GOVERNMENT OWNERSHIP OF BANKS AND BANKING REGULATION

1
GOVERNMENT OWNERSHIP OF BANKS AND BANKING
REGULATION

• Florencio Lopez-de-Silanes
• IADB Conference,
• Washington, DC. February 25, 2005.

2
Motivation

• There is mounting research on privatization and
  what the Government does in the real sector.
• But there is little knowledge about what the
  Government does in the financial sector.
• Government can participate in the financing of
  firms in a variety of ways
• provide subsidies directly,
• encourage private banks to lend to desirable
  projects, or
• own financial institutions.
• Advantage of owning banks
• enables G to collect savings and direct them
  towards its chosen projects, thus promoting Gs
  goals.
• Two views about Government participation in
  financial markets.

3
Theories of Government Participation in
Financial Markets

• Optimistic (Development) View Focuses on the
  necessity of financial development for economic
  growth.
• Privately owned commercial banks were crucial in
  channeling savings to industry in some
  industrializing countries (19th century Germany).
  
• In other countries, economic institutions were
  not sufficiently developed for private banks to
  play the crucial development role The scarcity
  of capital in Russia was such that no banking
  system could conceivably succeed in attracting
  sufficient funds to finance a large scale
  industrialization . and no bank could have
  successfully engaged in long term credit
  policies (Gerschenkron, 1962).
• In such countries, the government could step in
  and through its financial institutions jump start
  both financial and economic development.
• These ideas were widely adopted with governments
  nationalizing or starting new banks in Africa,
  Asia, Latin America.

4
Theories of Government Participation in
Financial Markets
(2)

• Skeptical (Political) View
• Government control of finance politicizes
  resource allocation for the sake of getting votes
  or bribes for office holders, softens budget
  constraints, and lowers economic efficiency
  (e.g., Kornai 1979).
• Sustained by considerable evidence on
• Inefficiency of government enterprises,
• Political motives behind public provision of
  services,
• Benefits of privatization.
• Gerschenkron has some sympathy for this view
  The government as an agens movens of
  industrialization discharged its role in a far
  less than perfectly efficient manner.
  Incompetence and corruption of bureaucracy were
  great. The amount of waste in this process was
  formidable.
• Still, Gerschenkron considers government
  financing of industrialization in Russia in 1890
  a great success.

5
Different Hypotheses of Gov. ownership of Banks

• Development and Political Views
• GoB is more prevalent in poorer countries,
  countries with less developed financial markets
  and with less well functioning institutions.
• Development view
• ? GoB ? ? subsequent financial development
• ? GoB ? ? subsequent economic development,
  factor accumulation,
• and especially productivity growth.
• Political view
• ? GoB ? does not ? subsequent financial
• ? GoB ? does not ? subsequent economic
  development
• ? may ? savings and capital
  accumulation,
• ? but ? productivity growth.

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Outline

• Government ownership of Banks (GoB) around the
  world
• How significant is GoB in different countries?
• What types of countries have more GoB?
• Does GoB promote subsequent financial
  development?
• Does GoB promote subsequent economic development?
  
• Banking Regulation Learning to live with Private
  and State Banks
• Regulation and Supervision of Lending practices
  of Banks
• Why are banks usually bankrupt?
• Related Lending
• Poor Creditor Rights

7
Government Ownership of Banks Industry

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bgd
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prt
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1
grc
chl
per
ven
mex
tur
ita
idn
fra
pak
arg
aut
bra
dom
mar
col
nga
Gov Banking in the 1970s
kor
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slv
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0
.012375
.6545
SOE output /GDP 1978-91
8
Government Ownership of Banks
9
II. Which Countries have High GoB?

• Most characteristics come from 1990s, or are
  averages of 1975-95.
• ?No structural interpretations (causation), only
  correlations.
• Poorer countries (1960) ? ? GoB
• ? financial development (1960) ? ? GoB
• ? G intervention in economic life ? ? GoB
• ? Importance of SOEs in overall economy ? ? GoB
• Government spending ??? GoB
• ? Efficiency of government ? ? GoB
• ? Security of property rights, rule of law ? ?
  GoB
• Political and financial crises in the economy
  ??? GoB

10
III. Does GoB speed up Financial Development?

• ? GoB ? ?? subsequent financial growth. Not
  support for the development view.

11
IV. Does GoB speed up Economic Development?

• ? ? GoB ?has a negative impact (?) on subsequent
  economic growth.
• Does not support the development view of GoB.

12
V. Channels through which GoB may influence
Economic Development?
(2)

• ? ? GoB ? significantly ? productivity growth
• Support for political view GoB creates resource
  misallocations that are detrimental to
  productivity growth, and ultimately growth.

13
VI. GoB and Efficiency of Resource Allocation

• ? GoB seems to be associated wiith misallocation
  of resources in the economy.

