (1994), in Rochon (1999) especially chapter 7 and in Rossi (2003).
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information seems a little bit obscure. Bearing in mind the fact that banks are not
even able to properly identify the characteristics of individual borrowers in the first
place, the origin of this kind of information remains obscure. In fact, the suprainformation of New Keynesian banks comes from nowhere, enters the decisional
process of a bank and subsequently goes back to nowhere4. Mankiw argues that this
information “…is public knowledge” (Mankiw 1986 p.458). But why should it be? If it
was derived from the past performance of borrowers there would be no reason why
the variance should remain unknown. Even more, New Keynesians developed
models where credit rationing can lead to a situation in which the entire market is
prevented. Also in these situations New Keynesian banks are able to perfectly reveal
the correct statistical properties of the total population of their “never-to-beborrowers”. Therefore this information has to come from somewhere else, which is of
course a place New Keynesians are reluctant to reveal (but which still is publicly
known, of course).
The second reason why the New Keynesian story of credit rationing is incompatible
with Post Keynesian views is that it is fundamentally rooted in the loanable funds
theory. A cornerstone of Post Keynesian monetary theory is the assumption of an
endogenous money supply. The theory of endogenous money argues that it is credit
that makes deposits and not vice versa and banks therefore are able to supply credit
virtually on demand (which does not mean that banks effectively do supply credit on
demand). Even, if we hypothetically allow the New Keynesian concept of asymmetric
information in this environment, rationing would not occur. There would be nothing
that effectively prevented banks from expanding credit until the market clearing level
is reached, as it is credit that creates deposits. As banks are not able to distinguish
between high and low risk borrowers each borrower that applies – from a banks point
of view – would promise identical contributions to the bank’s profits. No profit- (or
growth-) maximizing bank would stop to supply credit before the demand overhang
was extinguished.
Towards a Post Keynesian approach
Post Keynesian contributions concerning credit restriction mainly originate in the
debate on endogenous money. Consequently their major task is to support one or
4 There is not even the taste of a possible feedback effect that might be induced via the rationing decisions of banks. Either
banks know how their decisions affect outcomes (and know how all other banks decide) or their decisions do not affect
outcomes, at all.
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the other respective view on endogenous money and the explanation of structural
biases is not the main objective. The objective of this paper is vice versa. This
section briefly presents the contribution of Post Keynesian authors and aims at
developing an extended synthesis.
A remark on rationing on Post Keynesian credit markets
Nonetheless it is necessary to make some terminological clarifications before
proceeding further. As long as the concern has been with New Keynesian credit
rationing it was reasonable to talk about credit being rationed. As we proceed and
enter into Post Keynesian considerations it becomes more and more difficult to
maintain a non-reflected usage of this term. The reason is simple. In a New
Keynesian world there exists complete information about the future (even though not
everybody might have access to it). There is stochastic though correct statistical
information about the prospective earnings of firms. Therefore in principle there exists
a hypothetical market-clearing equilibrium on credit markets at the loan rate where
the interests of banks and borrowers can be brought together. As this equilibrium is
not achieved due to the specific informational problem of banks it is reasonable to
talk about credit being rationed as compared to a market-clearing equilibrium.
The Post Keynesian credit market, however, is – compared to the New Keynesian
market – in a state of semi-information. There might exist correct information with
regard to the past but this information does not necessarily have to reveal all
eventually relevant causational relationships of the past; nor does it reveal
enlightenment about the futures course of events. Banks might have an opinion
about the “creditworthiness” of their borrowers and their prospective earnings, indeed
they will have one if they are about to grant credit. However the correct statistical
properties of firms’ future earnings cannot be accurately forecasted by banks (or by
firms themselves). In a situation where there is no actuarial way to predict the future
both banks’ and borrowers’ opinions are subject to instability and potential (frequent)
shifts. A stable equilibrium does not exist. A ‘correct’ total against which a rationing
could be defined is not given on a Post Keynesian credit market. Such a total
presupposes that the associated with credit can be objectively measured (see Dow
1998, p.223) But this capacity does not exist in a Post Keynesian framework. The
possibility to judge credit as being rationed against a hypothetical correct, marketclearing equilibrium is lost.
