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Benefits and Costs of Privatization of State-Owned Banks Lessons for Development Banks

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Title: Benefits and Costs of Privatization of State-Owned Banks Lessons for Development Banks


1
Benefits and Costs of Privatization of
State-Owned BanksLessons for Development Banks
  • Lemma W. Senbet
  • University of Maryland
  • UN Ad Hoc Expert Group Meeting
  • Rethinking the Role of National Development
    Banks
  • New York, December 1-2, 2005

2
Bank PrivatizationsRelevance to Development Banks
  • In the wake of extensive financial sector reforms
    and financial globalization, development banks
    are being increasingly privatized.
  • While development is still central to the agenda
    of development banks, they are, nonetheless,
    expected to maintain their financial viability in
    terms of asset quality, profitability, and
    efficiency.
  • Commercial banks do also foster development.
    Growing evidence for positive linkage between
    banking development and economic development.
    Privatization experiences of these banks relevant
    to development banks.
  • Yet, development gap due to financing gap to be
    bridged

3
Background
  • Continuing debate on bank privatizations
  • Pro-privatization reformers
  • Resisters to privatization at the extreme even
    hostile to privatization of finance altogether
  • Pro and anti privatization experience of Africa
    a region of highly volatile economics and
    politics
  • Privatization reformist experiments without
    getting underlying governance and incentives
    right (e.g. Nigeria)
  • Extreme resisters, even hostile to privatization
    of finance altogether (e.g., Ethiopia)
  • The available evidence is mixed depending on the
    developing regions (say Latin America versus
    Africa)
  • Both reformers and resisters are reassured!

4
Resistance to Bank PrivatizationIllustration
Ethiopia
  • 100 government ownership of the Commercial Bank
    of Ethiopia (CBE)
  • Gradual and encouraging entry of private banks
  • But the CBE has a lions share of the banking
    market
  • Private banks are not only just small but 100
    domestically owned
  • No foreign ownership in the financial sector,
    including insurance market nor is new foreign
    entry allowed in the financial sector
  • No stock market
  • Hence, no market-based privatizations no basis
    for financial cooperation and integration with
    other emerging economies in Africa
  • Thus, no privatization of finance in Ethiopia.
    Just a command financial economy!

5
Conceptual Framework Multiple Functions of a
Financial System
  • The firm as a nexus of contracts (Figure 1)
  • Mobilization of domestic financial resources
  • Risk sharing and risk diversification
  • Information production and price discovery
  • Promotion of corporate governance
  • Mobilization of global capital and promotion of
    financial globalization
  • Summing up Mere existence of banks and stock
    markets value?

6
The Public Firm A Network of Contracts
7
Potential Benefits of Bank Privatization
  • The government (politicians and bureaucrats) is
    not a benevolent social guardian
  • State-owned banks can be used for political and
    personal gains
  • Privatization improves bank governance
  • Privatization improves bank competition
  • Privatization improves bank efficiency and
    performance and fosters stability

8
Potential Costs of Bank Privatization
  • Private banks shun underserved markets (e.g.,
    rural sectors)
  • Private banks engage in excessive risk lending
    and hence engender banking crisis and instability
  • Private banks provide insufficient but
    concentrated lending if the banking sector is
    concentrated post-privatization
  • Borrowers with informational and contractual
    difficulties are rationed out by private banks

9
Bank Privatization and Performance Available
Evidence
  • There has been sharp decline in the state
    ownership of banks, particularly in low income
    countries (Cull, et al, World Bank Data)
  • The available evidence is primarily on bank
    performance and efficiency
  • Post-privatization profitability versus
    preprivatization and private banks (Performance)
  • Cost reductions (Efficiency)
  • Factors affecting performance (e.g., governance,
    regulation, competition)

10
Government Holdings of Bank Assets
Source George Clark, Robert Cull, Mary Shirley
(2004)
11
Available Evidence(contd)
  • Recent studies based on World Bank project
  • Performance effects of privatizations vary across
    countries.
  • In most cases, performance improved.
  • Cost efficiency improved less than measures of
    profitability (e.g., ROE.)
  • Performance gains were smaller when governments
    retained partial ownership.
  • Greater gains when bought by strategic investors.
  • Greater gains with more foreign participation.

