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 G’s 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.

6

Outline

I. Government ownership of Banks (GoB) around the world:

1. How significant is GoB in different countries?

1. What types of countries have more GoB?

1. Does GoB promote subsequent financial development?

1. Does GoB promote subsequent economic development?

II. Banking Regulation: Learning to live with Private and State Banks

1. Regulation and Supervision of Lending practices of Banks

2. Why are banks usually bankrupt? Related Lending Poor Creditor Rights

7

Government Ownership of Banks & Industry

Gov

Ban

king

in th

e 19

70s

SOE output /GDP 1978-91.012375 .65450

1 dza

arg aut

bgd

bel

bol

bra

chl

col

cri

civ

dnk

dom

ecu egy

slv

fra

deu

grc

gtm

hnd

ind

idnita

ken

kor

mys

mex

marnga

pak

pan

pry

per

phl

prt

sen

zaf

esp

lkatza

tha

tto

tun

tur

gbrusa

ury

ven

8

Government Ownership of Banks

RegionGovernment Banking in

1970Government Banking in

2000

African average 59.92 47.7

Latin American average 62.72 39.81

North American average 31.2 11.87

European average 63.66 37.25

Middle East average 47.09 44.2

Asian average 65.08 52.08

Oceania average 27.18 6.16

Sample average 58.89 42.57

Share of the assets of the top 10 banks owned or controlled by the government

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

Independent variables

Dependentvariables

G B B P P r iv atecred it /G D P

L iq u idlia b ilitie s /

G D P

C la im s o nth e p r iv ate

sec to r / G D P

Q u as i L iq u idL ia b ilit ie s /

G D P

L o g G D Pp er c ap ita

In tercep t A d ju s tedR 2

[N ]

G ro w th o fp r iv ate cr ed it /G D P 6 0 -9 5

-0 .0 2 7 6 b

(0 .0 1 3 0 )-0 .0 6 0 8 a(0 .0 2 2 9 )

0 .0 0 1 4(0 .0 0 4 8 )

0 .0 4 7 6(0 .0 3 0 7 )

0 .1 5[8 3 ]

G ro w th o f liq u idlia b ilit ie s / G D P6 0 -9 5

-0 .0 1 3 5 c(0 .0 0 7 7 )

-0 .0 5 4 2 a(0 .0 1 7 7 )

0 .0 0 0 9(0 .0 0 3 1 )

0 .0 4 9 3(0 .0 1 8 8 )

0 .2 9[8 3 ]

G ro w th o f c la im so n p r iv a te s ec to r/ G D P 7 0 -9 5

-0 .0 4 5 2 a(0 .0 1 6 6 )

-0 .0 7 5 4 a

(0 .0 1 9 9 )-0 .0 0 1 2(0 .0 0 3 3 )

0 .0 6 2 8 b(0 .0 2 8 1 )

0 .2 3[8 2 ]

G ro w th o f q u as iL iq u id L ia b ilit ie s/G D P 7 0 -9 5

-0 .0 1 5 7 c(0 .0 0 9 4 )

-0 .0 7 4 6 a(0 .0 11 8 )

-0 .0 7 4 6 a(0 .0 11 8 )

-0 .0 0 5 9 b(0 .0 0 2 5 )

0 .1 0 3 7 a

(0 .0 2 1 6 )0 .3 8[8 1 ]

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.

GoB has a negative impact () on subsequent economic growth.

Does not support the development view of GoB.

In depen den t va ria b les

D ependen t va riab les

G B B P Init ial lo g o fG D P p er c ap ita

Initial p rivatec red it/G D P

A verage yearso f s c hoo ling

Interc ep t A d j. R 2

[N ]

P an el C : C on trols for in itia l d evelopm en t a nd in itia l fin ancia l d evelopm en t a nd a vera g e levels of

G D P p er c ap ita gro w th 1960-95

-0.0173 b

(0.0068)-0.0175 a

(0.0030)0.0297 a

(0.0100)0.0054 a

(0.0012)0.0942 a

(0.0012)0.4183

[83]

G N P p er c ap ita gro w th 1970-95

-0.0146 b

(0.0068)-0.0118 a

(0.0021)0.0345 a

(0.0089)0.0035 a

(0.0011)0.0820 a

(0.0149)0.3612

[83]

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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.