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Therefore in Post Keynesian texts credit restrictions – whether being labelled as
restrictions or rationing – often turn out to be either excessive or too loose 5 (consider
e.g. the literature inspired by Minsky’s financial fragility hypothesis). However, the
major interest here lies on biased credit restrictions, which will be used instead of
credit rationing to make a clear distinction to New Keynesian economics. Biased
credit restrictions thereby refer to situations where, at any state of expectations,
certain groups within the population of potential borrowers suffer from a structurally
aggravated access to credit as compared to other borrowers. It has to be borne in
mind whatsoever that such credit restriction still can occur in a situation where the
overall credit supply might be considered as being too high. Nonetheless probably
insights into the structural forces of capitalism might be gained by a deeper
understanding of credit restrictions.
Post Keynesians and “the fringe of unsatisfied borrowers”
To demonstrate the Post Keynesian view on credit restrictions it seems adequate to
start with the specific features of a credit contract as in New Keynesian theory. There
is not much reason to deviate from the New Keynesian position6 a lot in this respect.
A bank runs the risk of defaults on loans (lenders risk) whereas borrowers
themselves run the risk of not earning as much as they expected (borrower’s risk)
(see Dow and Dow 1989, Dow 1996 or Wolfson 2003). Banks earnings concerning a
particular borrower are limited by the sum lent plus the stipulated interest. There is
the possibility that borrowers default on their loans. Also in the Post Keynesian case
therefore a bank wishes to account for “riskier borrowers” via a premium on the loan
rate.
The most crucial difference to the New Keynesian analysis (apart from the monetary
environment) arises in the next step. New Keynesians – as already mentioned –
provide banks and borrowers with probabilistic information about the future course of
events. Where both parties have access to information the expectations e.g. with
regard to expected profits (not necessarily the risk preferences) on both sides are
identical. Contrary to this a Post Keynesian bank is not even hypothetically able to
“calculate” the risk of a borrower. Their evaluations of the creditworthiness of
borrowers are more akin to bets (see e.g. Rochon 1999). The Post Keynesian bank
5 For an interesting dynamic approach see e.g. Dow and Dow (1989).
6 To some extent, without of course accounting for uncertainty properly, also New Keynesians rely on the concepts of
borrower’s and lender’s risk.
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uses knowledge, experience and confidence to grade borrowers; the bank has to
make a judgment. A ‘correct’ projection with regard to ex post outcomes, still, to a
considerable extent is a question of chance (even a correct ex post evaluation of
outcomes hardly is feasible (see e.g. Dunn 2000). To come to their judgments about
the creditworthiness of borrowers banks apply rules of thumb and conventions (see
e.g. Moore 1988, Lavoie 1996 or Rochon 1999). Yet, there is no rule that the
evaluation of the profitability of an investment should turn out to be identical on the
side of a bank as on the side of a borrower. Some borrowers simply will be judged as
not being creditworthy by banks and there will be a ‘fringe of unsatisfied borrowers’.
Dow argues that “[t]he volume of credit reflects the state of knowledge among
borrowers and among lenders, which in turn is the product of evidence, theoretical
knowledge, conventions and animal spirits of each.” (Dow 1998 p.225). For Dow the
basis of credit refusals therefore is rooted in the knowledge through which
conventions and practices can arise which structurally discriminate against certain
borrowers, e.g. against SMEs (see Dow 1996). This analysis – despite considerable
divergences at the macro level – is similar to that of Wolfson (1996). Wolfson (1996
p.450) argues that “… although the borrower may know some things about the future
the lender does not know (and indeed the lender may know some things that the
borrower does not know), both of them are subject to fundamental uncertainty about
the future (…) it is not necessarily the case that both will come to the same
conclusion about the future profitability of any particular project.” Asymmetric
expectations therefore are the principal reason for credit restrictions according to
Wolfson. To summarize, it seems that the majority of Post Keynesian would agree
that one major reason for credit refusals are asymmetric expectations that are
caused by divergences in the knowledge of the respective actors.
