How to Hide a Banking Crisis
Reid TuximunPackilvania has been in the news for the seeming collapse of a mid-tier bank. The Packilvanian Central Bank (PCB) has been taking active measures to insulate depositors and bondholders from the fallout. Would it surprise you if I told you that the Post Bank of Packilvania is only one of several Packilvanian banks that have collapsed in the past few years?
Let’s take a step back for a moment. Packilvania is a big country and a massive economy. But, at end of the day it is a poor country. As such, the country is often viewed by foreign investors as a risky destination to invest in or lend to. The country offsets the cost of that investment with a profound return on that risk. In part, its companies are able to round up low cost labour, abundant fossil fields and weak regulations, to produce goods cheaper and quicker than almost anywhere else on the planet. On the other hand, it offsets the risk of investing in Packilvanian dinar denominated instruments such as bonds and money market funds by offering high interest rates.
As we know, most rich countries do not offer high interest rates except perhaps during periods of high inflation. For instance, the Auroran Central Bank has barely raised interest rates above 1% simply because the Kirib and the Auroran economy are unfailingly stable and inflation is comfortably low. In contrast, Packilvania has much higher inflation than its peers. As such, the Packilvanian Central Bank uses high interest rates to attract foreign investors to put their money in its banks to cash in on the Great interest rates (capital controls and currency manipulation notwithstanding).
However as a poor country that has achieved massive growth through scurting the kinds of regulations one would expect in such a large country, Packilvania has allowed thousands of small rural banks to spring up like weeds. Although they offer high interest rates to their clients, these banks are often highly risky. Every year, a few of them collapse, taking their depositors’ funds with them. The government often simply leaves them to dry. Many of these banks are too small to afford the depositary insurance premiums that medium to large banks like the Post Bank are able to make.
As such, almost every year, without fail, a few banks collapse and often without government assistance. The government will make a show of arresting the directors, but it simply deems these banks too small to save. Firstly, it does not want to encourage reckless lending and it also wants to impose fiscal discipline (without the protections that citizens of rich countries take for granted). Every year, hundreds of thousands of people lose their money and no one helps them. The government is willing to sacrifice these small banks to maintain the health of the larger banking system.
Why is the Post Bank so important? It’s the largest bank to fail in this way. The PCB knows that they cannot allow the Post Bank to fail because it will make the Packilvanian banking system look weaker if did. While rural depositors wait weeks and months for their money as the PCB takes months to liquidate these small banks, the Post Bank depositors and bondholders were paid in full. This is also why the PCB is always urging the public to be calm to avoid a run on the banks.
Now, is Pax a good place for large institutional investors to park their funds? If the FX rate and capital repatriation restrictions don’t scare you and you have the stomach for real risk, then the rewards can be quite great, so sure thing go ahead. It may be well worth the time. But when in doubt, avoid putting your funds in an obscure bank in the middle of nowhere with a dinky website that charges 0 fees. Unfortunately, for many poor rural people in Packilvania, these small and somewhat shaky banks are a risk they must bear.