Reforming and Privatization of Public Sector Banks

1
Reforming and Privatization of Public Sector Banks

• By
• Louis A. Kasekende
• Executive Director, World Bank
• April 9,2003.

2
Introduction

• Objectives of financial sector reforms
• Why Reform or Privatize Public Sector Banks?
• Ugandas Experience-Cost of Restructuring UCBL.
• What was Done Wrong in Ugandas Case?
• What did the Government do Right?
• Political related problems in Restructuring
  Public Sector Banks.
• Role of International Community in dealing with
  Public Sector Banks.
• Lessons from Uganda experience.

3
Objectives of restructuring

• Macro-economic stability
• Promoting GDP growth
• Financial Deepening

4
Why Reform or Privatize Public Sector Banks

• Poor Corporate Governance, including insider
  lending, reckless concentration in credit,
  frauds, falsification of financial accounts.
• An inefficient financial sector leads to
  misallocation of resources at a big cost to the
  economy.
• Direct financial losses when taxpayers money is
  used to protect depositors due to accumulation of
  Non-performing assets.

5
Continued.

• Poses macro-economic management challenges e.g
  complication of management of monetary policy.
• Cost to the general public due to high cost of
  capital, lack of adequate resources to fund good
  private investments.
• Continued intervention from the Central Bank
  weakens the Monetary Authority often leading to
  recapitalization and restructuring of the Central
  Bank at a very high cost.
• Major impediment to enhancing competition and
  efficiency, especially in Credit markets.

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Ugandas Experience-Cost of Restructuring UCBL

• Costly in terms of the financial resources
  expended in compensating or protecting
  depositors, macroeconomic management challenges
  and in terms of costs borne by the public.
• -Preparation of UCBL for privatization cost 2
  of GDP in 1998.
• -Central Bank recapitalization cost 1 of GDP.
• .

7
What was Done Wrong in Ugandas Case

• Took too long to implement restructuring and
  privatization. Reform of UCBL was supposed to
  start in 1992, however, transfer of its bad debts
  to NPART took until 1997. The delay was costly on
  two counts
• - First, it impeded competition and efficiency
  especially in the credit market
• - Second, losses incurred through mismanagement
  of the public sector banks that proved costly for
  the tax payers Restructuring UCBL cost 2 of GDP
  in 1998, and recapitalisation of the Central Bank
  cost 1 of GDP.

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What was Done Wrong in Ugandas Case

• Sold to a buyer without capital, banking
  reputation or expertise, which secretly assigned
  the shares to another bank, further weakening the
  sector.
• Central Bank intervention in 1999 proved
  protracted (1999-2002) and was in conflict with
  the regulatory role.
• Regulatory Forbearance
• Joint Responsibility between the BOU and Ministry
  of Finance.

9
What did the Government do Right?

• Implementation of Market Based Policies-which are
  relatively more efficient and effective that
  administrative controls in the allocation of
  resources.
• Political Commitment in the later stages of the
  reform ensured consistent implementation of
  agreed programs and protection of the reform
  process from interest groups and political
  interference.

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What did Government do Right? Continued.

• Establishing the policy makers credibility
  through maintaining a stable macro-economic
  environment.
• Commitment to fiscal reforms and fiscal
  discipline.

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Political related Problems in Restructuring
Public Sector Banks

• Problem of selling reforms to the politicians who
  fear to loose the benefits associated with
  directed credit, including loss of political
  influence
• Managing the tension between strict prudential
  requirements intended to promote a strong
  financial sector and allocation of resources to
  attain development goals as determined by the
  Government
• Slow process of restructuring and divestiture
  because of political interests risks asset
  stripping and therefore reducing the market
  price.

12
Continued

• The privatization process could be hijacked by
  the politicians resulting into failures in the
  process with huge financial costs.
• Blurred delineation of roles and responsibility
  between the Central Bank and the Ministry of
  Finance.
• Fear that the new owners will contract services
  especially in rural areas.
• Inverse relationship between price and quality of
  buyer, could sell at low price but to reputable
  buyer.

13
Role of International Community in dealing with
Public Sector Banks.

• Provide resources to restructure public banks,
  however, effective solution is divestiture,
  including privatization. Donor led restructuring
  did not succeed.
• Support the Government in due diligence and
  advisory services, because this is highly
  specialized.
• Sharing country experiences on best practices,
  and helping in the standardization of reporting
  and information systems.
• Independent auditing of the restructuring process
  to assure credibility.

14
Lessons from Ugandas Experience in restructuring
Public Sector Banks

• First, the best strategy for dealing with
  troubled government owned banks should be to sell
  them as quickly as possible to a reputable
  investor.
• Genuine restructuring requires hard decisions
  which governments rarely have the incentives or
  political courage to take.
• It is better to leave as much of the
  restructuring as possible to the new owners even
  if this may require providing them with financial
  incentives.

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Lessons continued.

• The primary objective of a government in
  privatizing a state owned bank should be to sell
  the bank to an investor who can best ensure the
  safety of the banks deposits.
• The best investor to purchase and run a public
  sector bank is a large, well established private
  sector bank with substantial financial, technical
  and management resources at its disposal, and
  crucially, a long established international
  banking reputation to protect.

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Lessons Continued..

• Political commitment to reform is critical, to
  ensure consistent implementation of agreed
  programs and protection of the reform process
  from interest groups.
• Neither government nor donors have adequate
  incentives to ensure sound management of a bank
  and consequently, neither should play a leading
  role in bank governance.
• Do not let statutory management drag on in fact
  try and avoid it in the the first place.

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Lessons Continued..

• Dont avoid after-the-fact accountability in
  fact prepare for it.
• Dont sell under any circumstances, because
  credibility of Government policy could be at
  risk.