12
Bank Privatization and PerformanceAfrican
Experience
  • Widespread privatization of banks in Sub-Saharan
    Africa in the wake of financial sector reforms
  • Africa experienced the sharpest decline in state
    ownership during the 1999-2002 period (see
    earlier charts)
  • Otchere and Senbet, 2005 Based on World Bank
    Privatization database and supplemental appendix
    to Megginson (2000)
  • Are they gains from African privatizations? (see
    tables)

13
Gains from African Bank Privatizations?
  • Measures of performance looked at
  • Asset quality, profitability, cost efficiency,
    etc.
  • There was deterioration in asset quality.
  • Profitability worsened post privatization.
  • No significant improvement in efficiency.
  • Privatized banks experienced negative abnormal
    returns.
  • Possible factors
  • share issue privatizations and partial
    privatizations

14
Table 7 Bank
Privatization and Performance Operating
performance of Privatized Banks in Africa This
table contains the median operating performance
measures for the sample firms the operating
performance measures analyzed include Asset
quality, Management efficiency, Earnings ability
and Labor (employment levels and labor
productivity). The z-statistics for the Wilcoxon
signed rank test of the difference in median
ratios between the two samples are presented in
Panel C. The median ratios and z-statistics are
reported where enough observations exist to
compute the z-statistic. Panel A Asset Quality
Ratios
Year Difference Privatized Banks Rivals Difference (Priv-Rival) Privatized Banks Rival
-1 2.38 (0.89)
0 3.06 (1.34) 0.27 (1.36) 2.79 (1.74) ----- -----
1 1.97 (1.89) 1.43 (2.61) 0.54 (0.80) 5.73 (0.01) 7.33 (1.90) -1.6 (0.59)
2 3.69 (1.89) 1.42 (3.60) 2.27 (1.33) 31.61 (0.89) 6.45 (2.62) 25.16 (1.06)
3 2.00 (2.10) 0.94 (4.19) 1.06 (0.80) 6.33 (1.34) 7.29 (3.03) -0.96 (0.51)
4 2.54 (2.10) 1.31 (4.61) 1.23 (0.57) 20.25 (1.34) 7.25 (2.77) 13.0 (1.27)
5 1.04 (1.64) 1.21 (3.97) -0.17 (0.33) 15.26 (0.89) 6.09 (1.70) 9.18 (1.15)
Pre-mean 2.83 (1.86)
Post-mean 3.05 (2.72) 1.44 (15.10) 1.61 (1.43) 21.64 (2.40) 9.34 (6.58) 12.30 (1.35)
Difference (Post-Pre) -0.22 (0.12)
Panel B Profitability
Return on Assets (ROA)
Return on Equity (ROE)
Year Privatized Banks Rivals Difference Privatized Banks Rivals Difference
-3 3.41 (0.89) 28.19 (0.89)
-2 4.27 (0.89) 27.55 (0.89)
-1 3.53 (1.34) 12.52 (1.34)
0 4.23 (1.33) 1.89 (1.90) 2.34 (0.30) 16.25 (1.33) 33.25 (1.90) 17.0 (1.19)
1 3.56 (1.64) 2.43 (2.10) 1.13 (0.96) 16.52 (1.64) 29.24 (2.10) -12.72 (1.39)
2 1.24 (0.54) 2.05 (3.55) -0.81 (0.63) 13.94 (0.54) 21.77 (3.44) -7.83 (2.11)
3 2.22 (0.25) 2.32 (4.07) -0.10 (0.60) 12.58 (0.59) 16.86 (3.58) -4.28 (0.59)
4 1.49 (0.51) 1.88 (3.77) -0.39 (0.33) 15.35 (0.71) 16.19 (4.02) -0.84 (0.62)
5 2.22 (1.10) 1.70 (2.05) 0.52 (1.19) 21.97 (0.93) 15.89 (1.83) 6.08 (1.00)
Pre-Mean 3.23 (2.36) 21.47 (1.84)
Post-Mean 2.55 (1.62) 1.84 (5.40) 0.41 (0.69) 10.45 (1.23) 10.60 (2.80) -0.15 (0.17)
Difference 0.68 (0.22) 11.02 (0.63)
15
Bank Privatization and Performance Africa
(Senbet and Otchere, 2005) Operating performance
of Privatized Banks in Africa This table contains
the median operating performance measures for the
sample firms the operating performance measures
analyzed include Asset quality, Management
efficiency, Earnings ability and Labor
(employment levels and labor productivity). The
z-statistics for the Wilcoxon signed rank test of
the difference in median ratios between the two
samples are presented in Panel C. The median
ratios and z-statistics are reported where enough
observations exist to compute the
z-statistic. Panel A Asset Quality Ratios
Year Difference Privatized Banks Rivals Difference (Priv-Rival) Privatized Banks Rival
-1 2.38 (0.89)
0 3.06 (1.34) 0.27 (1.36) 2.79 (1.74) ----- -----
1 1.97 (1.89) 1.43 (2.61) 0.54 (0.80) 5.73 (0.01) 7.33 (1.90) -1.6 (0.59)