Dymski’s (1992) and (1994) approach is different from the majority of the
contributions as he attaches a bigger role to information. For Dymski information can
and does play an important role in the decision making process of agents. In
‘turbulent ages’ the confidence of banks into their own profit predictions – that are
based on information – will be too low to develop considerable confidence in those
predictions. Banks might not trust their own predictions of the profitability of a loan. In
‘tranquil time’ however outcomes might closely track expectations. This will lead
banks to a higher confidence in their predictions. For this reason information – as the
basis of banks’ predictions – and its availability will become important within the
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credit granting process. Dymski even goes so far as to argue that in tranquil times
asymmetric information as described by New Keynesians might be appropriate to
describe the situation on the credit markets.
For the reasons presented above – especially those with concern to New Keynesian
supra-information – Dymski’s argument that asymmetric information might be
complementary to the Post Keynesian analysis is not further pursued here. Still it
seems that Dymski had much reason to argue for a greater role of information on
Post Keynesian credit markets. A further discussion of the credit granting process
seems to be a good basis to reorganise the arguments.
Extending the analysis: knowledge, expectations and information
Especially for the investigation of structural and institutional forces that affect credit
restriction it seems reasonable to decompose the decisional process of agents into
its components. Biases can – hardly surprisingly – enter the market via the process
through which banks arrive at their judgments about the creditworthiness of a
prospective borrower. The starting point here is Dow’s proposition that knowledge
can be seen as the basis of decision making in Post Keynesian economics.
Knowledge crucially determines the development and the state of expectations (see
also Dequech 1999) via rules of thumb, conventions and so forth. Of course in an
environment of fundamental uncertainty there is nothing like absolute true or
complete knowledge and therefore no true or complete set of conventions or rules of
thumb that can be used. It seems clear that when – for this reason – the usage of
e.g. rules of thumb for expectation formation differs among agents, asymmetric
expectations are the result. Divergent knowledge that causes different processes of
expectation-formation therefore is the source of asymmetric expectations.
Nonetheless asymmetric expectations are not the only result of divergent knowledge.
Decisional rules are applied to form expectations; still they are not applied in vacuum
but with regard to the outside world. The connex between knowledge, expectations
and the outside world is brought in via information. Information is the crucial bridge
between an agent’s reflections and the outside world. Dow has made an interesting
distinction between knowledge and information that is important here:
“The term ‘knowledge’ refers more to processes than to facts; information on facts is thus a subset of
knowledge. The knowledge-information distinction is thus parallel to the distinction between ‘knowing
how’ and ‘knowing that’. (…) Knowledge therefore requires knowledge of structural relationships in
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order for judgments to be made as to what is and what is not relevant for the future” (Dow 1998 p.221,
emphasis added).
Information is not knowledge but it still is a subset of knowledge. To be precise it
seems that with regard to decisional processes it is one of the two most important
components of knowledge. The first is that subset of knowledge that serves to deduct
expectations. The second however is that subset of knowledge that determines which
information is used to deduct expectations. Indeed, many Post Keynesians
nowadays agree that the expectation formation can be best imagined as being partly
endogenous (apart from Dymski e.g. Basu 2003, Dow 1995, Crotty 1994 and 1996,
de Carvalho 1988, Neal 1996). This endogenous component comes into the
decisional process via information7. The central point made by authors as Wolfson or
Dow is that the future cannot be actuarially predicted by the use of information, not
that agents do not rely at all on information. (see e.g. Dow 1996 p.504f. or Wolfson
1996 p.451f.). To the contrary agents will often use information whether it is
successful or not to maintain a rational habitus or simply because others proceed like
that as well. A result of divergent knowledge – besides asymmetric expectations –
therefore can be incompatible information8. Banks might use entirely different
information than borrowers. If therefore a borrower is not able to present such
information, a bank might not even be able to form an expectation. This in praxis will
make the uncertainty on behalf of the bank so high that the decision will be
postponed until the required information is received. If a borrower is not able to
produce such information at reasonable costs this is identical to a refusal.
