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Public Sector Banks and Privatization World Bank Workshop Washington. D.C. 10 December 2002. Reforming Development Banks: A Framework. Augusto de la Torre Senior Regional Advisor World Bank. Agenda. The problem: under-served sectors’ access to financial services

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reforming development banks a framework

Public Sector Banks and Privatization

World Bank Workshop

Washington. D.C.

10 December 2002

Reforming Development Banks:A Framework

Augusto de la Torre

Senior Regional Advisor

World Bank

agenda
Agenda
  • The problem: under-served sectors’ access to financial services
  • Traditional response: establish a development bank
  • Public sector banks
    • The hard evidence
    • Parcial solutions
    • The inherent contradiction
  • Public sector bank reform – guiding principles
  • The role of public policy
    • The enabling environment
    • What to do with development banks?
    • Sustainable broadening of access to financial services
      • Examples of financial market promotion
  • Final remarks
the problem underserved sectors access to financial services
The Problem: Underserved Sectors’ Access to Financial Services
  • Risks
    • High, often correlated, and complex – particularly in small farming
      • Low and volatile incomes
    • Substantial agency and information asymmetry problems
      • Screening and monitoring challenges in the absence of reliable financial statements and planning
      • Weaknesses in enforceability of property and creditor rights
    • Limitations in the use of collateral, particularly movable
  • Crowding out (lending to government option)
    • Reduces appeal of higher return/higher risk combinations
  • Macro-systemic voltility
    • Raises liquidity premium, limiting credit in general
traditional response establish a public development bank
Traditional Response:Establish a (Public) Development Bank
  • Perception that private financial entities are inherently uninterested in the under-served
    • Small farmers, low income families, SMEs, and micro-enterprises
  • State takes the “bull by the horns” to correct this perceive “market failure” via the creation of public banks
    • Long-duration finance in national currency as a key missing market
  • Emphasis is on credit provision and direct State involvement in the sector (R&D, investments, etc.)
slide5

Developing countries

Developed countries

State Ownership of Banks:

Declining but Still Substantial

(Caprio et. al 2000)

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

60

40

20

0

1970

1985

1995

slide6

75% - 100%

50% - 75%

25% - 50%

10% - 25%

0 - 10%

N.A.

State Ownership of Banks, 1998:

Popularity is International

(Caprio et. al 2000)

public sector banks the hard evidence
Public Sector Banks – The Hard Evidence
  • Greater participation of State in bank ownership leads to (Caprio et al. 2000):
    • Less financial sector development, less growth, and lower productivity
    • Greater financial intermediation spreads
    • Less credit to the private sector
    • Grater concentration of credit
    • Some propensity to crises (weaker monitoring)
    • Recurrent fiscal drains
public sector bank reform partial solutions
Public Sector Bank Reform – Partial Solutions
  • Improve governance
    • More professional directors and administrators
    • Shields against exesive politial interference
    • Stricter accountability and greater transparency
  • Improve regulation and supervisory enforcement
    • Leveling the playing field vis-a-vis private banks
  • Abandon first-tier banking, but not second-tier function
    • Private banks evaluate and take on risks
    • Second-tier bank evaluates and controls exposure to risk of private banks
public sector banks inherent contradiction activities versus social policy mandate
Public Sector Banks – Inherent Contradiction: Activities versus Social Policy Mandate
  • The Sisyphus syndrome
    • Social policy mandate
    • => concentration on high risk/ low return activities
    • => systematic losses and recurrent recapitalizations
    • => improvements in governance and supervision
    • => re-orientation towards profitable activities, in direct competition with private banks
    • => insufficient attention to social policy mandate
    • => political pressures to implement social policy mandate
  • Neither governance/supervision improvements, nor shift towards second-tier banking eliminate the Sisyphus syndrome
guiding principles for public sector bank reform
Guiding Principles for Public Sector Bank Reform

( 1 )

Reduce, simplify, and re-define the role of the State in financial markets

Exit first-tier banking

Modernize the enabling environment

Role of State

Promote financial market development via well-designed instruments (incl. Subsidies)

Some second-tier credit activity (subject to adequate governance and accountability)

Transfer programs for the non-bankable poor

guiding principles for public sector bank reform cont
Guiding Principles for Public Sector Bank Reform (cont.)

( 2 )

Avoid major disruption of credit flows during the transition

  • Anticipate credit flow reductions as result of reform
  • Adopt compensating measures

( 3 )

Avoid a “central planning” approach to reform

  • Set up a process that allows for:
  • Competition and choice
  • Learning, discovery, innovation
  • Mistakes – without exesive shifting of risks and costs to the government
public policy the enabling environment
Public Policy – The Enabling Environment
  • Market-friendly regulatory and supervisory framework
  • Financial market infrastructure – to reduce costs of screening, monitoring and enforcement
    • Information on debtors
    • Accounting and disclosure standards
    • Contractual environment: quality, diversity, enforcement
      • Movable collateral
      • Shareholder and creditor rights, including in corproate insolvency proceedings
  • Extreme (unrealistic) option – let the market do the rest
public policy what to do with public sector banks
Public Policy – What to do with Public Sector Banks?
  • Radical solution – separate the terms of the contradiction
    • Development bank without social policy mandate = private bank
    • Social policy mandate without a bank => vehicle?
  • Intermediate solution
    • Emphasize the promotion of financial market development
    • With limited second-tier lending activity (long-term finance; finance for investment at local government level)
      • Note: some traditional second-tier lending activities cannot compete under financial globalization (e.g., export finance)
public policy sustainable broadening of access to financial services
Public Policy – Sustainable Broadening of Access to Financial Services
  • A function of a “development agency”(DA) – not a bank
  • What is a DA?
    • Flexible vehicle for focused public policy
    • Operates principally with budgeted fiscal transfers
    • Its priorities are determined and scrutinized by Congress within the budgetary process
    • Own evaluation criteria – e.g., benefits per unit of subsidy, subject to promotion of financial markets
    • May or may not include risk taking
    • Can be part of a second-tier development bank
promotion of financial market development examples of instruments
Promotion of Financial Market DevelopmentExamples of Instruments

Criteria: Align Incentives

Increase availability of information, strengthen demand, widen options, do not distort relative prices, lower transaction costs

  • Matching grants (transitory)
  • Grouping debtors (collateral; collective monitoring)
  • “Brokerage” – information, financial services, etc.
  • Direct subsidies (declining, transitory) for investment
      • Adoption of new loan technologies
      • Professional services networks
  • Creation of market infrastructures
      • E.g., NAFIN’s system for discounting receivables of SMEs
  • Partial guarantees (transitory risk sharing)
final remarks
Final Remarks
  • The re-definition of the role of the State tends to lack behind fast-paced change in financial markets
  • Segmentation of access to financial services could deepen with financial globalization
  • A sole emphasis on the enabling environment appears insufficient for public policy
  • The are potentially constructive roles for some functions of development banks and development agencies
  • “Better practices” emerging but there is no simple recipe