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Government involvement in Parex Banka
The Parex Banka is a major Latvian bank in the mostly Scandinavian-controlled banking sector of Latvia. In 2008 the Latvian Government bought 51% of the bank’s shares for a symbolic payment of LVL 2,00. Large sums of money were invested into the bank in order for Parex Banka to be able to keep on working normally. In March of 2010 Latvia’s Government decided to take a new course concerning the case of Parex Banka. It was decided to split up the bank into a new "good” bank and to keep the old Parex Banka. "The existing Parex banka will continue to pursue some of its business activities, focusing primarily on recovering resources” (Artūrs Grants, source: Latvian Institute), however "the old Parex banka will not offer any new products or additional loans to the existing clients"(Matthew French, source: Latvian Institute). The new bank on the other hand will be sold to private investors, once the economic situation improves the bank is expected to make profits and should be able to repay the money that the government invested within 5 years. "The New Bank was expected to close this year in the red, but to increase its profit by 17% in 2014” (Matthew French, source: Latvian Institute).
Whether the governments of different countries should financially support, or even nationalize banks has been debated all around the world due to the economic crises. To nationalize means if the Government is taking over the shares, and therefore taking control of the Company. In most cases it was a debate in which it was hard to tell what the better choice was, not so in Latvia. In fact there is no similar example in which it was clearer that the government has to act. The opportunity cost of not saving it would have been immense for the country since one of the biggest supply of capital in Latvia would have been gone. Opportunity cost is what is giving up when making any decision, in this case not saving the bank would have had the opportunity cost of all economic ramifications of that decision. Capital is a factor of production which is the resources (not natural) which are needed for production usually money. Latvia is one of the countries in which the economic crisis had the biggest impact; why? The answer lies in the banking sector. A German banker told me a couple of years ago that there will be a financial crisis in Latvia in the next couple of years, long before anyone expected a worldwide economic crisis. It is simply not normal nor economically smart to give anyone a loan who wants one no matter whether they have a reliable concept for how they are going to pay it back or not, to do so is a sign of extreme naivety. Nor is it safe to give people up to 13% interest for their savings, as to do so increases short term profits but no long term financial security. However both these way too risky strategies were used by banks in Latvia, by Scandinavian banks but mainly by the Parex banka. Parex banka lost so much gambling that the Latvian government with no choice but to safe them "The failure of a bank as large as Parex would have had a catastrophic effect on the Latvian economy” (European Bank). That they had too risky policies is shown by the fact that the European bank thought it was necessary to have send a consultant "One consultant reviewed the extent of the problem loan portfolio, took an overview of risk management procedures” (European Bank). It is sad and ironic that the now government-owned bank is once again choosing the risky path of doing business and prefers gambling over safety. It was necessary for the government to get involved in the bank’s business, but they should have learned from the mistakes of the bank and changed the bank’s policies that got them into all this trouble. The new restructuring program is a risky maneuver "…the plan to create two credit institutions […] is expensive, operationally risky” (Valerijs Kargins, source: The Baltic Course).
The nationalization of parex banka also moved Latvia back closer to a centrally planned economy, a system that was in place in Latvia before the break-up of the Soviet Union. A centrally planned economy is an economic system in which the complete economy is planned and organized by the Government. Over the last couple of years Latvia has been moving closer to a free market economy and is currently a mixed economy. A free market economy is an economic system in which the production is not planned but is up to the market price which is determined by demand and supply, a mixed economy is a mixture of the centrally planned and the free market economy. With the nationalization the Government got involved in an economic issue, therefor Latvia is currently closer to a centrally planned economy than before. However overall Latvia is still closer to a free market economy since nationalizations do not usually take place here. A step towards a centrally planned economy is not necessarily bad. In fact experiences such as the failure of Soviet economic plans and the economic crisis have shown that neither a complete free market economy nor a centrally planned economy work, but that a mixed economy works best.
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Category: IB1 Economics | Views: 510 | Added by: atg | Rating: 0.0/0
Total comments: 1
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1 DanDomanevski  
Great Analysis Anselm, applause I totally agree that it should be PArex to take the consequences of mortgage and loan defaults, but i think it was mandatory to pull the bank out of the trouble. Many depositors would have been hit by the defaulting, and government would have to pay compensations. nevertheless, the government shouldn't haven't spent twice as much then it would paying the compensations. Also, the restructuring of the bank is a complete fail. Essentially, they just changed the signboard and spent a couple of hundred million on it nono :nono: nono

Nevertheless, nice analysis, applause :applause: applause


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