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1 The Shift to Government Banking: Risks for the Netherlands and other Developed Countries Prof. Florencio Lopez de Silanes EDHEC Business School, NBER and DSF April 28, 2011 Amsterdam

2 Outline I. The Policy Response to the Banking Crisis II. Government Intervention in the Banking Sector III. Banking Regulation: Governance of Privatelyowned Banks 2

3

4 The international dimension of the crisis Figure: Stock price changes for year ending in Dec 2008 to the bottom Source: New York Times 4

5 The Crisis and the Banking System Banks around the world have similar exposures to subprime, other declining assets Nearly universal uncertainty about bank solvency Crisis was spreading to other assets and institutions New Euro shock has translated into a second blow for banks, particularly those in Europe. 5

6 The shrinking banking system

7 But we have seen a large rebound already

8 World Industrial Production, Now vs. Then (2010) Production continues to recover something for which policy deserves considerable credit. But the level of industrial production is still 6% below its previous peak. (At the trough it was 13% below its previous peak.)

9 Money Supplies, Now vs. Then 19 Countries (2010) Monetary expansion was more rapid in the run-up to the 2008 crisis than during Moreover, the global money supply continued to grow rapidly in 2008, unlike in 1929 when it levelled off and then underwent a catastrophic decline.

10 Government Budget Surpluses, Now vs. Then (2010) Fiscal policy for 24 countries. Current data include the IMF s World Economic Outlook Update forecasts for 2009 and Willingness to run deficits was greater at the beginning of this 2008 crisis.

11 Sources: Financial Times; press search Summary of actions worldwide Liquidity or lending Bank deposit Short selling guarantees Interest rate moves guarantees Bank recapitalization Asset purchase regulation US x x x x x x Canada x x Mexico x Brazil x Argentina x Ireland x x Iceland x x x x UK x x x x x France x x x x Spain x x x x x Portugal x x x Switzerland x x x x Belgium x x x Germany x x x x x Netherlands x x x x Denmark x Norway x x Sweden x x Finland x x Austria x x x x x Italy x x x x x Hungary x Greece x x x x Ukraine x x Russia x Saudi Arabia x x Qatar x UAE x x India China x x South Korea x x Taiwan x x Hong Kong x x Japan x x Singapore x Indonesia x x Australia x x x x New Zealand x x 11

12 Bailouts by country Figure 14: All values in $Bn Fannie and Freddie (200), Wachovia (12), Citigroup (25), JPMorgan (25), Bank of America (20), Merril Lynch (5), Wells Fargo (25), Goldman Sachs (10), Morgan Stanley (10), New York Mellon (3) and State Street (3), AIG (123), Bear Sterns (29) Bradford and Bingley (32), RBS (35), HBOS (20), Loyds TSB (10), Northern Rock (47) Hypo Real Estate (67) Fortis (23) Fortis (6), Dexia (5) Globex (2), Svyaz Bank (2), Sobinbank (0.5), KIT Finance (1) UBS (5) Dexia (5) Fortis (3), Dexia (1) Glitnir (1), Landsbanki (0), Kaupthing (0) Source: Press search 12

13

14 Outline I. The Policy Response to the Banking Crisis II. Government Intervention in the Banking Sector: Does Government Strengthen Banks? 1. Does GoB promote subsequent financial development? 2. Does GoB promote subsequent economic development? III. Banking Regulation: Governance of Privately-owned Banks 14

15 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 15 or starting new banks in Africa, Asia, Latin America.

16 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. Although Gerschenkron has some sympathy for this view, he still considers government financing of industrialization in Russia in 1890 a great success. 16

17 Different Hypotheses of Government Ownership of Banks 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 it may savings and capital accumulation, but productivity growth. 17

18 Does GoB speed up Financial Development? Growth of of Private Credit Credit ( ) ( ) bgd tza sau idn rom kwt tha hkg bol mys zaf gbr omn nld cypirl jpn jor pan dnk esp mar kor bel che ind zwe tto sgpkenusa nga canaus swe tun pak isr chl pol hun hnd pry fin nzl are irn aut lka gtm col dom deu nor nicfra gr chn prt sen bhr civ phl slv bra mex ita lby tur egy ecucri ury per syr ven arg isl afg irq Growth of Private Credit Credit/GDP / ( ) coef = , (robust) se = , t = dza

19 Does GoB speed up Financial Development? Loan Loan Availability (2010) 2009 omn cyp tha sgp mys bhr pan ken sau nld dnk ausswe fin idn kor zaf jor pak nzl bel can che tunmar jpn usa col bra tto slv irl hkg gtm esp kwt gbr hnd phl nga pry deu bol dom zwe ury sen civ nor irn ind chl are tza per egy lka lby aut prt rom fra grc chn cri pol mex bgd nic ecu syr hun dza tur isr arg irq ita ven isl Loan Availability (2010) 0.5 Loan Availability 2009 coef = , (robust) se = , t =

20 Does GoB speed up Financial Development? Soundness of Banks of Banks (2010) 2009 omn zwe tto mys hkg sgp panld swe cyp sau bhr ken usaaus tun tha zaf jor dnk kor can pak irl gbr nzl bel esp mar che jpn bol nga bra gtm hnd col phl slv sen pryury civ fin idn kwt deu dom ind norirn isr tzaper lka fra are aut lby nic irq egy chl chn cri grc prt pol rom tur syr mex ecu bgd dzahun ita arg ven Soundness of Banks (2010) 0.5 Soundness of banks 2009 coef = , (robust) se = , t = isl

