Public Sector Banks

In fact, the dominant role of private banking is mostly a North American phenomenon.  This did not become a problem in terms of reckless endangerment until the 1933 laws separating banking and other financial enterprise were repealed in 1998.  Without that separation, the leaders will always succumb to the temptation to borrow short and lend long, however one paints the picture with CDOs.

We have discovered just how damaging that can become in 2008 and in 1929.  This time, governments had the sense to print their way out of the mess.  What they have failed to do is rein in the private banking racket by outright nationalization as needed to be done.  This is not socialism, but pulling back control of the currency management function of government.

This article by Ellen Brown nicely outlines just how useful the public bank model has become.  It puts final responsibility on public officials who know that their mandate does not include putting the private savings at risk.  Reckless endangerment becomes far less likely as occurred in Canada were the banking although private is also linked at the hip with the central bank and tightly regulated.  Thus it became necessary for these same bankers to apply to the Prime minister’s office for license to take on the new instruments been peddled in New York in 2008 as well as to actually merge with each other.  The PMO knows that they will wear failure and provides a critical first line of defense against the type of risk acceptance that was on tap at the time.  Such activity was disallowed and has proven to be totally correct as I thought at the time also.

For the same reasons, the Bank of North Dakota also did not dabble.  As Ellen points out, we are in an age in which managers are not restrained by shareholders and the temptation to loot is always there.  The public private model works very well in Canada in that a uniform discipline is imposed.

Public-Sector Banks: From Black Sheep to Global Leaders

           

Posted on Mar 8, 2012

Gamma Man (CC-BY)

Detail of Alexander Hamilton’s face on a $10 bill. Hamilton was a strong proponent of public banking, championing the establishment of the first U.S. national bank in 1791.

By Ellen Brown, Truthout

This article originally appeared at Truthout.

Once the black sheep of high finance, government owned banks can reassure depositors about the safety of their savings and can help maintain a focus on productive investment in a world in which effective financial regulation remains more of an aspiration than a reality.

—Centre for Economic Policy Research, VoxEU.org (January 2010)

Public-sector banking is a concept that is relatively unknown in the United States. Only one state—North Dakota—owns its own bank. North Dakota is also the only state to escape the credit crisis of 2008, and has sported a budget surplus every year since, but skeptics write this off to coincidence or other factors. The common perception is that government bureaucrats are bad businesspeople. To determine whether government-owned banks are assets or liabilities, then, we need to look farther afield.

When we remove our myopic US blinders, it turns out that, globally, not only are publicly owned banks quite common, but countries with strong public banking sectors generally have strong, stable economies. According to an Inter-American Development Bank paper presented in 2005, the percentage of state ownership in the banking industry globally by the mid-nineties was over 40 percent. The BRIC countries—Brazil, Russia, India and China—contain nearly 3 billion of the world’s 7 billion people, or 40 percent of the global population. The BRICs all make heavy use of public-sector banks, which compose about 75 percent of the banks in India, 69 percent or more in China, 45 percent in Brazil and 60 percent in Russia.

The BRICs have been the main locus of world economic growth in the last decade.  China Daily reports, “Between 2000 and 2010, BRIC’s GDP grew by an incredible 92.7 percent, compared to a global GDP growth of just 32 percent, with industrialized economies having a very modest 15.5 percent.”

All the leading banks in the BRIC half of the globe are state-owned. In fact, the largest banks globally are state-owned, including:

—The two largest banks by market capitalization (Industrial & Commercial Bank of China [ICBC] and China Construction Bank)

—The largest bank by deposits (Japan Post Bank)

—The largest bank by assets (Royal Bank of Scotland, now nationalized)

—The world’s largest development bank (Brazilian Development Bank [BNDES by its Portuguese acronym] in Brazil).

A May 2010 article in The Economist noted that the strong and stable publicly owned banks of India, China and Brazil helped those countries weather the banking crisis afflicting most of the rest of the world in the last few years. According to Professor Kurt von Mettenheim of the Sao Paulo Business School of Brazil:

Government banks provided counter cyclical credit and policy options to counter the effects of the recent financial crisis, while realizing competitive advantage over private and foreign banks. Greater client confidence and official deposits reinforced liability base and lending capacity. The credit policies of BRIC government banks help explain why these countries experienced shorter and milder economic downturns during 2007-2008.

Surprising Findings

In a 2010 research paper summarized on VoxEU.org, economist Svetlana Andrianova and her colleagues wrote that the post-2008 nationalization of a number of very large banks, including The Royal Bank of Scotland, “offers an opportune moment to reduce the political power of bankers and to carry out much needed financial reforms.” But, wrote Andrianova, “there are concerns that governments may be unable to run nationalised banks efficiently.”

