The Future of State-Owned Financial Institutions

1. Introduction

 Introduction 1 I   a short time ago that it was fashionable for some to speak of “the end of history”—or the conversion of most of the world’s economies to various forms of democratic capitalism. The tragic events of September 11, 2001, and the terrorism leading up to and following the Iraq war clearly demonstrate that democracy has not yet taken root in much of the world. Meanwhile, on the economic front—even outside former planned economies (such as China)—neither has capitalism completed its triumph. The state, it turns out, still is alive and well in owning a key sector—finance—in the economies of many countries. This volume focuses on the rationale and performance of these state-owned financial institutions as well as on policies that governments may wish to take to privatize them (the ideal outcome, for reasons developed in the chapters that follow ) or to manage them (the more likely outcome in most countries). The issue is important in light of growing evidence from the official development institutions and private economists around the world documenting the linkage between more rapid (and stable) economic growth, on the one hand, and sound financial systems, on the other. The chapters in this book stem from papers presented and discussed at the Sixth Annual Conference on Finance in Emerging Markets held at the World Bank in late April 2004 and cosponsored by the World Bank, the International Monetary Fund, and the Brookings Institution. The opinions expressed in the    .   .    01-1335-5-CH 01 12/9/04 3:34 PM Page 1 chapters in this volume are those of the chapters’ authors. In this introduction, we highlight the key themes of those chapters. How Much State Ownership, and Why? Despite numerous privatizations over the past decade, publicly owned banks and other state-owned financial institutions still serve the majority of individuals in developing countries (see the chapters by James Hanson and by George Clarke, Robert Cull, and Mary Shirley). State-owned financial enterprises are less prevalent in developed economies, with very few exceptions, such as Germany and, to a lesser extent, the United States, with its large government-sponsored entities supporting residential home ownership that have what is perceived to be implicit government backing (see the chapter by David Marston and Aditya Narain). Public ownership of these financial institutions (and others) has been rationalized on several grounds: —To counter the power of strong private sector banks or to promote the development of home-grown banks in the early stages of an economy’s history, the so-called infant industry rationale. Both arguments helped justify the formation of the First and Second National Banks of the United States in the early 1800s, for example. —To ensure that economic growth is consistent with national objectives. This is a clear rationale for socialist economies, but even in private economies there is a view that governments have better knowledge of socially beneficial investment opportunities than private banks. —To ensure that underserved groups or sectors, such as agriculture and small businesses, receive credit. —To respond to financial crises, which have hit developed and developing countries alike. In some of these cases, government ownership is temporary, but in some cases it lasts for significant periods. Among government officials around the world there is support for some government ownership of financial institutions based on one or more of these rationales . Economists generally, however, are skeptical of these rationales, except for the last. Performance of State-Owned Banks With rare exceptions, public sector banks have performed poorly by conventional financial measures, such as returns on equity or assets, the extent of nonperforming loans, and expense levels (see the chapter by Hanson). In principle, these  , , ,   01-1335-5-CH 01 12/9/04 3:34 PM Page 2 banks may fare better when account is taken of their broader social missions (for example, to finance roads, sewers, and the like), wherein the benefits to the entire economy may exceed those to the specific borrower. But in practice these banks tend to extend much if not most of their credit to large borrowers, in which case one would not think that social returns would be larger than private gains. Public sector banks often provide subsidized lending and directed credit to special industries or enterprises identified by the government. They also can burden their governments with large contingent liabilities arising from explicit guarantees or the implicit assumption that some...