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Summary:
– If traditional banks are no longer lending enough, perhaps the government should lend directly to profitable economic actors who are financially constrained?
– In a recent publication, Duprey (2012) revisits the impact of partially state-owned banks, moving away from the traditional analysis of their long-term inefficiency to consider their short-term usefulness in times of crisis.
– On the one hand, the ownership structure of banks can be an important factor in determining economic fluctuations by lending in a less pro-cyclical manner, particularly in the event of a negative shock.
– On the other hand, however, their stabilizing role in times of crisis reflects a different economic model, which is sometimes a sign of deeper inefficiency in credit allocation, particularly for less developed countries.
The period of apparent calm in the financial world that preceded the crisis was accompanied by a dual movement of financial market deregulation and deregulation of economic financing actors. Was this a case of poor risk assessment or ideological choices? Some are asking the legitimate question of whether the state has lost one of its tools for improving resource allocation and increasing the stability of the financial system (Figure 1).
Figure 1: Percentage of banking assets held directly or indirectly by the state among the top 20 (maximum) banks in each state.
Source: Duprey, 2012.
The outbreak of the 2008 crisis and its many ramifications in Europe have indeed generated renewed attention on the interaction between the role of banks and that of governments, with in particular (i) the partial rescue of Dexia bank in mid-2012, whose French activities were taken over by Caisse des Dépôts et Consignations, (ii) the recapitalization of Spanish banks in late 2012 via the European Stability Mechanism to prevent their abysmal losses from further deteriorating Spanish public finances, (iii) and the launch in early 2013 of the Public Investment Bank, which is supposed to combat the ongoing credit crunch observed in Europe since Q3 2007 (Chart 2). The strengthening of the state’s role in the banking sector has thus reopened the debate on the costs and benefits of public banks, which seemed to be unanimously associated with poor credit allocation, a slowdown in the development of financial markets, and less wealth creation.
Chart 2: Net percentage of banks tightening credit standards (Eurozone)
Source: ECB, Quarterly Survey on Bank Lending Conditions
A new analysis of the role of public banks
In a recent article, Duprey (2012) analyzes the extent to which public banks can effectively distribute credit in a (seemingly?) more useful way during times of crisis.
The article shows that the ownership structure of banks can be an important factor in determining economic fluctuations; while at the macroeconomic level it does not seem desirable to strengthen the weight of the public banking sector in order to reduce the volatility of the economic cycle, at the microeconomic level, the lower sensitivity of public bank loans may prove useful for the financing of certain projects. However, their stabilizing role in times of crisis reflects a different, less cyclical economic model, which may be a sign of deeper inefficiency in credit allocation, particularly for less developed countries.
The existing literature on the impact of the role of public banks pays little attention to periods of crisis
Previous analyses, which have mainly focused on the long-term consequences of strengthening the public banking sector, unanimously conclude that such a system is inefficient (La Porta, 2002). On the one hand, public banks are able to extract rent from their position thanks to a certain degree of protection from competition, which has the effect of preserving less efficient risk management and organizational systems and limiting the reduction in intermediation costs without promoting better investments (Berger et al., 2005; Ianotta et al., 2007). On the other hand, political struggles for influence lead to poor credit allocation without necessarily taking into account the profitability or usefulness of the projects financed (Shleifer et al., 1994; Khwaja and Mian, 2005; Dinç, 2005; Micco et al., 2007; Iannotta et al., 2013). However, this problem is not limited to developing countries; Sapienza (2004) shows that Italian public bank lending increases in the years leading up to elections, mainly in administrative regions controlled by the ruling majority.
A few contemporary articles suggest, however, that an inefficient banking system, for example with strong involvement from public authorities, made it easier to overcome the early stages of the crisis (Giannone et al., 2011). In South Korea, for example, loans from public banks fully offset the decline in lending by private banks during the 2008 recession (Leonya and Romeub, 2011). Similarly, analyzing credit growth before and after the 2008 crisis, Cull and Martinez Peria (2012) find that public banks reacted countercyclically in Latin America but not in Europe. It therefore seems necessary to supplement the traditional analysis of the long-term impact of public banks with a short-term analysis based on fluctuations in the economic cycle.
Public bank loans are less sensitive to the economic cycle, particularly in times of crisis in sufficiently developed countries
Analysis of the raw data (Figure 3) shows that the growth differential between aggregate loans from public (state-owned) and private banks increases in favor of public banks when growth is sluggish. The trend is similar when looking at developments by country (Figure 4). Statistical analysis thus reveals that this lower sensitivity of the loan stock to economic fluctuations is mainly found in times of crisis characterized by a negative deviation of GDP from its long-term trend or potential level.
Chart 3: Aggregate loans from public banks are less cyclical than those from private banks
Note: in orange, the difference in growth between aggregate loans from public and private banks in percentage points; a bar above zero means that public banks increased (reduced) their loans more (less) than private banks. In black, the GDP growth rate. Average weighted by the size of the countries in the sample.
Source: Duprey, 2012
Figure 4: Breakdown by country
Note: in orange, the difference in aggregate loan growth between public and private banks in percentage points; a bar above zero means that public banks increased (decreased) their loans more (less) than private banks. In black, the GDP growth rate. Average weighted by the size of the countries in the sample.
Source: Duprey, 2012
The origin and changes in the ownership structure of banks must be analyzed precisely.
