Recent Trends In Bank Privatization
Public Disclosure AuthorizedPublic Disclosure Authorized9318Recent Trends in Bank PrivatizationAta Can BertayPietro CaliceFederico Alfonso Diaz KalanOliver MasettiPublic Disclosure AuthorizedPublic Disclosure AuthorizedPolicy Research Working PaperFinance, Competitiveness and Innovation Global PracticeJuly 2020
Policy Research Working Paper 9318AbstractThis paper revisits trends in bank privatization and analyzestheir economic impact over the past 25 years. Building ona novel data set of privatization events for 70 developedand developing countries, it shows that bank privatizationbecame more frequent since the Global Financial Crisis,especially in emerging markets such as China and India,but also smaller in that the fraction of a bank’s ownershiprelinquished during privatization events declined. Themajority of privatizations happened via public sales indomestic capital markets. The banks that were chosen tobe privatized tended to underperform their peers and hadweaker asset quality pre-privatization, but the empiricalevidence on banks’ post-privatization performance is mixed.The paper finds that privatized banks turn toward more traditional banking models and increase credit extension withno apparent negative distributional implications. However,the analysis does not reveal significant differences in bankprofitability post-privatization, although differences existbetween developed and developing countries. Notably,banks that have been recapitalized prior to privatizationperform significantly better afterward privatization.This paper is a product of the Finance, Competitiveness and Innovation Global Practice. It is part of a larger effortby the World Bank to provide open access to its research and make a contribution to development policy discussionsaround the world. Policy Research Working Papers are also posted on the Web at http://www.worldbank.org/prwp. Theauthors may be contacted at ata.bertay@sabanciuniv.edu; pcalice@worldbank.org; fdiazkalan@worldbank.org; andomasetti@worldbank.org.The Policy Research Working Paper Series disseminates the findings of work in progress to encourage the exchange of ideas about developmentissues. An objective of the series is to get the findings out quickly, even if the presentations are less than fully polished. The papers carry thenames of the authors and should be cited accordingly. The findings, interpretations, and conclusions expressed in this paper are entirely thoseof the authors. They do not necessarily represent the views of the International Bank for Reconstruction and Development/World Bank andits affiliated organizations, or those of the Executive Directors of the World Bank or the governments they represent.Produced by the Research Support Team
Recent Trends in Bank PrivatizationAta Can Bertay, Pietro Calice, Federico Alfonso Diaz Kalan, Oliver Masetti 1JEL Classification Numbers: G210, G28, G23, H13, H81Keywords: State-owned Banks, Financial Crisis, Financial Development, Public Economics,Privatization, Bank ProfitabilityAuthors’ E-Mail Addresses: ata.bertay@sabanciuniv.edu; pcalice@worldbank.org;fdiazkalan@worldbank.org; and omasetti@worldbank.org.The authors would like to acknowledge the financial support of the FIRST Initiative and thank Carlos Piñerúa andMoni Sengupta for their support. The authors would also like to thank Tatiana Alonso Gispert, Alexander Berg, TitoCordella, Robert Cull, Eva Gutierrez, William Megginson, Zafer Mustafaoglu, Ugo Panizza and Valeria SalomaoGarcia for their comments. The views expressed in this paper are those of the authors and do not necessarily representthose of the World Bank or of its Board of Directors.1
1. IntroductionPrivatization programs implemented over the past quarter of a century have significantlycontributed to the diminished role of state-owned commercial banks (SOCBs) globally. While themedian share of SOCBs over total banking assets was 40 percent in developing economies and 36percent in advanced economies in 1995, it had declined to 18 percent and 12 percent, respectively,in 2016 (Cull et al, 2018). This is despite the wave of temporary nationalizations of privatelyowned banks that occurred in many countries after recent banking crises, when bank bailouts (e.g.through direct capital injections and purchase of banks) were a common government response. 2However, government ownership of banks remains still dominant in some parts of the world. Forexample, the market share of SOCBs is above 50 percent in countries such as Uzbekistan, theRussian Federation, Uruguay and Qatar and exceeds 40 percent in the South Asia region.Privatization programs around the world have traditionally been motivated by the notion thatextensive government ownership in banking is problematic for financial development, which, inturn, is crucial for economic development (Megginson, 2005). 