2 3.69 (1.89) 1.42 (3.60) 2.27 (1.33) 31.61 (0.89) 6.45 (2.62) 25.16 (1.06)
3 2.00 (2.10) 0.94 (4.19) 1.06 (0.80) 6.33 (1.34) 7.29 (3.03) -0.96 (0.51)
4 2.54 (2.10) 1.31 (4.61) 1.23 (0.57) 20.25 (1.34) 7.25 (2.77) 13.0 (1.27)
5 1.04 (1.64) 1.21 (3.97) -0.17 (0.33) 15.26 (0.89) 6.09 (1.70) 9.18 (1.15)
Pre-mean 2.83 (1.86)
Post-mean 3.05 (2.72) 1.44 (15.10) 1.61 (1.43) 21.64 (2.40) 9.34 (6.58) 12.30 (1.35)
Difference (Post-Pre) -0.22 (0.12)
Panel B Profitability
Return on Assets (ROA)
Return on Equity (ROE)
Year Privatized Banks Rivals Difference Privatized Banks Rivals Difference
-3 3.41 (0.89) 28.19 (0.89)
-2 4.27 (0.89) 27.55 (0.89)
-1 3.53 (1.34) 12.52 (1.34)
0 4.23 (1.33) 1.89 (1.90) 2.34 (0.30) 16.25 (1.33) 33.25 (1.90) 17.0 (1.19)
1 3.56 (1.64) 2.43 (2.10) 1.13 (0.96) 16.52 (1.64) 29.24 (2.10) -12.72 (1.39)
2 1.24 (0.54) 2.05 (3.55) -0.81 (0.63) 13.94 (0.54) 21.77 (3.44) -7.83 (2.11)
3 2.22 (0.25) 2.32 (4.07) -0.10 (0.60) 12.58 (0.59) 16.86 (3.58) -4.28 (0.59)
4 1.49 (0.51) 1.88 (3.77) -0.39 (0.33) 15.35 (0.71) 16.19 (4.02) -0.84 (0.62)
5 2.22 (1.10) 1.70 (2.05) 0.52 (1.19) 21.97 (0.93) 15.89 (1.83) 6.08 (1.00)
Pre-Mean 3.23 (2.36) 21.47 (1.84)
Post-Mean 2.55 (1.62) 1.84 (5.40) 0.41 (0.69) 10.45 (1.23) 10.60 (2.80) -0.15 (0.17)
Difference 0.68 (0.22) 11.02 (0.63)
16
Panel C Efficiency
Year Privatized Banks Rivals Difference (Priv-Rival) Privatized Banks Rival Difference
-1 80.85 (0.89) 73.92 (1.66) 6.93 (0.69) 3.10 (0.89)
0 70.03 (1.64) 65.66 (1.90) 4.73 (0.12) 12.36 (1.34) 4.40 (1.66) 7.96 (1.95)
1 73.17 (1.65) 66.20 (2.61) 6.97 (0.08) 7.09 (1.34) 3.20 (1.90) 3.89 (0.01)
2 83.04 (1.89) 68.54 (3.60) 14.5 (1.18) 2.67 (1.88) 7.05 (2.61) -4.38 (0.27)
3 81.03 (2.10) 71.85 (4.19) 9.18 (1.48) 3.52 (1.89) 3.20 (3.60) 0.32 (0.55)
4 85.04 (2.09) 72.08 (4.36) 12.96 (1.98) 2.32 (2.10) 4.10 (4.27) -1.78 (2.10)
5 70.55 (1.65) 73.46 (3.81) -2.91 (0.61) 3.10 (1.64) 3.03 (3.71) 0.07 (0.43)
Pre-mean 80.35 (5.63) 75.64 (8.85) 4.71 (0.30) 3.10 (1.56)
Post-mean 80.61 (20.39) 83.65 (13.87) -2.91 (0.24) 4.10 (5.81) 5.08 (11.53) -0.90 (1.01)
Difference (Post-Pre) -0.26 (0.03) -8.01 (0.47) -1.00 (0.62)
Panel D Changes in Employment
Year Privatized Banks Rivals Difference
1 -1.21 (0.01) 0.12 (0.01) -1.33 (0.61)
2 0.70 (0.01) 2.66 (1.94) -1.96 (1.03)
3 -1.22 (0.27) 2.66 (2.87) -3.88 (1.21)
4 1.54 (0.51) 0.87 (1.95) -0.67 (0.59)
5 -2.06 (1.01) 1.10 (3.39) 0.316 (0.38)
Post-Mean -4.67 (1.00) 1.33 (2.69) -6.00 (3.14)
Difference (Post-Pre) (1.35)
Results Asset Quality ratiosLoan loss
provision has increased in the post privatization
period. The privatized firms loan loss provision
of 3.05 is significantly different from that of
rival banks at 1. Impaired assets of the
privatized banks have also worsened in the post
privatization period. Profitability ROA
Profitability has reduced in the post
privatization period, even so the privatized
banks are more profitable than rivals albeit the
difference is not statistically significant. ROE
of the privatized banks have also fallen. This
could be due to the increase in equity following
the privatization and the issue of more
equity. Efficiency No perceptible change in the
efficiency of the privatized firms vis-à-vis the
rivals. Changes in staff levels The privatized
firms have significantly reduced their staff
levels. The change in staff levels of -4.67 is
significantly different from that of the rivals
of 1.33 at the 1 level. Overall
observation Consistent with Otchere (2004) the
privatized firms have not significantly improved
upon their operating performance.
17
Challenges to African Bank Privatizations
  • Volatile economic and political environment
  • Quality of data
  • Measurement issues (e.g., benchmarking)
  • Limited measures of privatization gains (private
    gains versus social gains)
  • Bank profitability (ROE, ROA, NPL)
  • Cost efficiency

