Is lending by state banks more stable over the business cycle?

Ata Can Bertay, Asli Demirgüç-Kunt, Harry Huizinga 02 August 2012

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During the banking crisis of 2008-2009, government bailouts of banks in Europe and elsewhere frequently resulted in state ownership of the bank. The rescue of Fortis Bank in 2008, for instance, involved the nationalisation of ABN Amro by the Dutch state.

And state involvement in banks seems set to rise. On 29 June 2012, Eurozone finance ministers agreed that the European Stability Mechanism will be able to directly recapitalise Eurozone banks. On 20 July 2012 they signed off on a loan of €100 billion to Spain to be provided by the EFSF for purposes of recapitalising Spanish banks.

The increase in state banking provides renewed impetus to the debate on the economic costs and benefits of state-led banking. A large literature, starting with La Porta et al. (2002), finds that state ownership of banking is associated with poor credit allocation, lower financial development, and also lower economic growth.

New evidence

In a recent paper (Bertay et al. 2012), we ask whether state banking may bring the benefit of more stable credit over the business cycle and especially at a time of financial crisis. We find that lending by state banks varies less with the economic cycle, and it even rises during a banking crisis. While this is a definite benefit of state banking, we do not conclude that countries should further increase their involvement in banking. The main reason is that state ownership of banks is an inflexible and economically costly way to bring about credit and economic stabilisation. For this purpose, more appropriate tools, including monetary policy and banking regulation in the form of procyclical capital requirements, are available.

State banking rises in high-income countries

Recent public recapitalisations of banks reverse a trend towards less state banking in high-income countries. La Porta et al. (2002) report an overall downward trend in state banking, with an average state ownership share of the equity of large banks around the world of 42% in 1970, down from 59% in 1995. Using data from 1999 for an international sample of 1633 banks in 111 countries, we find that the average share of state banking has continued to decline in developing countries, from 34.6% in 1999 to 19.4% in 2010 (see Figure 1). The share of state banking in high-income countries, however, has increased from 7.9% in 1999 to 9.9% in 2010, with most of the increase occurring after 2007 during the recent financial crisis.

Figure 1. Average share of assets owned by state-owned banks

The figure shows the yearly average share of bank assets owned by state-owned banks, computed as a weighted average of individual country shares with the weights reflecting the number of observations in individual countries. The three lines represent all countries, high-income countries, and developing countries and emerging markets.

Previous research on impact of state banking

A large number of cross-country studies show that state ownership of banking is associated with low bank efficiency and lower levels of financial development (Barth et al. 2001, 2004; La Porta et al. 2002). Furthermore, state ownership lowers banking sector outreach (Beck et al. 2007), and it leads to wider bank interest spreads and slower economic growth as well as greater financial instability (La Porta et al. 2002; Caprio and Martinez Peria 2002). In addition, Dinc (2005) shows that state bank lending is politically motivated, since state banks in emerging markets increase their lending relative to private banks in election years. Banking outcomes also worsen with state ownership. Mian (2003), for example, finds that state-owned banks report higher loan loss provisioning and achieve lower profitability than private banks using data for a large set of emerging economies.

Bank lending over the business cycle

Our study examines the lending behaviour of private and state banks over the business cycle. A 1% increase in GDP growth is associated with a 2.0% increase in the credit growth of private banks, while credit growth of state banks is a much lower 0.6%. Thus, credit growth of state bank moves with the economic cycle, but much less than for private banks. This could reflect that public banks have a mandate to stabilise credit over the business cycle, rather than simply to maximise profits.

Lending by state banks is seen to be especially stable over the business cycle, if the bank is located in a country with good public governance (as captured by an index of government effectiveness). Lending by state banks located in countries with the highest quality of public governance is even found to be countercyclical, moving against the economic cycle. Good public governance turns out to be key in enabling public banks to stabilise overall credit over the business cycle.

