Public Sector Banks and their Transformation

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Public Sector Banks and their Transformation

• James A. Hanson Sr. Advisor
• Operations and Policy Department,
• Financial Sector Vice Presidency,
• The World Bank

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The opinions in this presentation and paper are
solely those of the author and may not reflect
the opinions of the World Bank, its Executive
Directors, or the countries which they
represent. Based on Bank Work led by Jerry
Caprio and by Bob Cull and on a seminar last
year Transforming Public Sector Banks
(available on Web Site)
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State Banks Performance is Important because
State Banks are Important
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Outline of the Presentation

• Why Did Public Sector Banks Develop?
• The Performance of Public Sector Banks
• Why has Their Performance Been Bad?
• Lessons for Improving Performance Incentives and
  Governance Improvements
• Privatization
• Other Options
• Agencies, Closure, Narrow Banks

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Why Public Sector Banks?

• 1. Political power and de-colonization
• 2. State-Led Develop. needs State Banks
• Channel cheap funds to Public Sector and friends
• 3. Market Failure
• Lack of Credit for industry(LT), agric., SMEs,
  housing, (new) export
• Failure to Recognize Good Clients SMEs Farmers
• (Sometimes) Offset Non-financial Distortions.
• 4. Takeovers after Crises

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Performance of Public Sector Banks

• A few have done well, most poorly
• High NPLs
• High spreads and overhead costs
• Often lend mainly to public sector
• Often lend to higher income clients
• Cross country macro-relationships
• Less private sector credit financial
  development
• Less growth.

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Why Poor Performance?

• Credit Allocation differs from private banks.
  Different Allocation means worse results unless
  market really fails.
• The Negative View the evidence is consistent
  with the political view of government ownership
  of firms, including banks, according to which
  ownership politicizes the resource allocation
  process and reduces efficiency. La Porta, Lopez
  de Silanes, and Schliefer (2002)

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Why Poor Performance?

• A More Benign View Even well intentioned Govs.
  face
• 5 Problems
• Multiple Objectives/State Intervention
• Lack of Information (Pol. not Tech. Problem)
• Political Problems in Setting Realistic Interest
  Rates and Collecting
• Culture of Non-Payment
• Corruptionthe Iron Law of Credit Allocation

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Transforming Public BanksThe Standard Approach

• New Management
• Write-off or remove bad loans
• Try to reduce costs
• Improve information technology and risk
  management
• Bank will be as good as private banks

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Failure of the Standard Approach

• Recaps are often Too Small
• More fundamentally
• Doesnt Deal with the 5 Issues.
• Costs are not the issue.
• Incentives and reducing NPLs are.
• No market discipline.

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Transforming State Banks

• Eliminate government interference in lending,
• Incentives for the management and staff to lend
  and collect well,
• Information system for accountability,
• Interest rates that cover costs of lending to
  high-risk clients, and
• Eliminate the culture of borrowers non-payment
  through enforcement of contracts.
• Still no market discipline.

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Specific Suggestions

• Government defines a simple objective, e.g. rapid
  privatizationand avoids interventions.
• The new management chosen to manage
• Management and staff have good incentives.
• Information for timely monitoring, esp. the cost
  and benefits of subsidies
• New lending constrained, especially large loans,
  to limit new non-performing loans.

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Privatization

• If trying to make a state bank resemble a private
  bank, then why not privatize?
• Privatization can yield substantial gains,
  especially in terms of lower NPLs. In Clarke
  -Cull study of Argentine provincial banks,
  recapitalization would have cost 2-4 times as
  much as privatization, over time.
• Privatized banks appear to be more efficient,
  especially when privatization done to strategic,
  reputable international investor.

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Privatization Is Not Easy

• Governments want to keep the policy
  instrument
• Staff and clients want to keep benefits
• Political issues in sale price
• Partial Privatization may cause problems
• Biggest Problem
• Divesture to unsound buyers or through equity
  market, e.g., Mexico, Africa, Czech Rep.,
  Poland, and Hungary.

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Making Privatization Work Better

• Improve the informational and the regulatory and
  supervisory environments
• Set a well-defined timetable for privatization
• Recapitalization is probably necessary
• Buyers should meet fit and proper test
  foreigners should not be excluded
• Best results when sold to a reputable
  international bank.

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3 Alternatives to Privatization

• Closure, Agency, Narrow Bank
• All the alternatives focus on limiting new bad
  loans.
• All have some faults/not perfect, but better/less
  costly than keeping the bank public and making
  more bad loans.

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3 Alternatives to Privatization I. Closure and
Liquidation

• Often used when bank culture is failure
• Recapitalization will bring only new NPLs
• Banking is essential, a bank is not.
• Bad credit drives out good credit
• Other banks will take up the business
• Sell-off parts, transfer deposits, etc.
• Make the rest of the system work better.

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3 Alternatives to Privatization II. Government
Agency

• Transparentannual parliamentary review
  eliminates the non-transparent tax/subsidy system
  of public sector banks, and distortions created
  in system by state banks.
• Be careful with lending, agencies can be worse
  than state banks in collecting.

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3 Alternatives to Privatization

• III. Turn a Bank into a Narrow Bank
• Holds only Central Government Debt (and there is
  plenty after a recapitalization)
• Provides Deposit and Payments Services
• Limits New NPLs (some do micro-credits, with
  approach similar to private banks).
• Can compete, particularly in rural areas
• Beware widening of lending scope to provincial
  and state governments, they often dont pay.
• Eventually narrow banking may be a problem as
  allows too easy financing of gov. deficits.