18
Gains from Bank Privatizations? Incomplete!
  • Performance and cost efficiency effects are
    incomplete in terms of judging the overall gains
    of bank privatizations (Private vs. social gains)
  • Lending to government vs. private sector
  • Non-intermediation (lending to government and
    non-banking activities) dominates in terms of
    performance
  • Rent-seeking and dysfunctional banking system
  • Thus, apparently positive performance is a
    reflection of malfunctioning banking system and
    rent-seeking behavior

19
Toward Complete Gains from Bank Privatizations
  • Improvements in quality of financial
    intermediation (notice exorbitant bank spreads in
    Africa)
  • Improvements in in capacity to manage and control
    risk
  • Improvements in bank governance
  • Management, compensation structure, ownership,
    board effectiveness
  • Bank privatization and stock market development
  • Market depth and liquidity Pricing efficiency
    Risk management
  • Quality of bank regulation
  • (Cull, Sorge, Senbet, JMCB, 2005)

20
Conclusions Lessons for Development Banks
  • Development banks should play a role in creating
    an environment for gains from bank
    privatizations gains from bank privatizations
    are linked to economic development
  • Thus, an indirect role of development banks in
    economic development through the development of
    traditional financial institutions
  • Strengthening institutions bankruptcy code,
    contract enforcement, rule of law, etc.
  • For share issue privatizations get corporate
    governance right concentrated ownership, yet
    protection of minority shareholders

21
ConclusionsLessons for Development Banks
  • Development banks should play a role in the
    development of benchmark bond markets as well as
    stock markets e.g., regional integration of
    thin local markets regional stock markets
  • Human capital and financial manpower development
    also, regional synergy in skills development
  • Ultimately helping establish an appropriate
    platform for the development banks themselves to
    be privatized
  • Separating the development agenda from ownership
    structure development banks need not be owned by
    governments
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