In a simplified form asymmetric expectations refer to a situation where, when
receiving the informational set x agent A finds y the appropriate action whereas agent
B considers z to be the best choice. Incompatible information on the other hand
refers to a situation where after receiving the informational set x, agent A finds y the
appropriate action whereas agent B has no clue what is going on. Both incompatible
information and asymmetric expectations can be identified as possible credit
restrictions accruing out of divergent knowledge.
Structural influences and biases on the credit markets
7
This position is not unequivocal amongst Post Keynesians. For a prominent opposing view see e.g. Davidson (2002) : “…
information about the future does not exist and agents know that they don’t know the future.” or Heine, M.; Herr, H.: (2003) p. 46
“[i]n the result expectations can not be made endogenous and have to be set exogenous.” (own translation from German). See
also Isenberg (1998)
8 Also Dow seems to imply this possibility. (see Dow 1996)
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In the previous section it has been established that incompatible information and
asymmetric expectations – both originating in divergent knowledge – can cause
credit restrictions. In the next step structural and institutional forces which have an
impact on the expectation formation and the information usage of different
participants on the credit markets are investigated to find out more about possible
biases. The empirical evidence suggests that higher size positively affects the credit
availability of a firm. Additionally the larger a bank is, the smaller the propensity to
lend to SMEs becomes. These factors will be investigated separately.
Why bank size matters
It is an odd remark that with an increase in an enterprise’s scalation the number of
hierarchical levels increases. Still, for the banking industry there is a distinct feature
that can be associated with increases in size that bears specific impact on the credit
granting process. Moore (1988) was motivated to develop his horizontal approach to
endogenous money partly by the following observation “[a]s bank wholesale markets
such as CDs and Repos have developed, banks have increasingly become brokers,
buying and selling for commissions more closely matched marketable assets and
liabilities” (Moore 1989 S.14). These activities of banks have even increased
throughout the 90ies as the securitization of bank loans – including industrial loans
as well – grew at a formerly inexperienced pace. Moores assumption has recently
found support from a rather unexpected side. As Allen and Santomero (1998,
p.1474) note especially being concerned with ‘large banks and insurance
companies’:
“… [t]the traditional distinction between financial markets, where securities are issued by firms and
directly owned by individuals, and intermediaries, where depositors and policy-holders provided funds
to banks and insurance companies who lent out these funds, has broken down. (…) The increased
use of securitization of loans has exacerbated this trend in that it has altered the lending functions
performed by banks. Now much of the asset origination activity is merely the first step to asset sales or
complex stripping and repacking. At the very least such assets are viewed as available for sale.”
Still, this development of the banking sector as a whole does not mean that
differences within the sector do not persist. In fact, there still are a considerable
number of banks that do not engage in the business of securitization. The most
interesting finding for our purposes is that the total assets held by (US) banks that
engage in securitizing on average are five times higher than those of non-securitizers
14
(see Uzun and Webb 2006). On average larger banks more heavily engage in the
business of securitization. Additionally in the US the number of total assets held by
the acquiring bank in the period from 1990-2003 was on average roughly 5.5 times
higher than that of the acquired bank (own calculations based on Jones and Nguyen
2005). The assumption that following a merger there is a considerable likelihood that
a shift from ‘traditional lending’ to more emphasis on securitization occurs seems
therefore quite realistic. Put differently it can be assumed that the larger a bank
becomes the more akin to brokerage its activities become.
Smaller banks still seem to undertake banking in a rather ‘traditional way’. Granting a
loan means sticking with a borrower over the entire loan maturity. This guarantees
that a bank devotes all efforts (and knowledge) to evaluate the profitability with
regard to the entire loan maturity. Under fundamental uncertainty this especially
means that banks establish long run relationships with borrowers and give them the
chance to establish a reputation as ‘good borrower’ (see Wolfson 1996). They build
up liquid reserves in good times and run them down in bad times.