14
Some Key Aspects of Banking Regulation

• Learning to live with Private and State Banks
• Regulation and Supervision of Privatized Banks
• Evidence shows that many of the failures in
  Privatization come as a result of lack or
  re-regulation of the industries privatized.
• SOEs regulation was there to shield the firm
  from competition so as to reduce losses and
  subsidies
• SOEs disclosure is opaque no real regulator to
  disclose to
• Why are banks usually bankrupt?
• Related Lending
• Resulting from unsound lending practices
• Poor Creditor Rights
• Impossible for banks to collect on defaulting
  debtors

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1. Strong Creditor Rights

• Although over-capacity may explain a bit of the
  problem in financial institutions, it cannot be
  blamed for all the malaise in the banking sector.
• A key aspect of lending is collecting
• Banks, private and public, need to have
  effective collecting mechanisms in place.
• These mechanisms are a result of creditor rights
  embedded in bankruptcy and reorganization laws in
  the enforcement of law.
• Effective creditor protection has recently been
  shown to be a key component of the development of
  financial systems around the world.

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Size of Debt Markets and Creditor Protection


0
10
20
30
40
1.5
1.5
JPN
GBR
DEU
NDL
1
1
FRA
THA
ZAF
NZL
MYS
USA
Debt Markets/GNP
AUT
AUS
FIN
ESP
KOR
CAN
ISR
PRT
NOR
CHL
SGP
ITA
SWE
.5
.5
MEX
IDN
BRA
IRL
BEL
DNK
IND
PER
PAK
GRC
COL
ARG
TUR
PHL
0
0
0
10
20
30
40
Creditor RightsEfficiency of Judiciary
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2. Related Lending

• Conflicts of interest in banking has become more
  significant in recent years due to bank
  privatizations as banks were bought and
  controlled by domestic industrial groups.
• ? But the same conflicts have been a problem in
  state owned banks.
• Information View RL have better terms because
  close ties between banks and borrowers improve
  efficiency.RL may improve credit efficiency
• Bankers have more information about RL than UL
  (they are in BoD)
• Bankers use information to assess the ex-ante
  risk characteristics of investment projects or to
  force borrowers to abandon risky projects.
• Looting View RL have better terms to divert
  resources from depositors and/or minority
  shareholders to directors and controllers of the
  bank.
• Incentive to expropriate minority shareholders
  exists if the insiders exposure to the cash flow
  of the firm is greater than his exposure to the
  profits of the bank.
• Deposit insurance makes looting more profitable.

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Related Lending Episodes

• Venezuela
• The banking systems collapse of 92-94 resulted
  in estimated government losses of nearly 11
  billion, equivalent to 13.5 of GDP.
• Banco Latino lent money under favorable terms to
  companies controlled by the banks directors and
  their friends. These companies were shells that
  siphoned cash to the personal offshore accounts
  of directors.
• Turkish banks taken over by the government are
  owed about 12 billion by customers that have
  defaulted on loans. Some 80 of the bad loans
  were those given to companies that belonged to
  the banks former owners. Many loans were
  transferred to the companies controlled by banks
  owners, endangering the stability of the lenders.
  Economy Minister said in Washington the country
  needs about 12 billion from international
  lenders which will be used to inject cash into
  ailing banks.Milliyet Daily, March 28, 2001.
• Ecuadors banking system imploded in 1998 and
  1999 owing to lax supervision The cost of the
  bank bailout is estimated at about 25 of GDP.
  The absence of vigorous regulations and effective
  credit policies contributed to related-party
  lending that destabilized the system.Standard
  Poors, November 2000.

19
Chile Self-loans, early 1980s
20
Mexico after the Tequila Crisis (1994-95)

CRE
0.41
INV
UNI
CEN
BPI
PRO
ATL
SER
CON
Related private loans/ Private loans
BAN
BCR
BIT
BCO
PRB
ORO
BNO
ORI
MEX
CIT
0.00
0.00
0.62
Non-performing private loans/ Private loans
21
Terms of loans Related vs. Unrelated Loans
22
Default and Recovery RatesRelated vs. Unrelated
Loans
23
Conclusions

• Government Ownership of Banks
• Some aspects of the empirical story are
  consistent with the 1960s view that GoB may arise
  as a response to institutional underdevelopment.
• However, the results shed little support for the
  optimistic assessment of the beneficial
  consequences of such ownership for subsequent
  development.
• Ultimately, GoB politicizes the resource
  allocation process retarding financial and
  economic development, especially in poor
  countries.
• The Common Problems with Bank Privatization
• Re-regulation of formerly GoBs must be
  undertaken.
• Banks are often bankrupt as a result of
• Lenient Related Lending Practices
• Poor Creditor Rights