GoB significantly productivity growth

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

In d ep e n d en t va r ia b les

D ep e n d en t va r ia b les G B B P L o g o f G D P p e rcap ita in 1 9 6 0

P r iv ate cre d it /G D P in 1 9 6 0

A v e ra g e y ear s o fs ch o o lin g

In te rc ep t A d j. R 2

[N ]

P ro d u ctiv ity g ro w th 1-0 .0 0 9 0 c

(0 .0 0 4 6 )-0 .0 1 0 1 a

(0 .0 0 2 1 )

0 .0 1 9 8 a

(0 .0 0 7 0 )0 .0 0 3 2 a

(0 .0 0 0 8 )0 .0 5 2 0 a

(0 .0 1 0 1 )0 .3 3 7 6 [7 7 ]

P ro d u ctiv ity g ro w th 2-0 .0 11 1 b

(0 .0 0 4 9 )-0 .0 1 2 5 a

(0 .0 0 3 0 )0 .0 1 8 3 b

(0 .0 0 7 5 )0 .0 0 3 2 a

(0 .0 0 0 8 )0 .0 5 2 0 a

(0 .0 1 0 1 )0 .4 6 2 7

[7 7 ]

P ro d u ctiv ity g ro w th 3-0 .0 0 9 3 (0 .0 0 7 8 )

-0 .0 1 2 9 a

(0 .0 0 3 3 )0 .0 2 5 0 a

(0 .0 0 9 2 )0 .0 0 3 9 a

(0 .0 0 1 4 )0 .0 6 2 3 a

(0 .0 1 5 3 )0 .2 6 7 5

[6 1 ]

13

VI. GoB and Efficiency of Resource Allocation

Ind epend ent variab les

D ep end entvariab les :

G B B P Lo g G D P p erc ap ita in 1960

P rivate c red it/G D Pin 1960

Interc ep t A d justed R 2

[N ]

P rivate c laim sno ntop 20/G D P

-0.3445 b

(0.1553)-0.0181(0.0583)

0.6189 c

(0.2938)0.6091 c

(0. 3413)0.3734

[32]

Interes t rates pread

24.3407 a

(8.3999)4.2412

(4.1960)-27.8036 c

(14.6115)-8. 8076

(22.6723)0.1716

[58]

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

14

Some Key Aspects of Banking Regulation

II. Learning to live with Private and State Banks

1. 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

SOE’s disclosure is opaque: no real regulator to disclose to

2. Why are banks usually bankrupt? Related Lending:

Resulting from unsound lending practices Poor Creditor Rights

Impossible for banks to collect on defaulting debtors

15

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.

16

Size of Debt Markets and Creditor Protection

Deb

t M

ark

ets/

GN

P

Creditor Rights*Efficiency of Judiciary

0 10 20 30 40

0 10 20 30 40

0

.5

1

1.5

0

.5

1

1.5

MEX

PHL

FRA

PERCOL

PRT

BRA

ARGGRCTUR

IRL

CAN

THA

IDN

USAAUSFIN ESP

ITACHL

ZAF

KOR

BEL

NOR

PAK

SWE

JPN

NDL DEU

AUT

DNK

NZL

IND

MYS

SGPISR

GBR

17

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.

1. 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.

2. 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 insider’s 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.

18

Related Lending Episodes

Venezuela:The banking system’s 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 bank’s 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 bank’s 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.

“Ecuador’s 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

0% 10% 20% 30% 40% 50%

Banco de Santiago

Banco de Chile

Banco Nacional

Banco de A. Edwards

Self-loans as a percentage of total loans

20

Mexico after the “Tequila” Crisis (1994-95)

Rel

ated

pri

vate

lo

ans/

Pri

vate

lo

ans

Non-performing private loans/ Private loans0.00 0.62

0.00

0.41

BNO

BAN

ORO

ATL

BCO

PRO

MEX

PRBBIT

SER

INV

CEN

CON

ORI

BPI

BCR

CRE

UNI

CIT

21

Terms of loans: Related vs. Unrelated Loans

0%

2%

4%

6%

8%

10%

12%

14%

Interest rate forPeso loans

Interest rate forUS$ loans

Related Unrelated

0%

50%

100%

150%

200%

% loans withcollateral

Collateral value /value of loan

Related Unrelated

22

Default and Recovery Rates:Related vs. Unrelated Loans

0%

10%

20%

30%

40%

50%

60%

70%

80%

Default rates Recovery rates ofbad loans

Overall Recoveryrates

Related

Unrelated

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