This situation has become different in larger banks; this already is the case to a
considerable large extent in the Anglo-Saxon area and progressively so in Europe
and Japan as well. Through increased securitization the relations between banks and
borrowers become looser (devastating professional knowledge). Holding liquid
reserves has lost importance as loans have become increasingly liquid anyhow. As
Davidson (2002 p.116) writes “[t]he downside aspect of this shift of bank profits from
interest earnings to originating and servicing fees is that loan officers do not worry as
much about the creditworthiness of borrowers as long as there is a strong market for
these loans.” Put differently, with an increased shift to securitizing and brokerage
activities an implementation of the expectation formation on financial markets straight
into the loan granting process occurred.
Borrower’s size, expectations and the impact of financial markets
To investigate the importance of a firm’s size within the credit granting process it
seems useful to consider the role that the firm plays under fundamental uncertainty.
The very existence of the firm has been explained by Post Keynesian authors by its
ability to handle uncertainty (Dunn 2000 and 2001). Power hereby has been
interpreted as the most important tool of firms to cope with an unpredictable future
(Lavoie 1992). Stockhammer argues “[c]ontrol/power in the sphere of production
15
plays a role similar to that of liquidity in the financial market: it is a strategy that allows
to maintain a degree of flexibility in a situation where irreversibilities reduce flexibility.”
(Stockhammer 2007 p.15). Uncertainty can be distributed and power is the mean to
shift uncertainty or to be more precise to shift the impacts of uncertain events (see
also Stockhammer 2007).
Highly flexible working schedules, just-in-time contracts with suppliers, franchising
and similar developments are nothing but the visible impact of power exerted to shift
uncertainty. If there is an unexpected decrease in demand less working hours are
purchased instead of increasing inventories. If uncertain events such as strikes or
weather impact disrupt the production chain the financial distress can often be shifted
to the supplier. Power to set or influence mark-ups also enables to shift unexpected
increases in costs to customers. Such uncertainties ‘usually’ would be borne by the
firm and the investor (and thereby used to justify profits by recourse on
‘entrepreneurial risk’). Still power increasingly enables investors and firms to shift
uncertainties to their stakeholders.
However there is a striking feature of power in uncooperative market economies,
which despite the fact that it is inherent in Kaleckis notion of “monopoly power” has
not found much attention thus far. Power is not a linear function of a firm’s size. To
the contrary, increased power can only be achieved by the loss of the power of
others9. In as much as power for instance is used to shift the negative impact of an
uncertain event to somewhere else, the uncertainty somewhere else is increased.10.
For simplicity it might be best to imagine power as growing exponentially with a firm’s
size. The larger the market share of an enterprise is the more discretion it has to
influence mark-ups (and the less discretion others have). The more production
capacity and factories a firm has the easier it is to shift production (eventually even
around the world) and to thereby make the firing threat credible to improve the
bargaining position against workers. The same is true with concern to suppliers.
Being a very large client will leave considerable power to put prices under pressure. It
might even be possible to exert power over politics and thus legislation and
institutional settings indirectly via the firing threat, if the number of employees
accounts for a critical mass. A firm then only has to threaten to shift production to
9
This is also inherent in Galbraith’s definition that „Power is the ability of an individual to impose its purpose on others. This
definition is the basis of the discussion of power here. (Galbraith 1975 p.108 after Lavoie 1992 p.99)
10 This does not is not to say that uncertainty could be in any way measured. Still uncertainty can be distributed as elaborated
by Stockhammer (2007) and even increased as remarked by Keynes 1972 p.291f.
16
somewhere else. By using power firms are able to shed themselves against the
occurrence of uncertain events. They are able to shift uncertainty and distribute it.
