Helping to Prevent Banking Crises: Taking the "State" Out of State Banks

The banking crises experienced in many countries worldwide in recent years can often be attributed, at least in part, to state owned or controlled banks. These banks are often not typically banks in the traditional sense, but are effectively arms of the government to direct credit to favored borrowers in pursuit of economic, political, or social objectives. This frequently results in costly misallocation of resources. In addition, because their bottom line is not necessarily profitability, many consistently generate losses and continue to operate while economically insolvent. They can do this because all of their deposit liabilities are perceived to be fully guaranteed. Thus, their negative net worths are effectively off-budget liabilities of the government. At some point, taxpayers become reluctant to bear this increasing burden and the government is forced to recapitalize their institutions explicitly. To avoid repetitions of these costly policies, state owned banks should be completely privatized.