21 Does GoB speed up Financial Development? Stock Market Capitalization / GDP / GDP (2010) 2008 hkg jor che zaf tha tto jpn mys sau gbr nldnk nga bol swe can usa aus finkor esp civ slvphl col idn pak bel bra ind per deu nor turarg tza vnm aut mex ita lka bgd chn egy fra isrprt chl romgrc bgr pol hun isl nzl sgp Stock Stock Market Capitalization / GDP / GDP (2010) 2008 coef = , (robust) se = , t =

22 Does GoB speed up Financial Development? Availability of of Equity Equity Finance Finance (2010) 2009 ind jor zaf omn sgp idn zwe mys kennga kor irn tha jpn sau can swenzl che egy fra chl irq nor pan aus are bgd lka usa tun fin pak mar bra nld isr aut cyp gbr civ phl dnk bel grc chn deu tur bhr esp kwt tza per prt pol ita col rom pry ttoirl sen slv mex cri nic hun dom bol arg hkg ven ecu syr dza gtm hnd lby isl ury Availability of of Equity Equity Finance Finance (2010) 2009 coef = , (robust) se = , t =

23 Does GoB speed up Economic Development? GDP per capia capita growth ( ) ( ) sgp chn omn hkg cyp kor zaf mys prt thairl nor tun esp idn fra irq bhr jpn jor tur aut grc itaegy tto pan bra gbr gtm nld pak fin ind mex bgd mar bel dom swecol isr syr nga usa can irn lby lkachl cri ven dza slv che aus deu ecu ken sau dnk hnd ury are pry kwt arg vnm phl per nzl sen bol tza nic civ afg isl hun bgrpol rom GDP per capita growth ( ) coef = , (robust) se = , t = -1.7 Controlling for education. 23

24 Does GoB speed up Economic Development? Macro Macro Stability Stability (2010) 2009 omn dza lby chn saunga tha bhr fin cyp tto mys pan sgp dnk mar kwt nor chl aus swe idnche mex ecu nld bol tun deu tzairn aut can zaf esp irl hkg gtm sen hnd civ slv nzl irq phl col tur arg per areind bgd syr prt ury gbr bel dom isr jpnjor pry pak bra ita ven fra pol rom hun cri grc ken usa kor egy nic lka isl zwe Macro Stability (2010) 2009 coef = , (robust) se = , t =

25 Channels through which GoB may influence Economic Development? Productivity Growth 1 cyp sgp omn zwe twn bhr mys tun tha ken bel pak irl sau col idn kor egy nor bgd prt dom isr aut fra gbr gtm bra mar panld can esp fin deu tur ita syr grc mex chl ecu zaf tto hkg hnd aus jpn swe ury ind lkadza cri civpry jor dnk sen usa are ven nic nzl arg bol phl tza per slv che nga pol hun isl irn lby Productivity Growth 1 coef = , (robust) se = , t = With all controls 25

26 GoB and Efficiency of Resource Allocation Private Claims - Private Claims of non-top 20 firms / GDP gbr tha mys jpn che deu sgp nld aut fra zaf esp aus fin idn nzl bra chl irl can dnk usa kor phl swe pak ind mex nor tur arg grc Private Claims - Private Claims of non-top 20 firms / GDP coef = , (robust) se = , t = -1.8 GoB is associated wiith misallocation of resources in the economy. 26

27 GoB and Efficiency of Resource Allocation GoB is associated wiith misallocation of resources in the economy. 27

28 Outline I. The Policy Response to the Banking Crisis II. Government Intervention in the Banking Sector III. Banking Regulation: Governance of Privately-owned Banks 1. Regulation and Supervision of Privatized Banks 2. Why are banks usually bankrupt? a. Related Lending, lower regulation standards b. Conflicts of Interest in the Financial Sector Examples of Conflicts of Interest Regulation of Self-Dealing around the World c. Poor Creditor Rights 28

29 Corporate Governance and Learning to live with Privately-Owned Banks Regulation and Supervision of Private 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 So, why are banks usually bankrupt if so favored by regulation? 1. Poor Corporate Governance: Related Lending was already a warning 2. Poor Creditor Rights Very hard for banks to collect on defaulting debtors 29

30 Chile: Self-loans, early 1980s 30

31 Related private loans/ Private loans Looting and Banking Crises: Mexico after the Tequila Crisis ( ) 0.41 INV CRE UNI CEN BPI BIT BCO ORO BNO ORI MEX PRB SERPRO CON BAN BCR ATL 0.00 CIT Non-performing private loans/ Private loans

32 Default and Recovery Rates: Related vs. Unrelated Loans 32

33 DSB

34 Financial Institutions and Capital Markets Development: Creditor Rights and Private Credit

35 Conclusions The financial crisis increased government ownership of banks again. 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, or as a result of countrylevel financial crises and government bail-outs. However, the evidence reject the optimistic assessment of the beneficial consequences of such ownership for subsequent development in the long run. Ultimately, GoB politicizes the resource allocation process retarding financial and economic development, especially in poor countries. 35

36 Conclusions (2) The Corporate Governance Problems with Private Bank Ownership: There are 2 key lessons from the previous wave that we should consider if and when we go back to private bank ownership after the crisis: 1. Re-regulation of formerly GoBs must be undertaken to strip them of their market power. 2. Private banks are often bankrupt as a result of: a. Lenient Related Lending Practices (Poor Corporate Governance) b. Poor disclosure standards (lower than those of firms, and mostly to regulators) c. Special regulatory units with high discretion d. Poor Creditor Rights 36

37 Conclusions (3) But careful: Disadvantages of Restrictive Regulation: Politicization of banking Adverse effects on growth Adverse effects on availability of credit Undermining of innovation 37

38 One view:

39 An Alternative View: Don t throw out the baby with the bathwater! Figure: World GDP Per Capita PPP

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