STATE BANKS

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• STATE BANKS
• Direct Fiscal
• Costs of Restructuring in Transition Countries
• By Dr. Khaled Sherif
• Sector Manager, The World Bank
• Date November 4, 2003

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Current Assessment of State Bank Costs

• A recent World Bank study
• Reviewed 14 transition countries
• Bulgaria, Czech Republic, Albania, Croatia,
  Romania, Slovakia, Turkey, Hungary, Lithuania,
  Macedonia, Slovenia, Latvia, Poland, and Ukraine
• Assessed 30 state owned banks from 1991-2002.

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Current Assessment of State Bank Costs

• The study focused on
• Direct fiscal cost recapitalization and bad
  asset transfers and guarantees issued for
  privatization purposes
• Magnitude of cost to GDP, fiscal impact, debt
  profile, bank capital

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DIRECT Fiscal Costs

• DIRECT costs approximate 50 billion
  (recapitalization/bad asset transfers and
  guarantees post-privatization)
• Does NOT include
• Forbearance
• Losses run through non-banks
• Higher bond yields to generate earnings for
  troubled banks
• Higher interest rates on government securities

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Cost Comparison

• What does 50 billion buy?
• The 50 billion lost on state banks in transition
  economies is equivalent to
• Ten times the post-war reconstruction aid in
  Bosnia over 7 years from all donors (5 billion)
• 25 times the GDP of Armenia in 2001 (2 billion)
• The GDP of Hungary in 2001Eastern Europes best
  performer (49 billion)
• More than twice annual lending of the World Bank
  to the entire world in 2002 (20 billion)
• Total privatization revenue in ECA region from
  1990-1997. (47 billion)

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Direct Fiscal Costs ( billions)
gt 20 billion Turkey (ongoing)
10-20 billion Czech Republic (guarantees still in effect)
1-5 billion Bulgaria, Croatia, Hungary, Poland, Romania, Slovak Republic, Slovenia
lt1 billion Albania, Latvia, Lithuania, Macedonia, Ukraine
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Gross Fiscal Costs to Average 1995-2002 GDP
gt15 Bulgaria, Czech Republic
10-15 Albania, Croatia, Slovakia, Turkey
5-10 Hungary, Lithuania, Macedonia, Romania, Slovenia
lt 5 Latvia, Poland, Ukraine
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Average Annualized Gross Fiscal Costs to Average
GDP (1995-2002)
gt 2 Bulgaria, Czech Republic
1-2 Albania, Croatia, Romania, Slovakia, Turkey
.5-1.0 Hungary, Lithuania, Macedonia, Slovenia
lt.5 Latvia, Poland, Ukraine
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Sales Proceeds of State Banks

• Total about 9.4 billion (18 of gross costs)
• Most in Poland, Czech Republic, Bulgaria and
  Slovakia
• Relative to Gross Fiscal Cost, proceeds have been
  material only in Bulgaria (52), Poland (gt100 so
  far), Slovakia (38) and Slovenia (46)
• Other countries proceeds generally lt25 of
  direct fiscal costs
• THEREFORE there is almost always a high net cost
  to recapitalization

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Fiscal Costs AFTER Bank Sales to Average
1995-2002 GDP
gt10 Albania, Czech Republic, Turkey
5-10 Bulgaria, Croatia, Lithuania, Macedonia, Romania, Slovakia
lt5 Hungary, Latvia, Slovenia, Ukraine
Surplus To date, only Poland has generated a net surplus. However, this is projected to be offset by PKO BP.
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Average Annualized Net Fiscal Costs to Avg.
1995-2002 GDP
gt1.5 Czech Republic, Turkey
1-1.5 Albania, Croatia, Romania
0.5-1 Bulgaria, Hungary, Lithuania, Macedonia, Slovakia
lt0.5 Latvia, Slovenia, Ukraine
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The Remaining Challenge

• The remaining challenge for policy makers is to
  privatize or liquidate the loss-making state
  banks.
• Major problems with state banks continue to
  plague the region.
• At end-2000 there were more than 78 state banks
  in Eastern Europe and Central Asia.

