The AAF Virtual Debates: Franklin Allen's Response on State-Owned Banks


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Charlie and Nachiket Mor raise very good points about the problems posed by public banks. India illustrates many of these difficulties—there is much too much political interference, regulations are designed to help state banks, and so forth. But India’s mix of banks is about four-fifths state-owned and only one-fifth privately owned. I’m suggesting precisely the inverse: about one-fifth of the banking sector would be state-owned and four-fifths would be privately owned. Reducing the share of state-owned banks to this minimal level should help alleviate many of the political economy issues. The state-owned commercial banks would need to compete with private banks in normal times as discussed in the blog and this should also act as a constraint on the problems.

The real advantage would come when there is a crisis. Rather than having central banks intervene in commercial credit markets where they have little expertise, the state-owned commercial bank can temporarily expand its role both in terms of assets and loans. This should considerably improve the functioning of the economy and overcome some of the credit crunch problems that Charlie has identified in his research and discusses in his post. The government should also find it easier to avoid bailouts and allow private banks to fail, which is an issue that recurs with every financial crisis. The most recent crisis is a clear case in point: at the moment large banks are not really privately owned. Large banks are privately owned until they get into trouble, at which point the state takes over ownership.


Franklin Allen

Professor of Finance and Economics

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Ivailo Izvorski
February 11, 2011

The possible benefit from state-owned banks in crisis - that they may expand lending - comes at the massive cost of them in good times when they, inevitably, get captured and misallocate credit. It is also not clear whether a crisis that was caused by too much credit to households that cannot afford it - because of explicit and implicit government guarantees and policies - can be resolved by more lending to the same households. Free liquidity to banks during a liquidity crunch - yes; more credit to overly indebted households to avoid a workout?

February 12, 2011

I agree with Professor Allen: although state banks can become vehicles for government policies and tend to be less efficient and competitive, developing and transitioning economies benefit from the stability and political security offered by state ownership as countries evolve from demand to market economy.Since the 1980s the mantra has been privatization, deregulation, acquisition and expansion, but as proven in 2008 this model has had very mixed results. France has had the most successful evolution from nationalization in the early 1980s to privatization of the top three banks through the 1990s, but the state maintains influence and the model of universal banking and expansion into global markets remained the same under state or private ownership. In Germany the Landesbanken were perfectly efficient and focused on regional client base as long as they were under state subsidies.Once the subsidies were removed under EU pressure, these banks tried to be become competitive and innovative , failing dismally and are now in process of being absorbed and consolidated.Former CEE countries without any experience or legal framework for bank privatization wanting to quickly emulate Western banks in 1991-1998, were unable to achieve credibility or viable ratings.By 2000 , 65-80% of the sector was taken over major foreign EU banks.
Israel began to privatize banks in 1986 and reached full privatization by 2000, with the government retaining minority shares.
Joint public private ownership for emerging economies (Brazil , India) is often a sounder political and social model as it guarantees additional stability and credibility.