1. 1 PUBLIC BANKS Restructuring and Privatization Issues By Khaled F. Sherif Knowledge Manager, The World Bank Date: March 13, 2001

2. 2 The Traditional Roles of State Banks n Vehicles of government spending n Directed lending to state enterprises and farms n Specialized savings and housing finance banks n Tax collection/processing n Export-import financing n “Private” pension funds n Brokerages (securities/vouchers) n State insurance investment

3. 3 Effects of Continued State Ownership in Banking n Delayed resolution of problem assets n Greater use of regulatory forbearance n Distorted credit markets n Imprudent cross-ownership n Deferred risk-taking by private banks n Deferred investment by foreign banks n High and unsustainable cost structures (personnel, manual processing)

4. 4 Policy Challenges to Continued State Ownership in Banking: Macroeconomic n Continued losses  continuous need for liquidity support and recapitalization  use of scarce fiscal resources n Continued losses  regulatory forbearance  monetary subsidy and/or higher intermediation costs n General losses  loss of confidence and higher risk  depreciating effect on exchange rate

5. 5 Policy Challenges to State Ownership in Banking: Financial Sector Stability n Decapitalization of banking system  reduces resource base for intermediation n Persistent asset quality problems undermine confidence, drive up rates, increase risk of adverse selection n Poor earnings drive up rates, increase risk of adverse selection and unsuitable NBFI activities n Liquidity constraints undermine confidence and stability, limit intermediation potential n General increase in vulnerability, which reduces banks’ ability to effectively manage market risk

6. 6 CIS vs. non-CIS Banking Divergence n CEE: state bank shares still very high at 56% in 1995; in many cases this was partly offset by strategic foreign investment, and in a few cases by strengthened banking supervision; initial imposition by some of hard budget constraints n Baltics: state bank shares lower at 27%; banks often small and weak, but willingness to liquidate and consolidate; Estonia consistent, Latvia tough after Baltija collapse n CIS: state banks at 35%, but almost all private banks = “pocket” banks; weak incentive structure; substantial asset stripping, arrears, losses

7. 7 CEE and Baltic Lending Trends n Net lending down from 1995-2000 n Lending up to the private sector n Lending down to the state sector n Net effect is decline to state sector greater than increase to private sector n Economic result: real GDP growth, greater financial discipline, growing depositor confidence, increasing competition

8. 8 CIS Lending Trends n Net lending down from 1995-2000 n Lending down to the private sector n Lending down to the state sector n Net effect is decline in role of banks  substitution with arrears on obligations to other enterprises, power companies, social funds, wage earners, fiscal authorities n Economic result: unstable economic performance, inadequate signs of financial discipline, lack of depositor confidence, high intermediation costs

9. 9 Correlation Patterns n High levels of positive correlation between state ownership of banks and persistence of NPLs n Correlation evident in all regions n NPLs are problem for state banks AND pocket banks n Systems of governance and modern risk management needed to correct, not just changes in ownership

10. 10 Major Problem: Privatization Prospects for State Savings Banks n Who wants them? Usually nobody, including the state, except for patronage purposes n Where is their franchise value? Bricks and mortar being replaced by bricks and clicks n Deposit value? New private banks can attract in an open, competitive environment, particularly from large and urban enterprises n Retail deposit value? High per-unit costs associated with small accounts; only real value is local currency requirements for reserves with monetary authorities n Cross-selling? Not much success demonstrated to date

11. 11 Prospects for Other State Banks? n Some potential for some specialized banks n Traditional export-import banks often have professionally trained staff, low cost structures n Industrial and agricultural banks have specialized personnel who know their fields well, but long standing links to loss-making companies and traditions of patronage financing n Housing finance banks have dubious prospects like savings banks due to overhead, maturity structure of assets, weakness of secondary markets