Late Payment, Adverse Incentives and Monetary Policy

A letter was written to the Straits Times Forum on Sat 12 Nov 2011 titled "Pay first, repaid last policy is unfair". The subject matter is rather obvious. I wrote back to the Forum with comments, my letter appeared in today's (15th Nov) issue of the papers (a day when it seemed that no one in my office touched the newspapers before 4pm). Let me give the gist of what I was trying to say:

One thing that one might learn in an introductory finance class is the value of holding other people's money. In particular, that one should watch one's cash flow, as some large clients are apt to make late payments. For insurers and other financial institutions, holding other people's money for longer times serves to artificially boost one's capital ratio. Hence, there exist incentives for insurers and other financial institutions to make late payment. (The same applies to B2B transactions, but these are harder to regulate and have less direct impact on "the citizen".)

This is a real concern. Laws do exist to limit the time banks can hold deposits before making them available to write cheques on. The Expedited Funds Availability Act in the USA is an example of this that addresses a particular face of this form of moral hazard. I previously heard an anecdote of some bank(s) in the USA being found guilty, a number of decades ago, of wrongdoing by their sending payment (in the form of cheques via snail mail) from the furthest branch away from the destination in order to have access to the customer's money for a day or so more. The sheer volume of payments made this profitable. Insurance and other financial transactions are similar. Long processing times seem like a weak excuse.

I wrote that it may be time for Singapore to deal with the underlying problem. I said that the MAS should determine whether deferred payments may be considered reserve capital. (Yes, money could be used for other things, but I thought pointing to reserve capital as something tangible would make sense.) If the response turns out to be "no", incentives for such, arguably dishonest, corporate behaviour would be reduced.