10 Years after the Financial Crisis: Alternatives to Private Banks Are Necessary As Ever

December 6, 2017

Author Articles

Financial Regulation

Christoph Scherrer explores the role of private banks after the financial crisis.

During the recent financial crisis starting in the United States in 2007, policy elites changed their negative perception of the state’s role in financial markets. Many banks were nationalized and the government infused new capital or provided large-scale loans and guarantees. It seemed as if the delegitimization that the private banks had suffered from their reckless behavior would relegitimize public banks. The government crisis measures, however, turned out to be ad hoc crisis interventions. They were not done with the intention of rebuilding the public banking sector. Once the depth of the crisis was over, they were returned to private investors or the respective government kept its stake but did not make any demands on the management (e.g., Commerzbank in Germany). Subsequent reform initiatives intended to make the financial system safer neglected public banks. The latest European reform to stabilize the financial system, the Banking Union, even discriminates against public banks. Despite the good performance especially of the municipal savings banks during the crisis of 2008, Halyna Semenyshyn argues in her chapter of the book “Public Banks in the Age of Financialization. A Comparative Perspective” the Banking Union will force savings banks to abandon their own crisis-tested joint liability schemes in favor of a more expensive European Union scheme.

As the call for expanding and strengthening public banks went unheeded, the question arises whether this neglect is justified. An international team of authors covering the experiences of public banks in countries with a large public banking sector has recently explored the role public banks could play in stabilizing the financial system. They aim at understanding how public banks fared in the current crisis. Do public banks serve as stability anchors in financial markets? Do public banks provide the much-needed finance for development? Against the background of the prevalent critique of public banks as politicized, badly managed financial entities, they also address the question: What kind of governance keeps public banks accountable to the public?

Given the significant differences among the investigated countries, Brazil, Germany and India, the authors did not compare these countries’ public financial sector in a strict sense. Rather, the differences are used to elucidate certain specific functions, performances and challenges of public banks. The case of Brazil allows for the study of a function seldom attributed to public banks, namely stabilizing the financial sector via anticyclical policies. Ana Rosa Ribeiro de Mendonça and Simone Deos argue that limiting public banks to filling the gaps left by private banks – the standard argument in economics – neglects a very important dimension of public banks, that is, their capacity to act countercyclically and thereby stabilize access to credit during economic downturns. Taking a cue from Hyman Minsky, they point to the immanent volatility of financial markets dominated by private actors. In order to counter destabilizing tendencies, the presence of institutions with a logic of action that differs from that of the market is necessary. As public banks are not primarily concerned with profitability, they can play this role. To a certain extent, their presence in the market is an automatic stabilizer because public banks provide credit with long maturation. In times of crisis, they can also be used for discretionary intervention, that is, opening up new credit lines. Empirically, they show that the impact of the 2008 crisis on the Brazilian economy was rather limited because the Brazilian Central Bank together with the public banks supplied sufficient liquidity for non-financial agents.

Since the broad-based nationalization of private banks in the late 1960s, India has been a country with one of the largest public banking sectors. It is therefore a good place to study the achievements and challenges of a largely publicly controlled financial system. India is also a country with historically high levels of unbanked households. Pallavi Chavan describes in detail the dramatic increase of branch outreach after the nationalization of the banks in the late 1960s. The expansion of public banking was accompanied by a striking increase of national savings and investments. However, the policy of financial liberalization in the 1990s brought about a reversal in most of these accomplishments. The policy of low interest–bearing loans to address agrarian distress resumed after 2005, but also included bulky loans to infrastructure and core industrial sectors with a higher propensity for default, a topic that Meenakshi Rajeev discusses in detail. Rejecting the call for privatization, Chavan asserts the need not only to preserve the public character of these banks by way of recapitalization given their role in financial inclusion but also of a professional and transparent management of these banks.

Germany lends itself to an analysis of the role of governance for public banks’ performance. Since not all German public banks were performing equally well, a comparison between successful and failing banks allows for insights into the factors that determine performance. By comparing an ambitious but ultimately failing Landesbank (WestLB) with a more prudent and so-far successful Landesbank (Helaba), Xeniya Polikhronidi confirms the importance of governance structures. While both banks suffered a major crisis in the 1970s, the owners of Helaba learned their lesson and set up a governance structure characterized by strict control and monitoring mechanisms. They also upheld the commitment to a public mandate. At WestLB, this commitment was dropped and the governance structure left management with a very high degree of autonomy. Why some public banks disregard their public service function is my topic in the book. Again taking the German public banks as an example, I briefly describe their ‘mission creep’ in the form of financialization. Guided by the theory of hegemonic discourse, I interpret mission drift as part of neoliberal hegemony. This leads me to be skeptical about technocratic organizational solutions to the problem. Awareness about the public mandate seems to be of utmost importance. If the key actors of public banks are not aware of the public mandate and do not identify with the public mandate, then staying within the public mandate cannot be expected.

The main insights gained from these case studies can be summarized in the following way. Beyond supporting their regional economies by providing patient money and expertise, public banks can stabilize the business cycle through their long-term orientation and short-term mobilization of liquidity for countercyclical investment and consumption. They also increase the level of financial inclusion by reaching out to low-income households. As even mature financial markets do not provide these kinds of services, public banks are also valuable for economically advanced countries. Despite, or because, of their social functions, public banks perform on average better than their private counterparts in these countries, even measured in terms of traditional managerial objectives such as profitability and cost efficiency. In sum, public banks can perform important functions for an economy without having to rely on risk-prone financial instruments. Strengthening the role of public banks in the financial system could contribute significantly to stabilizing it.

Yet, public banks are also prone to mission creep. They are sometimes misused for narrow, self-serving political purposes, for aggrandizing their management or by powerful debtors. To safeguard public banks against losing sight of their original mission, changes in the incentive structure for their management will not suffice. In addition, it is necessary for management’s as well as politicians’ perception of the mission of public banks to change. This calls for a much broader debate about the role of the public sector and the limits on private actors. It calls into question the underlying concepts and practices of financialization, starting with academia and not stopping at Wall Street.

Christoph Scherrer, University of Kassel, Germany

Scherrer PublicPublic Banks in the Age of Financialization is available now.

Read Chapter One free on Elgaronline.


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