3 Governments around the worldplay many important roles when it comes to establishing a growth-promoting financial system. Inmany countries, and especially in developing countries, governments go beyond their roles aseconomic policy makers, legal and informational infrastructure providers, and regulators, anddirectly intervene in their banking systems through government ownership of financial institutions(Demirguc-Kunt, 2012). The literature, however, points out that government ownership of bankscan be detrimental to economic welfare as it is correlated with lower financial development andeconomic growth and higher systemic fragility (La Porta et al., 2002). There is plenty of banklevel evidence documenting underperformance of government-owned banks in terms ofprofitability, especially in developing countries (Mian, 2003; Iannotta et al., 2007; Micco et al.,2007). An important contributing factor to such grim outlook is the political nature of governmentowned banks which may provide politically motivated inefficient lending―so-called ‘politicalview’ of banking (e.g. Sapienza, 2003; Dinc, 2005; Englmaier and Stowasser, 2017). 4There is also evidence showing that fundamental determinants of economic growth, such asinstitutional quality are critical in the relationship between government ownership of banks andfinancial and economic development outcomes as the negative correlation disappears and eventurns to positive when institutional development is factored in (see for example the cross-sectionalanalysis in Andrianova et al., 2012). This ‘developmental’ view suggests that governments havelonger term developmental goals, particularly addressing market failures which can be severe dueto, for example, lack of economic institutions such as informational infrastructure (World Bank,2012). Thus, government-owned banks with various objectives beyond profit maximization mayprovide funding to disadvantaged segments of the society. Such credit provision may havedevelopmental benefits, but they are also very risky due to the informational problems. Indeed,See Igan et al. (2019) for a discussion of government response after the global financial crisis (GFC).There is a vast literature documenting the positive relationship between financial development and real economicoutcomes (Levine, 2005; Popov, 2018, Brown and Earle, 2017; Levine and Warusawitharana, 2019). Also,privatization programs and related analyses involve not just financial markets and institutions but include almost allbusinesses. See, for example, Magginson (2017) for an extensive survey of recent research.4See Cull et al. (2018) for a recent analysis of trends in and implications of bank ownership for bank performance andcompetition, financial stability, and access to finance.232
there is evidence showing that the performance of government-owned banks depends on whetherthey purchased a distressed bank because of political factors. Unless they purchase a distressedbank, government-owned banks tend to perform as well as their private counterparts and especiallyso in countries with poor records on political rights and governance (Shen et al., 2014). Thissubstitution between institutional elements and effectiveness of government-owned banks was alsoevident in Andrianova et al. (2012), who show the positive correlation between government bankownership and argue that economic growth outcomes are stronger for the countries with weakerregulatory quality. One other aspect with possible developmental consequences is that theactivities of government-owned banks may differ from private banks in many dimensionsincluding the cyclicality of credit provision and asset and liability composition. Regarding thecyclicality of credit provision, Bertay et al. (2015) show that state-owned banks can smooth thecredit cycles even after controlling for the election cycles and help during a banking crisis byproviding countercyclical lending. 5 A country study by Gupta et al. (2015) provides an exampleof heterogeneity in asset composition by demonstrating that government banks in India invested alarger share of their assets in government securities, which may not be as growth enhancing assome alternatives such as corporate funding, even in the face of financial liberalization. 6Widespread privatization programs, however, are often controversial and difficult to implement inmany parts of the world, especially in developing economies where the share of SOCBs remainscomparatively high. This is a general trend that goes beyond the financial industry and affects allsectors of the economy that remain in state hands. It largely reflects political opposition stemmingfrom doubtful success in previous episodes of privatization, especially when corruption played arole; negative (actual or perceived) distributional consequences; and political economyconsiderations (see Estrin and Pelletier, 2019, for a discussion). Skepticism of privatization mayhave been exacerbated by the GFC, which in many respects has called into question the liberalapproach championed in the previous two decades and in the case of the financial sector hastarnished the reputation of private bankers in the eyes of voters, reducing governmental andinvestor appetite for privatization. This may change in the post-pandemic world, whengovernments around the world will have to find ways to manage the vast amounts of debtaccumulated as a result of the fiscal policy responses to the Covid-19 crisis. In this context,privatization programs, including of banks, may receive renewed interest in the next few years.Given the numerous trade-offs and dependencies surrounding government ownership of banks, itis crucial to optimize the privatization decisions and processes for the policy makers. The evidencefrom existing empirical studies on bank privatization, although not conclusive, shows that standardmetrics used to proxy bank performance typically improve post-privatization. 