Using IPOs as a Strategy for Bank Privatization

Bank Privatization in emerging economies: at early stage to date 156 SOBs privatized $ 38 billion transaction value 9% of transactions and 11% of volume only 41% non-OECD countries compared to 86% of OECD countries to have privatized banks 30% of banking assets SOB versus 10% in OECD

Impact of bank privatization Positive efficiency effects on banking sector in turn is of great importance in stimulating economic development however, bank privatization faces obstacles such as entrenched interests of stakeholders including government

IPOs and bank privatization 44% of emerging economy bank privatizations occurs by way of IPO book building method most frequently applied use underpricing and preferential allocation to reward certain groups of investors (e.g. SOB employees)

Objectives of privatization Increasing efficiency developing a market-oriented industry ensuring stakeholder support developing the local stock market building confidence in the program importing capital and know-how eliminating soft lending maximizing proceeds stimulating wider share ownership

Increasing efficiency Politicians use SOBs to pursue non- economic goals such as subsidize favored constituents weak corporate governance due to free rider problem of atomistic share ownership no market for corporate control since chance of bankruptcy is remote

Developing a market-oriented sector Government intervention lower welfare levels: Otchere (2003) underperformance of SOB explained by size of government stake stock market listing facilitates adoption of market-oriented management compensation also pressure from market for corporate control

Importing capital and know-how Allowing foreign (strategic) investors to participate in IPO important foreigners tend to upgrade technology, develop new business lines and pursue more fee-for-services

Ensuring stakeholder support Stakeholders such as employees and favored constituents have something to lose IPOs provide means to ensure stakeholder support underpricing and preferential allocation

Developing the local stock market State bank IPOs stimulate stock market capitalization and trading lowers cost of equity attracts further investment triggers gains in economic growth and efficiency

Building confidence in the privatization program To distinguish from populist (opportunist) government retain sizeable stakes and offer highly underpriced shares at IPO recover lost proceeds with subsequent share offerings to signal that government is committed to market reform and will not resort to populism by changing regulations for privatized companies

Eliminating soft lending Government retain stake even after subsequent share offerings median 57% in non-OECD countries versus 5% in OECD countries tendency to sustain soft lending to state- owned enterprises as government interferes to soften the blow of market reforms

Maximizing proceeds Government more likely to list companies during periods of high stock market valuation book building allows government to extract highest possible price since this process encourages investors to truthfully reveal their demand curve

Stimulating wider share ownership Insurance policy against later re- nationalization underpricing is used to entice the voters to participate in the IPO empirical studies find an underpricing differential but avoid incumbent management to retain control

Polish bank privatization First IPO was WBK in March 1993 EBRD 28% as strategic investor of default employees 15%; small investors 20%; institutional investors 7%; state 30% threefold increase from issue price on first day of trading June 22 invites criticism

Bank Slaski Responds to criticism by increasing valuation from 75% to 100% of book value failed tender of 45% stake offered to strategic investors IPO in November 1993 ING buys 25.9% stake through private negotiations in December fold increase from issue price cause outrage

Mexican bank privatization Announced program in October 1991 auction instead of IPOs as privatization strategy exclusive focus on proceeds maximization: select winners purely on bid level protect oligopoly structure: no new licenses no guidance as to valuation of SOB

Disastrous results Inexperienced investors overpay as they assume oligopolistic profits are secure government opportunistically starts granting new licenses lending increases indiscriminately: growth 24% p.a. versus GNP growth of 3% p.a. bailout cost $ 100 billion = 16% GDP

IPOs would have avoided most flaws of bank privatization Institutional investors demand reporting according to international standards avoids overstated profits and valuation IPO offer opportunity to attract experienced foreign strategic investor to take the lead IPOs penalize governments behaving in a populist manner by changing the rules in mid-game

Lessons from the Polish bank privatization program Avoided collapse of banking system delay and sub-optimal results as government shifts among conflicting goals initially foreigners restricted to 25% stake government holds on to long to too high a stake: slows pace of restructuring fact that IPO went through despite no strategic investor could be found is indication that wider share ownership, stock market development at least as important as increasing efficiency of banking sector