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Lessons from Experience

• Dos
• Privatize early, not late
• Seek out a strategic investor
• Keep direct costs down
• If restructuring, link to overall banking sector
  restructuring with time-bound plans and
  objectives

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Lessons from Experience

• Donts
• Incur major recapitalization and asset transfer
  costs
• Issue large or open-ended guarantees
• Provide ongoing forbearance to troubled banks
• Try to aggressively grow out of traditional
  problems

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Findings Support1

• Continued state ownership in the banking sector
  entails major direct economic costs
• ? distortions linked to government and real
  sector
• ? risk to systemic and macro stability
• ? political patronage is a major factor and risk
  item

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Findings Support2

• Enormous opportunity cost in foregone investment
• ? presence of state banks and protection deters
  prime-rated banks
• ? when prime-rated banks enter the market, they
  assume less credit risk when doubts linger about
  the role of the state
• ? credit remains costly
• ? systemic risk remains higher

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Findings Support3

• Too big to fail ? perverse effects
• ? Size and importance of state banks distorted
  by flawed valuation standards and classification
• ? Rooted in big banks financing big
  industries and big state farms, all of which
  was unsustainable and inefficient
• ? Delays in Bulgaria and Macedonia led to losses
  20-30 of 1998 GDP
• ? Estonias direct approach 1.4 of GDP

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Findings Support4

• Delayed reforms add to cost and reduce confidence
  in civil institutions
• ? Slow approach to correction higher cost of
  recapitalization
• ? Applies to private banks as well if run on a
  patronage basis
• ? Loss of confidence ? lower deposits, lower
  levels of intermediation, higher incidence of tax
  evasion

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Findings Support5

• Legal reform is insufficient
• ? Laws not enough
• ? Courts, extra-judicial supports needed for
  effective implementation
• ? Regulatory/supervisory capacity with strong
  mandate needed
• ? General culture of financial discipline
  required
• ? Better information needed

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Findings Support6

• Remaining state banks should generally be treated
  as resolution cases
• ? Most have poor earnings and solvency prospects
• ? Liquidation will help in many cases with
  consolidation, new entry of sound banks
• ? Effective resolution will ultimately stimulate
  competition, bring down net spreads, put
  intermediation on sound footing

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Recommendations 1

• Privatize or liquidate unless restructuring
  prospects are sound
• ? The test should be prospects for attracting
  strategic investment
• ? Costly recapitalization probably not warranted
• ? Whether restructuring should precede
  privatization should be determined case-by-case
  with clear criteria

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Recommendations 2

• Pre-privatization consolidation has been costly
  and complex
• ? Market mechanisms usually more efficient
• ? If sufficient number of well capitalized
  private and foreign banks in place, they will
  help to make the market
• ? Exit of state sends important signal

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Recommendations 3

• Purchase and assumption techniques should be
  applied
• ? Difficult in transition countries due to
  judicial and asset disposition constraints
• ? Nonetheless, market signals serve as catalysts
  for effective resolution
• ? Least-cost focus important as part of the
  signal, and for macro purposes as well

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Recommendations 4

• Regulatory options are available when the market
  is not as responsive as desired
• ? Regulatory/administrative approach can be
  carried out by specialists
• ? Should be structured as corrective action on
  systemic basis
• ? Should be linked to least-cost resolution
  approach

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Recommendations 5

• When all else fails, liquidate creatively
• ? Sell to credit unions, micro-finance, NBFIs
• ? Use to stimulate other financial services on
  broadly distributed basis
• ? Take into account specific needs of locations
  and account holders during the process
• ? BUT liquidate to contain the bleeding

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Final Thoughts

• Private banking needed, reinforced by strong
  governance AND sound prudential norms
• Overnight privatization is NOT required
• BUT, strategic vision and a determined,
  deliberate approach is
• Private investment, fit and proper management,
  modern systems, and open market opportunities in
  a growing economy can provide intermediation
  needs better than state institutions

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Final Thoughts

• Financial stability issues can be managed,
  including over the medium and long term
• Institutional capacity in banks and regulatory
  institutions is more likely to ensure stability
• Privatization is needed to cut the patronage
  chord
• Privatization is not enough
• Governance, ethics and observable codes of
  conduct are needed