The consequence of this situation is that a firm that is more powerful is in a more
secure position with regard to a particular investment than a less powerful firm11.
Power therefore will always play a crucial role when an investment or credit in a firm
is considered. For power-considerations to some extent less uncertainty seems to be
associated with investments in larger and more powerful enterprises than with
investments in smaller enterprises. This especially will be the case as often
uncertainty seems to be shifted from larger enterprises to SMEs. Such a situation of
course aggravates the credit availability of SMEs in general as the confidence in
whatever forecast will be higher with regard to a larger firm than with regard to a
smaller firm. Power associated with an investment improves the expectations via
confidence. This is a problem that could be overcome under ‘traditional banking’.
SMEs had an aggravated access to credit but when they eventually where able to
establish a relationship with a bank they could build up a reputation as good
borrowers via their lending history. ‘Relationship lending’ which is still pursued by
smaller banks thereby also is able to reduce uncertainty and increase confidence on
behalf of a borrower.
This situation has dramatically changed through the increased importance of financial
markets (see the discussion above). Banks that securitize are not interested in the
lending history of a particular borrower except the financial markets are. The ever
increasing turnover rates of financial assets (see e.g. Huffschmid 2002) and the
general behaviour on financial markets (as already demonstrated by Keynes 1937)
however indicate that investors do not aim to stick with a particular investment for a
long time. Financial investors that buy today and sell tomorrow are by no means
interested to develop specialised knowledge with regard to SME finance. If they
attach too less confidence in any particular investment they simply do not invest. For
a bank that wishes to sell a securitized loan this however means that it simply cannot
sell. For this reason there seem to exist structural biases in favour of investments in
larger and more powerful firms as these firms generally appear to be more certain
than smaller ones (see also Dunn 2001)12. From an investors point of view (not for
11 To be sure the uncertainty associated with an investment is not reduced. It may be reduced in Post Keynesian economics via
institution-building and the stabilization of expectations. This is not the case in the situation at hand. Herby uncertainty is only
shifted and still has to be borne by someone. The point is that it does not have to be borne by the enterprise any longer.
Therefore the uncertainty of the stake of a particular enterprise in an investment is reduced
12It is hardly a surprise that share prices tend to increase when ‘restructuring measurement’ or ‘layoffs’ (or whatever
euphemism might currently be en vogue) are announced. It is in these very situations in which a firm demonstrates and
17
any other stakeholder) it even seems that larger firms are more secure. This of
course will have considerable effects on the expectation formation. As a result of
reduced uncertainty each expectation with regard to a larger firm can be held with
more confidence than a comparable expectation in a smaller firm.
The corollary of the above is that power can influence expectations and a lack of
power can aggravate situations of asymmetric expectations adversely for SMEs. The
increased roles that financial markets play in the considerations of larger banks
aggravate this situation and structurally incorporate biases against SMEs. The
importance of power and financial market orientation of banks contribute to situations
of asymmetric expectations with regard to SME credits.
Borrower’s size and information
It could be seen in the first section that the standard argument brought forth by New
Institutional economists is that with increases in the organisational levels information
becomes ‘harder’ (as opposed to soft information). To make this kind of information
inter-subjectively understandable and transferable requires fewer costs than in the
case of ‘soft’ information, which prevails in SMEs. Relying on hard information within
the internal procedures therefore alleviates the access to credit. The result as such
does not necessarily have to be rejected from a Post Keynesian position. Still, as
already argued above, a Post Keynesian explanation of such a development might
be differing from the so called principal agent problem.
The explanation of the usage of ‘harder’ information in enterprises with more
hierarchical levels rather can be located in the increased division of labour and its
offshoots. As enterprises grow in size, the logical result is increasing complexity as
more departments, workers and hierarchical levels have to be coordinated. As
Hodgson (2003 p.473) points out “… the outcome of increased complexity within
capitalism is likely to be an increasing inequality of skill levels, with an elite of highly
trained and qualified workers at the one extreme and a substantial, unqualified, and
excluded underclass at the other.” In bigger organization an increasing number of
activities is likely to become routinized. Many tasks, that in a smaller organization
might be fulfilled by qualified workers in an (semi-)autonomous manner, in a larger
organization are deconstructed and reduced to check-list fulfilling activities.