7 This is trueespecially when the government fully relinquishes control, banks are sold to strategic investors,and bidding is open to all investors, including foreign investors. These findings are consistent withthe well-established literature showing the problems associated with government ownership ofbanks, which introduces several direct and indirect economic distortions (see, for example, Kumar,Choi et al. (2016) document the countercyclical role played by government-owned banks during the GFC. Moreover,Bosshardt and Cerrutti (2020) recently confirm earlier findings and show that during the GFC state-owned banks lentrelatively more compared to domestic private counterparts with an objective to stabilize the economy in their sampleof 25 emerging markets.6See Boubakri and Saffar (2019) on how state ownership affects the debt choices of privatized firms.7See, for example, Beck et al. (2005a), Beck et al. (2005b), Clarke et al. (2009), and Cull and Spreng (2011) for singlecountry analysis; or Azam et al. (2004), Boubakri et al. (2005) for cross-country setting.53
2019, or Bircan and Saka, 2019, on political lending)). Hence, when it comes to banking,ownership does matter and privatization decisions are critical for economic outcomes. It is,however, important to consider that the argument for bank privatization does not mean that thereis no residual role for SOCBs, especially in developing economies. In large countries, only SOCBsare likely to be willing to serve customers in remote areas and in chronically underserved segmentssuch as agriculture, though this argument may be losing power as digital technologies increasinglypermeate the banking industry. Another argument for the government to keep limited directownership of banks is that SOCBs exhibit less procyclical lending behavior than private banks(Bertay et al., 2015), which is crucial especially for small open economies. Being a second-bestsolution, it would be important to ensure that these banks are subject to the same supervisoryrequirements as private banks to avoid distortion and monitor accountability.This paper aims to revive the public policy and academic debate around bank privatization byanalyzing the following questions: What are the key trends and drivers in bank privatization inrecent years? Does privatization affect banks’ performance and business models? What methodsof privatization are prevalent and what maximizes post-privatization performance? Under whatinstitutional, market and regulatory circumstances does privatization lead to stronger bankperformance, if any? What are the implications of privatization on banking sector employment andcredit provision and composition?This paper complements the existing empirical literature on bank privatization by using a noveland up-to-date data set, which covers a large set of countries. Specifically, our data set covers 70countries during 1995-2017 and allows to compare the pre- and post-privatization profile of banksand to analyze the associations between sale events and various bank-level measures such asfinancial performance, business model, and distributional effects. Stylized facts presented in thispaper show that bank privatization did accelerate sharply post-2000, driven primarily bydevelopments in China and India, and remained constant following the GFC. While the number ofprivatizations increased, the average equity stake at sale per transaction declined and it is no longerthe case that the majority of sales involved significant changes in the control of financialinstitutions. Banks chosen to be privatized exhibited, ceteris paribus, a weaker performance andlower asset quality than market peers prior to the privatization event. Regarding the method ofsale, our data show that the majority of privatizations took the form of public equity sales ondomestic capital markets.Furthermore, the empirical results suggest that the short-term associations between bankingoutcomes and privatization activities may differ from longer-term banking outcomes after largeprivatization events. 8 Simple before- and after-privatization mean comparisons indicate that banksgoing through large privatizations turn to more traditional banking models characterized by lowernon-interest income shares and higher loans over assets ratios. Furthermore, privatized banksreduce their liquidity significantly while they hire more employees. These results can beinterpreted as higher post-privatization financial intermediation and even though we do not findsignificant differences in bank bottom-line profitability (ROA), in our panel regressions we showthat credit growth after privatization increases, with some reduction in cost-to-income ratios andnot much change in nonperforming loans (NPLs) over loans.8We use 30 percent share sales as our large privatization event.4
