Government ownership
Many countries in the world neglected one of the important aspects of financial sector - the government ownership of banks. The attitude toward government ownership of banks was different across time. In 1960s and 1970s government ownership of banks was strongly supported by economists. But recent economic views support benefits of private ownership of banks.
Supportive views consider banking sector as ‘strategic economic sector’ along with utilities, education, etc. (Hawtrey, 1926) and point out that the government can improve the functioning of this sector, since the government can overcome market failures, exploit externalities and invest in socially desirable projects.
The supportive view includes three more narrow views:
1. The Social view argues that government plays the important roles in compensating of market imperfections that leave the socially desirable investments under-financed (Atkinson and Stiglitz 1980; Stiglitz 1994).
2. The development view focuses on the necessity of financial development for economic growth and stresses governments’ development goals. This view is associated with Alexander Gerschenkron (1962). He argues that in some countries private banks can channel funds for economic growth, but there are some countries where private banks are not able to attract sufficient funds to engage in financing profitable investment projects, because of public distrust to banking sector and absence of honest business practices. He stresses that government has sufficient information and incentives to promote socially desirable investments and in such countries it can help the development of lending to the private sector or simply subsidize private banks. As a consequence government ownership of banks promote the development of institutions of lending and the whole banking sector. Read more
Banking Auditing
From the perspective of the regulatory institutions market discipline can exist only under the supervision of efficient regulatory bodies. One of the changes that occurred in the institutional environment of the financial system was the separation of the supervision and regulatory functions of the Central Bank of Argentina by re-creating the Superintendency as a semi-autonomous unit within the Central Bank
The availability of the information is not the only important factor determining the efficiency of market principles. The quality of information determines the quality of market reaction on changes in the financial environment and behavior of institutions. To ensure reliable and qualitative information, in Argentina was introduced the system of compulsory auditing of financial institutions and their rating. Auditing ensures the validity of the published information. To have reliable auditing procedures, the Central Bank of Argentina has set guidelines for minimum auditing requirements. The Superintendency adopted a system similar to CAMEL banking rating used mainly for capital requirement regulations. According to this system, the banks with a lower rating were subject to higher capital requirements. Market participants used this information as a signal about the sanity of the financial institutions. Besides institutional rating system Argentina introduced Credit Rating requirements. This measure meant to allow less sophisticated investors to have access to decision-making reliable information. Credit rating was a good measure to ensure market-discipline. The problem is that it did not function too well for Argentina. Credit rating system was criticized because different financial institutions were rated by different agencies, and there was no comparability between them. Economists argue that some credit rating institutions gave higher rates then others did and because of this it could lead to false signals for the market.
Privatization of Public Banks
Market discipline is enhanced by its institutions both the regulatory ones and the direct financial institutions. To be able to create an effective market-based regulatory system, Argentina started to make changes in the ownership structure of the financial institutions. Because of the administrative organization of the country at the end of 1980’s, every province had at least one bank under its authority. This allowed the provincial authorities to have access to cheap finances from the provincial banks. In the eventuality of a crisis it was considered that the central bank would bail out the banks in trouble. Privatization of provincial banks was the solution for this situation. At the beginning of 1990’s the proper environment for privatizing financial institutions was in place but investors did not rush to invest in the system. The reason for this is that investors lacked confidence in the regulatory and economic framework of the country. They waited for the system to be tested. This happened through the Mexican crisis after which the number of privatized banks increased. This allowed Argentina’s financial institutions to react in a better way to market incentives. After the privatization the financial institutions could adapt to the new market circumstances changing their activity from financing the state to channeling credits towards economic agents. The privatization of provincial banks was enhanced by the creation of a fiduciary fund. At the same time, a second fiduciary fund was created to restructure the private banking system. These two funds were created as a measure for the liquidity problems that the banking system of Argentina was facing during the Tequila crisis.
Regulations on Domestic and Foreign Bank Entry
Another issue, which is paid much attention, is regulation on bank entry. There are two opposing views about the regulation on bank entry in economic theory.
The supporters of regulation on bank entry stress the following arguments:
1. Effective regulation allows only healthy banks to enter the banking market and thus increase stability.
2. In reality markets often fail, so competition may not lead to lower prices and increased choice or it may lead to excessive choice but not innovation. Banks with monopolistic power may have more reason to innovate.
3. Banks with monopolistic power are expecting to make high profits, thus acquire higher franchise value, which increases prudent risk-taking behavior of banks. On the contrary competition destroys franchise value. The unti-competitive regulation, such as deposit rate ceiling may not be efficient in reducing the competition in banking sector. The only way to reduce competition in banking and enhance bank profits, is the restriction on entry in banking sector. (Keeley, 1990, Demsetz et al., 1996).
4. Fewer the number of bank greater the incentive for screening, and consequently higher the proportion of funds that is allocated efficiently to high quality enterprises (Nicola Cetorelli, 2001).
5. Few large banks are easier to monitor (Ward) Read more