The effect on credit cyclicality is much weaker if we do not take into account nationalizations carried out during a banking crisis, which tend to reinforce the decline in lending in order to carry out the necessary reorganization of a failed bank. Furthermore, including privatized banks allows us to observe precisely the change in behavior before and after the decline in the percentage of capital held by the state. Thus, before their privatization, public banks have a significantly less cyclical lending policy, whereas this is no longer significantly different afterwards.
However, the less cyclical movement of public bank lending with the economic cycle depends on the country’s level of development.
The article thus highlights a positive link between economic development and the ability of public banks to absorb shocks, i.e., public banks in developing countries are more prone to accentuate credit fluctuations. Such a conclusion seems to contradict the approach that less developed countries are in greater need of a public banking system as a vehicle for their long-term development. Nevertheless, in the short term, distortions may be such that these countries are unable to make good use of their public banks.
The lower responsiveness of public banks to negative shocks seems to correspond to a different economic model in developed countries.
Consistent with an economic model that is more focused on customer relations (Delgado et al., 2007), public banks have more stable sources of funding and a less fragile balance sheet structure. On the one hand, short-term financing, particularly via money market funds, is less prone to evaporation in times of crisis for public banks than for private banks. In times of crisis, direct state support is a stabilizing factor. Furthermore, acquiring more individual information about customers requires more resources and therefore involves paying a risk premium when using external financing, which ex ante limits the use of short-term financing by public banks.
On the other hand, the relative strength of public banks’ balance sheets, measured in particular by the relatively slower growth of non-deposit debt, suggests a higher capacity to absorb negative shocks, thus enabling public banks to invest more in long-term projects.
Nevertheless, this reveals poor risk management, particularly in less developed countries.
The lower responsiveness of public bank lending in times of crisis may simply reflect an accounting (and commercial) practice aimed at deferring losses to future years and extending maturities beyond what would be economically justified given the more stable financing on average. In fact, this poor management, which masks losses or asset depreciation, known as « forbearance, » results in higher growth in loss provisions in the years following a negative shock, even as economic conditions improve again.
Public banks may have played a positive role during the crisis, but they are not a panacea.
In conclusion, the article highlights the smaller fluctuations in the level of lending by state-owned banks, particularly in times of crisis. But while it is tempting to conclude that such financial intermediaries are useful, particularly in preventing a complete drying up of certain loans to the economy, it would be much more daring to attribute a stabilizing role to public banks at the aggregate level—other macroprudential policies are necessary— especially since the sensitivity of credit to economic fluctuations can sometimes reflect a deeper inefficiency (Duprey, 2013). While public banks are in principle considered inefficient in the long term, their credit allocation may be influenced by the political cycle—even in developed countries—which can lead to less efficient management of their portfolios in the short term.
References:
– Berger, A., N. Miller, M. Petersen, R. Rajan, and J. Stein (2005) “Does function follow organizational form? Evidence from the lending practices of large and small banks,” Journal of Financial Economics, Vol. 76, No. 2, pp. 237–269.
– Cull, R. and M.S. Martinez Peria (2012) “Bank ownership and lending patterns during the 2008-2009 financial crisis: evidence from Eastern Europe and Latin America,” Working paper, World Bank, 6195.
– Delgado, J., V. Salas, and J. Saurina (2007) “Joint size and ownership specialization in bank lending,” Journal of Banking and Finance, Vol. 31, pp. 3563–3583.
– Dinc, S. (2005) “Politicians and Banks: Political Influences on Government-Owned Banks in Emerging Countries,” Journal of Financial Economics, Vol. 77, No. 2, pp. 453–479
– Duprey, T. (2013). “Inefficient Banking and Heterogeneous Lending Cycle”. Working Paper.
– Giannone, D., M. Lenza, and L. Reichlin (2011) “Market Freedom and the Global Recession,” IMF Economic Review, Vol. 59, pp. 111–135.
– Iannotta, G., G. Nocera, and A. Sironi (2007) “Ownership structure, risk and performance in
the European banking industry,” Journal of Banking and Finance, Vol. 33, pp. 2127–2149.
– Iannotta, G., G. Nocera, and A. Sironi (2013) “The Impact of Government Ownership on Bank Risk,” Journal of Financial Intermediation, Vol. 22, pp. 152—-176.
– Khwaja, A. and A. Mian (2005) “Do Lenders Favor Politically Connected Firms? Rent Provision in an Emerging Financial Market,” Quarterly Journal of Economics, Vol. 120, No. 4, pp. 1371–1411.
– La Porta, R., F. Lopez-De-Silanes, and A. Shleifer (2002) “Government Ownership of Banks,” The Journal of Finance, Vol. 57, No. 1, pp. 265–301.
– Leonya, L. and R. Romeub (2011) “A model of bank lending in the global financial crisis and the case of Korea,” Journal of Asian Economics, Vol. 22, No. 4, pp. 322–334.
– Micco, A., U. Panizza, and M. Yanez (2007) “Bank Ownership and Performance: does politics matter?” Journal of Banking and Finance, Vol. 31, No. 2, pp. 219–241.
– Sapienza, P. (2004) “The Effects of Government Ownership on Bank Lending,” Journal of Financial Economics, Vol. 72, No. 1, pp. 357–384.
– Shleifer, A. and R.W. Vishny (1994) “Politicians and firms,” Quarterly Journal of Economics, Vol. 109, pp. 995–1025.