The ability of state banks to smooth credit over the business cycle could reflect a country’s overall level of economic development. Distinguishing between developing and high-income countries, we find that credit by state banks in developing countries is less procylical than credit by private banks in these countries (although we still find that credit by state banks in developing countries increases with economic activity). Credit by state banks in high-income countries also is found to be less procyclical than the credit of private banks, but to the point of being countercyclical. Public banks thus appear to stabilise overall credit particularly well in high-income countries.

During banking crises, bank credit tends to be scarce. This suggests that the ability of state banks to stabilise credit is most wanted during periods of financial crisis. Contrasting crisis and non-crisis times, we find that state banks expand their credit during banking crises, counterbalancing loan contraction at private banks.

How do state banks achieve stable credit?

More stable credit by state banks over the business cycle implies that the funding of state banks is more stable as well. During an economic upturn, state banks in particular require less additional funding to finance any additional lending. Looking at different funding categories, we find that state banks tend to increase their non-deposit funding relatively little during economic booms. Non-deposit funding includes the short-term capital market or wholesale funding that can quickly dry up if the bank’s prospects decline. State banks' low reliance on non-deposit funding during economic upswings can in part explain how they are able to maintain their overall funding and lending during downturns.

Another clue as to how state banks are able to stabilise their credit is offered when we look at banks' tendency to report non-performing loans over the business cycle. State banks are shown to reduce their reported non-performing loans relatively little during periods of economic growth, and vice versa. This smoothens the capital base of state banks, and also their ability to provide new credit, as compared to private banks.

State banking is not the solution

State banks play a useful role in stabilising credit over the business cycle and during periods of financial instability. This begs the question of whether countries should aim to increase their state ownership of banks so as to use state banking as a short-term countercyclical tool. Overall, we think this would be unwise, given the poor track record of state banks in credit allocation. For this purpose, alternative policy tools, in the form of monetary policy and macroprudential bank regulation (including procyclical capital requirements), are better suited.1  These alternative tools are more flexible than state ownership of banking, and would not lead to credit misallocation resulting in low economic growth. Any increase in state ownership of banking resulting from the crisis should therefore only be temporary.

The views expressed in this column are those of the authors and do not necessarily represent the views of the World Bank, its Executive Directors, or the countries they represent.

References

Barth JR, G Caprio Jr., and R Levine (2001), “Banking systems around the globe: Do regulations and ownership affect performance and stability?”, in FS Mishkin (Ed.), Prudential supervision: What works and what doesn't, University of Chicago Press, 31-96.

Barth JR, G Caprio Jr., and R Levine (2004), “Bank supervision and regulation: What works best?”, Journal of Financial Intermediation, 13:205-48.

Beck, T, A Demirgüç-Kunt, and MS Martinez Peria (2007), “Reaching out: Access to and use of banking services across countries”, Journal of Financial Economics, 85:234-266.

Bertay, AC, A Demirgüç-Kunt, and H Huizinga (2012), “Bank ownership and credit over the business cycle: Is lending by state banks less procyclical?”, CEPR Discussion Paper 9034.

Caprio, G, and MS Martinez Peria (2002), “Avoiding disaster: Policies to reduce the risk of banking crisis”, in Eliana Cardoso and Ahmed Galal (eds.), Monetary policy and exchange rate regimes: Options for the Middle East, 193-230, Egyptian Center for Economic Studies, Cairo.

Dinc, IS (2005), “Politicians and banks: Political influences on government-owned banks in emerging markets”, Journal of Financial Economics, 77:453-479.

La Porta, R, F Lopez de Silanes, and A Shleifer (2002), “Government ownership of banks”, Journal of Finance, 57:265-301.

Mian, A (2003), “Foreign, private domestic, and government banks: New evidence from emerging markets”, mimeo, University of Chicago.

Repullo, R and J Saurina (2011), “The countercyclical capital buffer of Basel III: A critical assessment”, mimeo, CEMFI.


1 For an analysis of countercyclical bank regulation in Basel III, see Repullo and Saurina (2011).

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Topics:  Global crisis International finance

Tags:  Credit crunch, Bailouts, state banks, bank ownership

PhD candidate at Tilburg University

Director of Research at the World Bank

Professor of International Economics in the Department of Economics, Tilburg University and CEPR Research Fellow