The trouble with state-owned banks

It is pleasing to note that the past weeks have been associated with growing scrutiny of the banking sector. The ongoing deliberations have highlighted the need for the transformation of the sector and brought to the fore the debate around the need, or otherwise, for publicly owned banks.

Advocates for state-owned banks suggest that it is only through state participation that this largely untransformed sector can reflect the majority's involvement in the financial industry.

Unfortunately for the government, the discourse on state ownership of banks is happening at the wrong time, as it comes when public trust in state-owned entities is critically low.

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Recurrent corporate governance squabbles, lack of transparency and the in-your-face inefficiencies in state-owned institutions like the Passenger Rail Agency of South Africa, SAA and the SABC have seriously compromised their ability to discharge their mandate and have deepened the general public scepticism about the governance of state-owned entities. It is no wonder, therefore, that the idea of a government-run bank has not been embraced in certain quarters.

As such, this issue demands extensive theoretical and empirical research around the costs and benefits of such banks as well as their design, operation and governance.

This is crucial because there is growing evidence that government ownership of banks in developing countries is associated with systemic fragility, lower economic growth and non-performing loans caused by concentrated lending.

Furthermore, cross-country research seems to validate the "political view of government banks" hypothesis that state-owned banks are frequently arm-twisted to channel credit not to commercially viable projects, but to the politically desirable. Likewise, they are often seen as a ready state apparatus for funding political undertakings, particularly prior to elections. It is common in many developing economies to use financial institutions as a source of employment and to subsidise cronies in return for votes.

China, Germany and Russia are the rare exceptions. Research has shown that state-owned banks in these countries fare no worse than privately owned banks - and, in fact, helped to promote economic growth.

Likewise, it has been shown that when compared with their privately owned counterparts, publicly owned banks have slight cost and profit advantages.

It is unfortunate that there are so few good examples of state-owned banks because there is an urgent need for new players who can disrupt the dominance of the current top four banks in South Africa.

However, judging by the government's handling of state-owned enterprises, perhaps instead of going solo, the government could consider partnerships with the private sector.

That way the state would have the benefit of influencing the financing agenda while entrusting the implementation of its strategic goals to its private sector partner.

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Another substitute for direct government ownership of banks would be proactive regulation aimed at achieving the government's goals, such as the provision of financial services to the poor.

A public bank would still face stiff competition from the long-established and immensely well-capitalised private sector in terms of incentives, innovation, services, financial products and attracting the best personnel.

Perhaps owing to their proximity to the state, publicly owned banks would have a strategic advantage as the government would be willing to use taxpayers' money to capitalise them in the event of financial distress. However, judging by the rescue of African Bank, such preferential treatment would generate an outcry.

Unless the state can show that it is determined to root out corruption and mismanagement of its entities, it would be fair to suggest that talk of a state-owned bank should be put on hold. Financial institutions are only as healthy as the faith that customers, lenders and investors have in them. Well-run state-owned enterprises would go a long way towards assuring cynics that the government's intended participation in the financial sector is motivated by social and economic considerations and not mere politicking.

Kawadza is a lecturer in banking and finance law at the University of the Witwatersrand