Distortionary finance

It seems that private banks in Jordan prefer lending to the construction sector and non-productive activities such as individual loans, which are usually consumption oriented. On the other hand, industry and the quality of innovations therein, which underpin the development of the economy, is not favored by banks. To remedy the situation, there is a role for regulators and the state if Jordan is to enhance its march toward development.

A cursory look at the percentages of loans provided by Jordanian private banks to industry shows that they averaged 12.6 per cent during 2019-2020, which is a low percentage when compared to loans to construction (25.7 per cent) and individuals (21.7 per cent). In other words, industry receives around half the credit from private banks that these two beneficiary groups obtain. 

Why is industry important? History shows that nations that improve their industrial sectors grow faster than others. Industrial based growth tends to create more jobs, increases income, and introduces advances and innovations that augment productivity and competitiveness. States that intervene to move industries towards high value-added production tend to gain the most.  

It is true that private firms in advanced economies undertake the bulk of research and development (R&D). However, it is also true that they receive significant support from the public sector. In Singapore, 60 per cent of spending on R&D comes from the private sector. In South Korea (the most innovative economy in the world), it is 78 per cent. In the US, 72 per cent comes from the private sector. The rest comes from the government. Moreover, the public sector provides the institutional set up to sustain private R&D spending and subsidies. Basic science and research labs are funded by the government. Research at universities is supported through public funds, while monopoly rights and patents ensure that innovators are rewarded.  

If industry is such a good thing in the long term, why do banks in Jordan favor providing credit to construction activities and individuals instead of industry? The answer is multifaceted. Giving a loan to someone to build a house or a compound is almost a straightforward and simple exercise. The bank sends an assessor who provides an estimate of the property (land or site) and the bank owns the property until the loan is fully paid. As to providing credit to individuals, if the person is employed by the government or a large corporation, the salary of the person is transferred from the employer to the bank and a monthly deduction is made until the loan is fully paid. The individual borrower is less sophisticated in terms of loan negotiation than an industrialist and would most likely accept a higher interest rate on the loan. Both types of loans offer very little risk and require unsophisticated approval and granting processes.

Banks tend to view loans to industry as more risky than other loan types due to a host of risks and exposure categories, the industrial venture is more complex and may require specialised technical expertise to assess which the banks may not have, and industrial projects require several years before they start to breakeven and make a profit. Consequently, many industrial ventures have collapsed over the years as banks refused them credit. 

Favouring construction over industry is a global phenomenon, which is why regulators, typically central banks, come up with policies to encourage private banks to lend to industry or utilise state investment banks to help industry introduce new technological frontiers and economic opportunities. State policies and measures include countercyclical credit, funds for catch-up strategies, long term funding, innovation based funding, etc. Worldwide, the four most active banks in this area are the Chinese Development Bank, the German KfW, the European Investment Bank and the Brazilian BNDES. 

Sadly, industry in Jordan faces the dual challenge of lacking state support/sponsorship and the absence of regulations that nudge the private banks toward funding industrial projects. The one state sponsored bank, the Jordan Industrial Development Bank, which was established in 1965 with the help of the World Bank, was acquired in 2010 by the Jordan Dubai Islamic Bank. Hence, industry remains without that much needed support.

The government, in its drive to reform the economy and make it less dependent on aid and enhance its competitiveness, must focus on the introduction of policies and measures that are aimed toward increasing value-added production, heightened productivity through innovation, and greater spending on R&D. Let’s not wait too long!