The Role of State-Owned and Development Banks Ugo Panizza October 25, 2004 Inter-American Development Bank Research Department

The Role of State-Owned and Development Banks

Ugo Panizza

October 25, 2004

Inter-American Development BankResearch Department

Based on:

• Should the Government be in the Banking Business? The Role of State-Owned and Development Banks – Eduardo Levy-Yeyati (UTDT), Alejandro Micco

(IDB), Ugo Panizza (IDB)

• Bank Ownership and Performance– Alejandro Micco (IDB), Ugo Panizza (IDB), Monica

Yanez (IDB)

• Bank Ownership and Lending Behavior– Alejandro Micco (IDB), Ugo Panizza (IDB)

Two Views

• Development and social views– State-owned banks can address market failures

and achieve development goals

• Political view– Politicians create and maintain state-owned

banks as a political tool aimed at maximizing their personal objectives

Two Views

The scarcity of capital in Russia was such that no banking system could conceivably succeed in attracting funds... Supply of capital for the needs of industrialization required the compulsory machinery of the government.

Gerschenkron (1962) pp. 19-22

…whatever its original objectives, state ownership tends to stunt financial sector development, thereby contributing to slower growth.

The World Bank (2001) p. 123

Outline

• A Taxonomy and admission of guilt

• State-owned banks around the world

• Theory

• What do we know about the performance of public banks– The Micro Evidence– The Macro Evidence

• Conclusions

Outline



• Theory


• Conclusions

Taxonomy

Assets

First-tier Second-tier Non-Banking Activities

First-tier

Retail banks and Hybrid Institutions

(Group1)

Quasi-narrow banks (Group3)

Second-tier Development banks (Group 2)

Development banks (Group 2)

Liabilities

Non-Banking Activities

Development

Agencies (Group 4)

Outline



• Theory


• Conclusions

State Ownership of Banks is Widespread, Especially in Developing Countries…

0

10

20

30

40

50

60

70

80

90

100

Industrial

Countries

Sub-Saharan

Africa

Latin America

East Asia and

Pacific

Developing

Countries

East and Central

Europe

Middle East and

North Africa

South Asia

(%)

1970

1985

1995

Source: Own calculation based on data from La Porta et al. (2001)

…even after a wave of privatizations

0.00%

10.00%

20.00%

30.00%

40.00%

50.00%

60.00%

70.00%

Industrial Countries

Sub Saharan Africa

Middle EastNorth Africa

Latin America

East Asia andPacific

East Europe andCentral Asia

South Asia

1995

1999

2002

Source: Own calculation based on data from Micco, Panizza and Yanez (2004)

State-Owned Banks in Latin America

0 20 40 60 80 100

TTOPANBOLCHLGTMSLVPERHNDBRAMEXDOMECUPRYCOLVENARGNICURYCRI

PSB1995

PSB1970

Source: La Porta et al. (2001)

Can we discriminate between the two views?

• State-Owned banks are prevalent in – Developing countries– Countries with low financial development– Countries with poor institutions– All these characteristics are consistent with both the

development and political views

• There is some evidence in support of the political view but only available for two countries– Italy (Sapienza, 2002)– Pakistan (Khawaja and Mian, 2004)

Outline



• Theory


• Conclusions

Two Key Questions

• Should the state intervene in the banking sector?

• How Should the state intervene?– Regulation, Subsidy, Contracting– Direct Ownership

Should the state intervene in the banking sector?

• Arguments for state intervention 1. Maintaining the safety and soundness of the banking

system 2. Mitigating market failures due to the presence of costly

and asymmetric information3. Financing socially valuable (but financially unprofitable)

projects 4. Promoting financial development and giving access to

competitive banking services to residents of isolated areas

How should the state intervene?

• Contracting and regulation versus direct ownership– If the characteristics of the goods or services to be

produced can be fully specified by regulation or written in a contract, it will not matter whether a given good or service is directly provided by the government or contracted to a private provider

How should the state intervene?

• What if this is not the case? What if the good or service to be provided has non-contractible qualities?– Holmstrom and Milgrom (1991) show that increasing the

incentives along a measurable performance reduces incentives along non-measurable dimensions

– If cost reduction leads to a deterioration of the non-contractible quality private provision may have benefits in terms of cost reduction but may have costs in terms of lower quality (Hart et al., 1997)

How does this apply to banking?

• Maintaining the safety and soundness of the banking system – While the inherent fragility of the banking system is an

important issue, it is not usually addressed with direct state ownership

– Banking regulation and supervision together with deposit insurance should be able to reduce banking fragility without eliminating the positive incentives of private ownership. This is indeed the avenue followed by most industrial countries

– However, deposit insurance and regulation do not work satisfactorily in most developing countries (Demirguc-Kunt and Detragiache, 2002, Barth et al., 2002)

– Hence, in countries characterized by very low levels of institutional quality, direct state ownership has the potential to increase the trust of the public in the banking system and lead to deeper financial markets (Adrianova et al., 2002)


“For what prides itself on being not only Russia's largest private bank but also its most advanced, with modernist branches and multifunctional cash machines, a run on deposits must have been a genuine indignity. On July 7th, Alfa Bank insisted for the third time in 48 hours that it was not running out of funds. It claimed that it was a victim of dirty public relations. Having survived the 1998 crisis that brought most other banks to grief, it is probably right; but many depositors (including our Moscow correspondent) took no chances…Does anyone gain? Yes: a clear winner is Sberbank, of which the state owns over 60%. It is the only bank with a full state guarantee and Russia's only widely traded banking stock. It has 64% of retail deposits.”

