State-Owned Banks versus Private Banks in South Asia: Agency Tensions, Susceptibility to Distress, and the Fiscal and Economic Costs of Distress
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he pros and cons of state banking are vigorously debated. State-owned commercial banks (SOCBs) can be established to help create markets and fulfill social goals and support fiscal policy (by raising additional revenues for public investment), but the operation of SOCBs has downsides because of possible inefficiencies, misuse, and financial distress. The upsides and downsides of SOCBs are increasingly being scrutinized by policy makers and the global community. This chapter contributes to the debate by examining episodes of distress at SOCBs and private banks, the drivers of distress, bank adjustments in times of distress, and the costs of bank distress to the real economy in Bangladesh, India, Pakistan, and Sri Lanka. Distinguishing banks by ownership type is important because state commercial banking is prevalent in these countries, and in South Asia overall. The analysis identifies episodes of bank distress, explores several adjustment channels through which banks cope with distress, and examines the relative intensity with
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which state-owned and private banks in distress use these channels. The study examines how firms’ links with SOCBs versus private banks affect their investment—focusing on small and medium enterprises (SMEs) and successful firms with high growth of sales. South Asian economies rely on their banking system to help allocate resources for greater productivity and employment as well as financial inclusion for greater access to opportunities. These functions cannot be performed effectively when banks are distressed. Therefore, understanding the drivers of distress is important for devising and implementing effective policy remedies for SOCBs. The chapter therefore concludes with recommendations to strengthen SOCBs and the financial sector for the benefit of economies and societies overall.
The Upsides and Downsides of State-Owned Commercial Banks By 2017, three countries stood out in the world because of the dominance of SOCBs in
Note: This chapter draws on the background research paper: Kibuuka, K., and M. Melecky. 2020. “State-Owned versus Private Banks in South Asia: Agency Tensions, Distress Factors, and Real Costs of Distress.” Background paper for Hidden Debt. World Bank. Washington, DC.
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