Crucially, the paper shows that if the privatized bank received a capital injection beforeprivatization its performance measures improve compared to the earlier period as well as toprivatized banks without recapitalization. The results, using sample splits between developing andadvanced economy banks, indicate that privatized banks in high-income countries perform betterand with lower liquidity and lower costs. Developing country banks, on the other hand, seem to beincreasing their credit growth (though still lower than their high-income country counterparts) aswell as their number of employees post privatization.The rest of this paper proceeds as follows. The next section presents the data set and some stylizedfacts about recent trends in bank privatization around the world. Section 3 presents the empiricalanalysis that estimates the relation between privatization and bank financial performance, strategy,as well as the distributional implications. Section 4 concludes.2. Data and stylized factsOur data set covers 475 privatization events, that is equity sales of SOCBs in 70 advanced andemerging economies over a period ranging from 1995 to 2017. 9 In terms of country level ofincome, two-thirds of the transactions refer to banks in middle-income countries, while the rest ismostly composed of public banks in high-income countries. The data set is compiled by merginginformation from multiple different data sources. The main source is the World Bank PrivatizationDatabase, but given that this database was discontinued in 2008, further bank privatization eventswere incorporated from additional sources, including the Securities Data Company (SDC)Platinum New Issues database and the Privatization Barometer’s online database on Europeantransactions as well as their annual reports, which included a section on both EU and non-EUprivatization trends and major deals. Current commercial bank ownership information wasobtained from Fitch Connect. The privatization events were individually examined to exclude noncommercial bank privatizations, and also to incorporate events announced in financial mediaoutlets such as the Financial Times or The Economist. Non-commercial bank sales excluded fromour database include development banks (agricultural banks, industrial banks, export-importbanks), financial companies associated to other industries (steel, real estate development),securities depositories and asset sales by central banks. Using the information from Igan et al.(2019), we excluded from our data set institutions that had received public financial support duringthe GFC and later proceeded to offer equity totally or partially to private investors.Our data set allows us to detect important trends and developments in SOCB privatization, whichare presented below as 10 key stylized facts: Privatizations increased sharply post-2000. The number of transactions doubled from 11 peryear in the second half of the 1990s to an average of 20 per year in the pre-GFC period (200007). This trend accelerated after the GFC when the average number of transactions increasedfurther to 27. Growth was even stronger in terms of proceeds, rising from an annual averageof USD 6.8 billion (this and all further references in 2017 constant US dollars) in the late 1990sto USD 16.6 billion in the pre-GFC years and surging to USD 26.8 billion in the post-GFCyears. These numbers count any sale of public banks’ equity as a transaction regardless of itssize, though we consolidate these by year and entity. Only considering sales of more than 309See section 3 for more details on the definition of privatization events.5
(50) percent of total equity for a better gauge of change in control, also points to a peak in thenumber of transactions in the pre-GFC period, when these increased from 4 (3) to 7 (4) peryear. After the GFC, sales of large shares of equity dropped to 4 (2) per year. China and India were the driving force behind the rise of privatizations post-2000. Chinahas changed the privatization landscape since 2005, when it decided to issue shares of its “BigFour” SOCBs, starting with Industrial and Commercial Bank of China (ICBC) and ChinaConstruction Bank Corporation (CCB). 10 China went from no bank transaction in 1995-99 toan average of two deals per year during 2000-07 worth USD 8.4 bill
Recent Trends in Bank Privatization Ata Can Bertay Pietro Calice Federico Alfonso Diaz Kalan . for a recent analysis of trends in and implications of bank ownership for bank performance and competition, financial stability, and access to finance. . regulatory quality.One other aspect with possible developmental consequences is that the
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