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Reforming and Privatization of Public Sector Banks

By

Louis A. Kasekende

Executive Director, World Bank

April 9,2003.

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Introduction• Objectives of financial sector reforms• Why Reform or Privatize Public Sector Banks?• Uganda’s Experience-Cost of Restructuring

UCBL.• What was Done Wrong in Uganda’s Case?• What did the Government do Right?• Political related problems in Restructuring Public

Sector Banks. • Role of International Community in dealing with

Public Sector Banks.• Lessons from Uganda’ experience.

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Objectives of restructuring

• Macro-economic stability

• Promoting GDP growth

• Financial Deepening

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Why Reform or Privatize Public Sector Banks

• Poor Corporate Governance, including insider lending, reckless concentration in credit, frauds, falsification of financial accounts.

• An inefficient financial sector leads to misallocation of resources at a big cost to the economy.

• Direct financial losses when taxpayers money is used to protect depositors due to accumulation of Non-performing assets.

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Continued…………….

• Poses macro-economic management challenges e.g complication of management of monetary policy.

• Cost to the general public due to high cost of capital, lack of adequate resources to fund good private investments.

• Continued intervention from the Central Bank weakens the Monetary Authority often leading to recapitalization and restructuring of the Central Bank at a very high cost.

• Major impediment to enhancing competition and efficiency, especially in Credit markets.

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Uganda’s Experience-Cost of Restructuring UCBL

• Costly in terms of the financial resources expended in compensating or protecting depositors, macroeconomic management challenges and in terms of costs borne by the public.

-Preparation of UCBL for privatization cost 2% of GDP in 1998.

-Central Bank recapitalization cost 1% of GDP.

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What was Done Wrong in Uganda’s Case

• Took too long to implement restructuring and privatization. Reform of UCBL was supposed to start in 1992, however, transfer of its bad debts to NPART took until 1997. The delay was costly on two counts:

- First, it impeded competition and efficiency especially in the credit market;

- Second, losses incurred through mismanagement of the public sector banks that proved costly for the tax payers; Restructuring UCBL cost 2% of GDP in 1998, and recapitalisation of the Central Bank cost 1% of GDP.

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What was Done Wrong in Uganda’s Case

• Sold to a buyer without capital, banking reputation or expertise, which secretly assigned the shares to another bank, further weakening the sector.

• Central Bank intervention in 1999 proved protracted (1999-2002) and was in conflict with the regulatory role.

• Regulatory Forbearance• Joint Responsibility between the BOU and

Ministry of Finance.

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What did the Government do Right?

• Implementation of Market Based Policies-which are relatively more efficient and effective that administrative controls in the allocation of resources.

• Political Commitment in the later stages of the reform ensured consistent implementation of agreed programs and protection of the reform process from interest groups and political interference.

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What did Government do Right? Continued…….

• Establishing the policy makers’ credibility through maintaining a stable macro-economic environment.

• Commitment to fiscal reforms and fiscal discipline.

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Political related Problems in Restructuring Public Sector Banks

• Problem of selling reforms to the politicians who fear to loose the benefits associated with directed credit, including loss of political influence

• Managing the tension between strict prudential requirements intended to promote a strong financial sector and allocation of resources to attain development goals as determined by the Government

• Slow process of restructuring and divestiture because of political interests risks asset stripping and therefore reducing the market price.

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Continued…………• The privatization process could be hijacked by the

politicians resulting into failures in the process with huge financial costs.

• Blurred delineation of roles and responsibility between the Central Bank and the Ministry of Finance.

• Fear that the new owners will contract services especially in rural areas.

• Inverse relationship between price and quality of buyer, could sell at low price but to reputable buyer.

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Role of International Community in dealing with Public Sector Banks.

• Provide resources to restructure public banks, however, effective solution is divestiture, including privatization. Donor led restructuring did not succeed.

• Support the Government in due diligence and advisory services, because this is highly specialized.

• Sharing country experiences on best practices, and helping in the standardization of reporting and information systems.

• Independent auditing of the restructuring process to assure credibility.

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Lessons from Uganda’s Experience in restructuring Public Sector Banks• First, the best strategy for dealing with troubled

government owned banks should be to sell them as quickly as possible to a reputable investor.

• Genuine restructuring requires hard decisions which governments rarely have the incentives or political courage to take.

• It is better to leave as much of the restructuring as possible to the new owners even if this may require providing them with financial incentives.

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Lessons continued……….• The primary objective of a government in

privatizing a state owned bank should be to sell the bank to an investor who can best ensure the safety of the bank’s deposits.

• The best investor to purchase and run a public sector bank is a large, well established private sector bank with substantial financial, technical and management resources at its disposal, and crucially, a long established international banking reputation to protect.

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Lessons Continued……..

• Political commitment to reform is critical, to ensure consistent implementation of agreed programs and protection of the reform process from interest groups.

• Neither government nor donors have adequate incentives to ensure sound management of a bank and consequently, neither should play a leading role in bank governance.

• Do not let statutory management drag on; in fact try and avoid it in the the first place.

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Lessons Continued……..

• Don’t avoid after-the-fact accountability; in fact prepare for it.

• Don’t sell under any circumstances, because credibility of Government policy could be at risk.