Not to worry, say the authors:

Follow-on research we have carried out (Andrianova et al, 2009) ... shows that government ownership of banks has, if anything, been robustly associated with higher long run growth rates.

Using data from a large number of countries for 1995-2007, we find that, other things equal, countries with high degrees of government ownership of banking have grown faster than countries with little government ownership of banks. We show that this finding is robust to a battery of econometric tests.

Expanding on this theme in their research paper, the authors write:

While many countries in continental Europe, including Germany and France, have had a fair amount of experience with government-owned banks, the UK and the USA have found themselves in unfamiliar territory. It is therefore perhaps not surprising that there is deeply ingrained hostility in these countries towards the notion that governments can run banks effectively…. Hostility towards government-owned banks reflects the hypothesis ... that these banks are established by politicians who use them to shore up their power by instructing them to lend to political supporters and government-owned enterprises. In return, politicians receive votes and other favours. This hypothesis also postulates that politically motivated banks make bad lending decisions, resulting in non-performing loans, financial fragility and slower growth.

But that is not what the data of these researchers showed:

[W]e have found that ... countries with government-owned banks have, on average, grown faster than countries with no or little government ownership of banks…. This is, of course, a surprising result, especially in light of the widespread belief—typically supported by anecdotal evidence—that ” ... bureaucrats are generally bad bankers.”

What accounts for their surprising findings? The authors provide a novel explanation:

We suggest that politicians may actually prefer banks not to be in the public sector…. Conditions of weak corporate governance in banks provide fertile ground for quick enrichment for both bankers and politicians—at the expense ultimately of the taxpayer. In such circumstances politicians can offer bankers a system of weak regulation in exchange for party political contributions, positions on the boards of banks or lucrative consultancies.  Activities that are more likely to provide both sides with quick returns are the more speculative ones, especially if they are sufficiently opaque as not to be well understood by the shareholders such as complex derivatives trading.

Government owned banks, on the other hand, have less freedom to engage in speculative strategies that result in quick enrichment for bank insiders and politicians. Moreover, politicians tend to be held accountable for wrongdoings or bad management in the public sector but are typically only indirectly blamed, if at all, for the misdemeanours of private banks. It is the shareholders who are expected to prevent these but lack of transparency and weak governance stops them from doing so in practice. On the other hand, when it comes to banks that are in the public sector, democratic accountability of politicians is more likely to discourage them from engaging in speculation. In such banks, top managers are more likely to be compelled to focus on the more mundane job of financing real businesses and economic growth.

The BRICs as a Global Power

Focusing on the financing of real businesses and economic growth seems to be the secret of the BRICs, which are leading the world in economic development today.  But the BRIC phenomenon is more than just a growth trend identified by an economist. It is now an international organization, an alliance of countries representing the common interests and goals of its members. The first BRIC meeting, held in 2008, was called a triumph for then-Russian President Vladimir Putin’s policy of promoting multilateral arrangements that would challenge the United States’ concept of a unipolar world.

The BRIC countries had their first official summit and became a formal organization in Yekaterinburg, Russia, in 2009. They met in Brazil in 2010 and in China in 2011, and they will meet in India in 2012. In 2010, at China’s invitation, South Africa joined the group, making it “BRICS” and adding a strategic presence on the African continent.

The BRICS seek more voice in the International Monetary Fund (IMF), the World Bank and the United Nations. They are even discussing their own multicultural bank to fund projects within their own nations, in direct competition with the IMF.  They oppose the dollar as global reserve currency. After the Yekaterinburg summit, they called for a new global reserve currency, one that was diversified, stable and predictable—and they have the clout to get it. According to Liam Halligan, writing in The UK Telegraph: “The BRICs account for ... around three-quarters of total currency reserves. They have few serious fiscal issues and all are net external creditors.”

Western financial interests have long fought to maintain the dollar as global reserve currency, but they are losing that battle despite economic and military coercion. Russia, China and India are now nuclear powers. The BRICS will have to be negotiated with, and the first step to forming a working relationship is to understand how their economies work. We need to lift the curtain on how the other half of the world does it. Rather than declaring war on their more successful practices, we may decide to assimilate some of them into our own.

As Gandhi said, “First they ignore you, then they laugh at you, then they fight you, then you win.”

Written for the Public Banking in America Conference to be held April 27-28 in Philadelphia.

This article is not covered by Creative Commons policy and may not be republished without permission.

TAGS: alexander hamilton bank banking banks brazil bric brics china currency hamilton imf india international monetary fund kurt von mettenheim north dakota privatization public sector russia sao paulo south africa