Why Should European Governments Privatize Public Banks
If the financial needs of European public coffers weren't a reason good enough to return to the private sector the banks nationalized in the aftermath of the 2007-2009 crisis, Andrea Sironi (Department of Finance) provides governments with a compelling argument to get rid of banks' shares in The Impact of Government Ownership on Bank Risk (with Giuliano Iannotta, Università Cattolica, and Giacomo Nocera, Audencia Nantes, forthcoming in Journal of Financial Intermediation).
Government owned banks (GOBs), the scholars find out, take advantage of implicit government protection getting better issuer ratings, and thus lower financing costs, than privately owned banks (POBs), notwithstanding higher operating risk and worse economic and financial conditions. Moreover, the risk-taking behaviour is sensitive to the electoral cycle, being higher in electoral years, when GOBs lend cheap money to political clients.
The authors compare issuer ratings (which reflect default risk) and individual ratings (which reflect operating risk, not considering the presence of external protection, but only the banks' economic and financial conditions) of European large banks in the 2000-2009 period, through a dataset of 210 banks from 16 countries, for a total of 1,541 bank-year observations. Large banks are defined as banks that have total assets of at least €10 billion in at least one fiscal year-end in the considered period.
They find out that GOBs enjoy better issuer ratings than POBs, despite worse individual ratings. It means that better issuer ratings are not due to better financial conditions but to government protection, which shelters GOBs from market discipline and induces them to take higher risks. If any loss should follow, the taxpayer would cover it. This translates into poorer asset quality, with GOBs being less capitalized and less profitable and having a higher ratio of loan loss provisions to total loans.
The results are robust to a number of checks, the scholars assert, and are stronger in the financial crisis period (2007-2009) and for German banks.
The difference between default risk and operating risk would be socially acceptable, the scholars claim, if GOBs would play a social role, financing ventures that can help economic development but POBs are unwilling to finance, thus addressing market failures and improving social welfare. Instead, they find evidence that GOBs are used as political tools to provide low cost of financing to political supporters, who return the favour in the form of votes and contributions. Also, GOBs operating risk and external support increase in election years and in the two following years, when GOBs inefficiently expand their loan portfolios to favour political clients.
"If European banking regulators are committed to levelling the playing field, safeguarding banks' asset quality, improving banking industry efficiency, and strengthening market discipline", Sironi and his colleagues conclude, "then the elimination of explicit government protection is not, according to the results of this study, a sufficient condition". A rapid privatization is needed.