Unqualified – and cheaper – workers are hired and basically act on the basis of
increases power. Setting of a considerable mass of colleagues makes the firing threat more visible and credible, and therefore
improve the bargaining situation against the workers.
18
“manual-orders”. Whereas the societal implications of the rise of such an unqualified
class without perspectives of social ascend might be an interesting field of research,
what is of major interest here is the informational system that arises out of this
situation. Strategic decision makers in such an environment – being indeed
separated to a large extent from the actual procedures of operational activity – need
to impose systems of control to mitigate uncertainty within the organization. Creating
routine procedures thereby can reduce the impact of uncertainty – including
uncertain (re)actions of a hired workforce – within the firm to a considerable extent
(see Dunn 2001). Therefore an informational system is likely to arise in bigger firms
that is reduced to hard and inter-subjectively exchangeable information. On the one
hand this is necessary to allow strategic decision makers to predict the reactions of
their own employees to uncertain events. On the other hand a system based on hard
information can cope more easily with high fluctuations within the above described
unqualified workforce as lower costs accrue when new workers are hired.
As a result there will be specialized personal in larger enterprises that exclusively
engages in the production of such information (e.g. controllers). These informational
structures will be used in higher hierarchical levels to design directions and to direct
the enterprise. Information to control and direct will be generated on a regular basis.
There are standing facilities to produce inter-subjectively exchangeable information.
This makes it easier – and of course cheaper – to present oneself as potentially
‘good borrower’ or ‘good investment’ when being evaluated by banks or financial
markets. Again smaller banks that rely on a more ‘traditional approach’ can overcome
informational problems with SMEs that do engage in the production of ‘hard’
information more easily. In larger banks and especially within the process of
securitization the fact that smaller organizations are not able to produce ‘had
information’ at low costs is likely to add to informational problems. Structural biases
against SMEs within the credit granting process due to an increased extent of
incompatible information between banks and SMEs are the result.
Summary and Conclusions
This paper aimed at explaining structurally biased access to credit of SMEs from a
Post Keynesian perspective. After a rejection of standard approaches a Post
Keynesian approach to explain structural biases in the credit granting process was
presented. Divergent knowledge on the side of lenders and borrowers was identified
19
as major source of credit refusals. Thereby asymmetric expectations and
incompatible information have been analysed as to separate streams through which
biases against SMEs can accrue. Incompatible information to some extent can be
regarded as a market failure that might be overcome e.g. through creating public
agencies that specialise in the transformation the ‘soft’ information that prevails in
SMEs to ‘hard’ information that is increasingly required by concentrated banking
industry. Asymmetric expectations that structurally entail biases against SMEs
however can be crucially aggravated by the distinct role of power in uncertain market
economies. Given that power can be interpreted as being positively related to a firm’s
size, and uncertainty is inversely related to power, this induces structural biases
against SMEs into the credit granting process. To some extent larger enterprises can
be seen as semi-secure monoliths in a stream of uncertain events creating swirls and
maelstroms elsewhere; including SMEs. Contrary to informational problems this is
more than a market failure but a systematic feature of modern market economies.
Whereas a reduction of uncertainty as such might be regarded as being a factor of
stabilization the problem with situation just described is that uncertainty is only
redistributed and shifted around. A framework that improves the position of
stakeholders of large enterprises – including SMEs – in a legally enforceable way
combined with corporative structures that in general stabilise expectations and
thereby reduce uncertainty might be a possible redemption. However, such a task
needed to be coordinated on the level of economic unions, not national states as
otherwise larger enterprises just could shift production elsewhere. This therefore
seems to be only achievable after a long gestation period. In the meantime, indeed,
subsidized credit programmes for SMEs might help to reduce the problem to an
acceptable level.
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