The Economist, July 8, 2004


• Mitigating market failures due to the presence of costly and asymmetric information and financing socially valuable (but financially unprofitable) projects

– Too little lending to certain economic sectors– This is where development banks come in – Their objectives cannot be monitored in the short run and

hence there is a tension between measurable and non-measurable performance

– What would make a development bank superior to grants and subsidies? • Feedback between lending and research• Political economy


• Mitigating market failures due to the presence of costly and asymmetric information and financing socially valuable (but financially unprofitable) projects

– Too little lending during certain periods of time– The case for too little lending of private banks during

recessions would make a case for direct state ownership (because private banks do not internalize the benefits of countercyclical lending)

– The empirical evidence is mixed:• Cecchetti and Krause (2001) find that PSB reduce the

effectiveness of monetary policy• Micco and Panizza (2004) find that lending of PSB is less

procyclical than lending of private banks


• Giving access to competitive banking services to residents of isolated areas

– This can be addressed with contracting, regulation, and subsidies

• Another argument for public banks: they provide an additional policy tool

– They solve political economy problems and allow to do “dirty works” (clean-up of bank failures, etc.)

– The costs in terms of transparency and accountability are very large

Outline



• Theory


• Conclusions

What do we know about the performance of public banks?

• The Micro evidence– In developing countries, public banks are

characterized by low profitability and low interest margins

• Profitability is particularly low in Latin America

– In industrial countries, public banks are not significantly different from private banks

Profitability and Interest Margin

-1.2

-1

-0.8

-0.6

-0.4

-0.2

0

0.2

IND DEV LAC ECA EAP SAS MENA

ROA: Difference between Public and Private Banks

Not SS

Source: Micco, Panizza, and Yanez (2004)

Profitability of public banks

- 0 . 0 1 2

- 0 . 0 1

- 0 . 0 0 8

- 0 . 0 0 6

- 0 . 0 0 4

- 0 . 0 0 2

0

0 . 0 0 2

R O A

C o s t a R i c aC h i l eG u a t e m a l aB r a z i lM e x i c oA r g e n t i n aE l S a l v a d o rH o n d u r a sC o l o m b i aN i c a r a g u a

What do we know about the performance of public banks?

• In developing countries, public banks have high employment and high non-performing loans

• In both industrial and developing countries, public banks have high overhead costs

Employment, NPL, and Overheads

- 0 . 1

0

0 . 1

0 . 2

0 . 3

0 . 4

0 . 5

0 . 6

0 . 7

E m p lo y m e n t N P L O v e r h e a d s

I N D

D E V

Not SS

Source: Micco, Panizza, and Yanez (2004)

Outline



• Theory

• What do we know about the performance of public banks– The Micro evidence– The Macro Evidence

• Conclusions

The development impact of state- owned banks

• The findings of the most influential paper on the development role of state-owned banks are (La Porta, Lopez de Silanes, and Shleifer, 2002): – A higher share of state-owned banks leads to a smaller

financial sector

– A higher share of state-owned banks leads to slower growth

– These findings should give a mortal blow to the development view


• However, when we try to address issues related to endogeneity, data quality, and model specification, we find that: – The relationship between state ownership of banks and subsequent

financial development becomes weaker and often not statistically significant

– The relationship between state ownership of banks and growth depends on the level of financial development and, in particular, becomes positive in countries with a high level of financial development

– This is puzzling: state-owned banks are particularly bad where they are needed the most!!!!

• Countries with high financial development know how to deal with the distortions brought about by PSB

• The model is misspecified (omitted variable and causality between PSB and financial development)


• Further evidence– PSB do not improve allocative efficiency

Impact of financial development on growth of sectors that require more

external financing

0

0.005

0.01

0.015

0.02

0.025

Average 0 20% 40% 60% 80% 100%

Source: Galindo and Micco (2004)

Public banks do not allocate more credit to small firms

-14

-12

-10

-8

-6

-4

-2

0

0 20% 40% 60% 80% 100%

PSB (not ss)

Source: Galindo and Micco (2004)


• Further evidence– PSB do not improve allocative efficiency– But they seem to limit lending procyclicality

Bank Ownership and Credit Cyclicality

-0.4-0.2

00.20.40.60.8

11.21.41.6

IndustrialCountries

DevelopingCountries

Private DomesticBanksState-OwnedBanksForeign-OwnedBanks

Source: Micco and Panizza (2004)

Outline



• Theory

• What do we know about the performance of public banks– The Micro evidence– The Macro Evidence

• Conclusions

Summing up

• There is evidence that state-owned banks: – Have fiscal costs (especially in developing countries)

– Play no beneficial role in terms of growth• Even though the evidence that state ownership of banks tends

to stunt financial sector development, thereby contributing to slower growth (WB, 2001) is less strong than previously thought

– Play no beneficial role in terms of allocative efficiency

– Play a beneficial role by reducing lending procyclicality

Summing up

• From the academic point of view, the research agenda is still open

• We need to address causality in order to make stronger statements

• Studies that use micro-data and focus on development banks would be very useful

From the Policy Point of View

• Is the previous evidence sufficient to conclude that PSB should be eliminated? Not necessarily

• The Sisyphus syndrome (De La Torre, 2002)1. Development mandate

2. Fiscal cost

3. Pressure to increase profitability

4. Pressure to achieve the development mandate

From the Policy Point of View• An even more intriguing question:

– Assume PSB are bad. However, they are popular with politicians. Are they so bad that international policy advisors should spend their limited political capital on this issue?

• Alternatively, what can be done to improve the performance of PSB?– A clear definition of the objective function and

measurement of the subsidy would allow conducting true cost benefit analyses and make managers accountable

– Governance structure• Learn from the literature on CB independence

The Role of State-Owned and Development Banks

Ugo Panizza

October 25, 2004

Inter-American Development BankResearch Department

Documents

The Role of State-Owned and Development Banks Ugo Panizza October 25, 2004 Inter-American Development Bank Research Department