Bank Privatization: Why, When, and How

George R.G. ClarkeRobert CullDecember 2002

Project Goals

Establish firm statistical basis for determining whether bank privatization succeeded in case study countries (bank-level panel data)

Analyze Determinants of Success or Failure Contract Features Political Economy

Criteria for Country Selection

Large number of privatizationsSufficient number of non-privatizers

(control group)Sufficiently long post-privatization

time seriesBank-level data available

Country List

Argentina [Clarke (WB), Cull (WB), Berger (US Fed), Klapper (WB)]

Bulgaria, Croatia, Czech Republic, Hungary, Poland, Romania [Bonin (Wesleyan), Wachtel (NYU), Hasan (NYU)]

Mexico [Haber (Stanford), Kantor (U Ariz)]Brazil [Beck (WB), Summerhill (UCLA)]Nigeria [Jerome (Univ Ibadan), Beck, Cull]

Background: Provincial Bank Privatization in Argentina

Eighteen Completed Privatizations Since 1992

Sale of a Fraction of Total Assets (and Liabilities)

Residual Entities: Provinces Faced Large Short-Term Obligations

Fondo Fiduciario: Term Transfer of Residual Obligations

The Provincial Bank

Poorly performingOverstaffedSmall (on national scale)Large (on provincial scale)Cheap source of patronage for

provincial politicians

Change in External Environment: The Impetus to Privatize

Convertibility Plan (1991) No more “lender of last resort” Imposed hard budget constraint on

provincesTequila Crisis (1994/5)

Hurt performance of banking sector Hurt provincial finances

Together resulted in privatization of many provincial banks

Determinants of Privatization(Clarke, Cull, “Political and Economic Determinants of the Likelihood of Privatizing Argentine Public Banks,” Journal of Law and Economics, April 2002, pp.165-98.)

Political Factors Important bank overstaffing, high public employment,

high unemployment lower p(privatization) dominance of local banking lower

p(privatization)

Tequila Crisis higher p(privatization)Poor Public Bank Performance

higher p(privatization)

Post-Privatization Performance (Clarke, Cull, “Why Privatize? The Case of Argentina’s Public Provincial Banks,” World Development, May 1999, pp. 865-88)

Rapid Growth in Assets, LiabilitiesImproved Performance (Higher ROE,

ROA; Lower NPLs)Declining (but Heavy) Reliance on

Income from Service ContractsDifficulty in Cultivating a Private

Lending Clientele

Salta: Post-Priv Size

0

50

100

150

200

250

300

Year 1 Year 2 Year 3

Mill

ions

of P

esos

Loans

Deposits

Salta: Post-Priv Performance

00.20.40.60.8

11.21.41.6

Year1

Year2

Year3

Per

cen

t (%

)

Bad Loans

ROA

Salta: Post-Priv. Income from Services

0

20

40

60

80

Year1

Year2

Year3

Shar

e of

Tot

al (%

)

Income fromServices

Salta: Post-Priv Portfolio Orientation

0

5

10

15

20

25

30

Year 1 Year 2 Year 3

Shar

e (%

) Personal

Mortgages

Financial

Future Re-Capitalization CostlierThan Privatization

Provincial Bank: $220 million Assets, Typical Loss Rate, Must Re-Capitalize

Every Three Years

0100200300400500

No Privatization:Discounted Re-Capitalization

Payments (10%)

Privatization:ExpectedResidualLiabilities

Mil

lio

ns

of

Pes

os

The Negotiation: Contract Provisions

Fiscal: Price Assets/Liabilities Assumed by Purchaser Portfolio Guarantees Provide Future Banking Services to the

Province

Political: Service Coverage/Branching Layoff Restrictions/Re-training

What Affects Contract Provisions(Clarke, Cull, “Bank Privatization in Argentina: A Model of Political Constraints and Differential Outcomes,” World Bank, Working paper 2633, July, 1999.)

Fiscal position of province Provinces with large deficits allowed

more layoffs and guaranteed more assets.

However, also received higher pricesTequila Crisis

Better outcomes (from politicians’ viewpoint) before crisis (e.g., fewer layoffs, smaller residual banks).

What Affects Contract Provisions

Local Dominance (Implies Unattractive Market?) Provinces where provincial bank had a

greater share of assets allowed more layoffs, larger residual banks, longer service contracts.

Lessons (to test)

Partial measures, partial sales not helpful. Maybe worse off than if you had done nothing.

It is possible to determine whether a country is serious about privatization.

Financial/fiscal crises offer opportunities for structural change in banking.

Lessons (to test)

Bank regulatory/supervisory environment important. Privatized banks won’t improve if all other banks are weak.

One-shot cleaning of bank balance sheets important (requires resources). Repeated re-capitalization a waste of funds.

World Bank assistance should disburse against specific privatization transactions (Argentina, Mexico).