Transcript Investor Protection and Capital Markets

GOVERNMENT OWNERSHIP OF BANKS
AND BANKING REGULATION
Florencio Lopez-de-Silanes
IADB Conference,
Washington, DC. February 25, 2005.
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.
2
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
3
starting new banks in Africa, Asia, Latin America.
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
4
Russia in 1890 a great success.
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.
5
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
6
Government Ownership of Banks & Industry
Gov Banking in the 1970s
1
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SOE output /GDP 1978-91
.6545
7
Government Ownership of Banks
Share of the assets of the top 10 banks owned or
controlled by the government
Region
African average
Government Banking in Government Banking in
1970
2000
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
8
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)
 
financial development (1960)
 
G intervention in economic life
 
Importance of SOEs in overall economy
 Government spending


 GoB


 GoB
≠≠≠
 GoB

GoB
GoB


 GoB
 Political and financial crises in the economy ≠≠≠
GoB
 
Efficiency of government
 
Security of property rights, rule of law
 GoB
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III. Does GoB speed up Financial Development?
Independent variables
GBBP
Private
credit /
GDP
Growth of
private credit /
GDP 60-95
-0.0276 b
(0.0130)
-0.0608 a
(0.0229)
Growth of liquid
liabilities / GDP
60-95
-0.0135 c
(0.0077)
Growth of claims
on private sector
/ GDP 70-95
-0.0452 a
(0.0166)
Growth of quasi
Liquid Liabilities
/GDP 70-95
-0.0157 c
(0.0094)
Dependent
variables
Liquid
liabilities /
GDP
Claims on
the private
sector / GDP
Quasi Liquid Log GDP
Liabilities / per capita
GDP
Intercept
Adjusted
R2
[N]
0.0014
(0.0048)
0.0476
(0.0307)
0.15
[83]
0.0009
(0.0031)
0.0493
(0.0188)
0.29
[83]
-0.0012
(0.0033)
0.0628 b
(0.0281)
0.23
[82]
-0.0059 b
(0.0025)
0.1037 a
(0.0216)
0.38
[81]
-0.0542 a
(0.0177)
-0.0754 a
(0.0199)
-0.0746 a
(0.0118)
-0.0746 a
(0.0118)
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 GoB   subsequent financial growth. Not support for the development view.
IV. Does GoB speed up Economic Development?
Independent variables
Dependent
variables
GBBP
Initial log of Initial private Average years Intercept Adj. R2
[N]
GDP per capita credit/GDP of schooling
Panel C: Controls for initial development and initial financial development and average levels of
GDP per capita -0.0173 b
-0.0175 a
0.0297 a
0.0054 a
0.0942 a 0.4183
growth 1960-95 (0.0068)
(0.0030)
(0.0100)
(0.0012)
(0.0012) [83]
GNP per capita -0.0146 b
growth 1970-95 (0.0068)
-0.0118 a
(0.0021)
0.0345 a
(0.0089)
0.0035 a
(0.0011)
0.0820 a 0.3612
(0.0149) [83]
  GoB has a negative impact () on subsequent economic growth.
 Does not support the development view of GoB.
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V. Channels through which GoB may influence
Economic Development?
(2)
Independent variables
GBBP
Log of GDP per
capita in 1960
Private credit /
GDP in 1960
Average years of
schooling
Intercept
Adj. R2
[N]
Productivity growth 1
-0.0090 c
(0.0046)
-0.0101 a
(0.0021)
0.0198 a
(0.0070)
0.0032 a
(0.0008)
0.0520 a
(0.0101)
0.3376
[77]
Productivity growth 2
-0.0111 b
(0.0049)
-0.0125 a
(0.0030)
0.0183 b
(0.0075)
0.0032 a
(0.0008)
0.0520 a
(0.0101)
0.4627
[77]
Productivity growth 3
-0.0093
(0.0078)
-0.0129 a
(0.0033)
0.0250 a
(0.0092)
0.0039 a
(0.0014)
0.0623 a
(0.0153)
0.2675
[61]
Dependent variables
  GoB  significantly  productivity growth
 Support for political view: GoB creates resource misallocations that are detrimental
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to productivity growth, and ultimately growth.
VI. GoB and Efficiency of Resource Allocation
Independent variables
Dependent
variables:
GBBP
Log GDP per Private credit/GDP
capita in 1960
in 1960
Intercept
Adjusted R2
[N]
Private claims -0.3445 b
nontop 20/GDP (0.1553)
-0.0181
(0.0583)
0.6189 c
(0.2938)
0.6091c
(0.3413)
0.3734
[32]
Interest rate
spread
4.2412
(4.1960)
-27.8036 c
(14.6115)
-8.8076
(22.6723)
0.1716
[58]
24.3407a
(8.3999)
 GoB seems to be associated wiith misallocation of resources in the economy.
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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
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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
Debt Markets/GNP
1.5
1.5
JPN
NDL
1
FRA
THA
ZAF
USA
AUS
FIN ESP
CAN
PRT
.5
MEX
PER
COL
PHL
CHL
ITA
IDN
BRA IRL
GRC
ARG
TUR
KOR
NOR
SWE
BEL
PAK
GBR
DEU
1
NZL
AUT
MYS
ISR
SGP
.5
DNK
IND
0
0
0
10
20
30
Creditor Rights*Efficiency of Judiciary
40
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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.
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.
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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 $12 billion from international lenders… [which] will be used to inject cash
into ailing banks.”—Milliyet Daily, March 28, 2001.
“Ecuador’s banking system imploded in 1998 and 1999 owing to lax
supervision… The cost of the bank bailout is estimated at about 25% of GDP.
The absence of vigorous regulations and effective credit policies contributed to
related-party lending that destabilized the system.”—Standard & Poors,
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November 2000.
Chile: Self-loans, early 1980s
Banco de A. Edwards
Banco Nacional
Banco de Chile
Banco de Santiago
0%
10%
20%
30%
40%
50%
Self-loans as a percentage of total loans
19
Mexico after the “Tequila” Crisis (1994-95)
CRE
Related private loans/ Private loans
0.41
0.00
INV
UNI
CEN
BPI
SERPRO
CON
BAN
BIT
BCO
BNO
ATL
BCR
PRB
ORO
ORI
MEX
CIT
0.00
Non-performing private loans/ Private loans
0.62
20
Terms of loans:
Related vs. Unrelated Loans
Related
Unrelated
Related Unrelated
200%
14%
12%
150%
10%
8%
100%
6%
4%
50%
2%
0%
0%
Interest rate for
Peso loans
Interest rate for
US$ loans
% loans with
collateral
Collateral value
/value of loan
21
Default and Recovery Rates:
Related vs. Unrelated Loans
80%
70%
60%
50%
Related
40%
30%
Unrelated
20%
10%
0%
Default rates
Recovery rates of
bad loans
Overall Recovery
rates
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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
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