Government failures in finance

1. Government failures in finance • State ownership declining but remains widespread • Poor record of state as permanent or temporary owner • Privatization can lead to a more efficient banking sector, though the process needs care

2. Developing countries Developed countries Government ownership of bank assets Share of the assets of the top 10 banks owned or controlled by the government 60 40 20 0 1970 1985 1995

3. 75% - 100% 50% - 75% 25% - 50% 10% - 25% 0 - 10% N.A. State ownership in banking, 1998-99

4. Bureaucrats as bankers: the ‘pros’ • State can better allocate capital – commanding heights • Private ownership will concentrate credit in the hands of a few • Private banking said to be more prone to crises and malfeasance

5. Bureaucrats as bankers: the ‘cons’ • Incentives: bureaucratic rewards usually linked to politics, not efficiency • Incentive conflict: government as owner vs. government as regulator and supervisor • Biggest failures have been state banks!

6. Nonperforming loans Net interest margin State-owned banks associated with poor bank performance Percent Bad countries 30 20 Good countries 10 0 Bank development

7. Bureaucrats as bankers: the evidence Greater state ownership leads to (BCL, LLS): • less financial sector development, lower growth, lower productivity • higher interest rate spreads, less private credit, less nonbank financial development • greater concentration of credit • some tendency towards more crises, weaker monitoring

8. State ownership and the real economy • Banking systems that take credit away from loss making firms are more developed, underwrite growth (SoBs don’t do this) • The larger the state role in banking, the greater the tendency for credit to be allocated on ‘non-market’ criteria, hence the link with slower productivity growth should not be surprising. • Greater state ownership makes the private part of the system function poorly.

9. Nonperforming loans Net interest margin Private monitoring index Good countries 7 Bad countries 6 5 Bank development

10. Privatizing banks • While state ownership is bad, privatization is dangerous, and requires care. Private banking without private capital can be dangerous! • Finance ministers sooner or later focus on the large fiscal savings from bank privatization • Bonus of the real economy: Improvement in performance under private ownership

11. All provincial banks 10 largest private banks Nonperforming loans, Argentina, 1991 Percent of total loans 60% 40% 20% 0%

12. Public Recently privatized banks Private Lending to state-owned enterprise in Argentina Percent 20 15 10 5 0 1996 1997 1998 1999

13. On the road to privatizing banks • Enforce regulations for all banks to reveal state banks’ weaknesses; publish audits. • Prepare regulatory/information environment, and banks themselves • Avoid rapid privatization (Mexico) and excessive delays (Czech Republic).