2. 2 Agenda Public bank reform debate – let’s be realistic The “Sisyphus syndrome” The “enabling environment” “Development agency” functions

3. 3 Public Bank Reform Debate – Reality Therapy The problem: the access to financial services for under-served, large populations seems trapped in a low-level equilibrium Diagnoses often wrong and “solutions” may do more damage than good, but politicians and policy makers will not cease to worry The extreme policy solutions At one end: subsidized lending through public banks At the other end: privatization or liquidation of public banks and restrict the government’s role solely to “improving the enabling environment” The shortcomings of extreme solutions Subsidized lending—“being there, done that, and did not work” Enabling environment only—a political non-starter (and possibly wrong on technical economic grounds)

4. 4 Public Bank Reform Debate – Reality Therapy (cont.) Realistic Prop. 1: public banks or banking functions, as a means to pursue social/development policy objectives, are unlikely to disappear Even in developed countries Realistic Prop. 2: the role of public banks and type of reform needed depends on degree of fin’l development and int’l integration Across countries: mechanical transplants can backfire For the same country: what works in one epoch does not work in other Realistic Prop. 3: durable reforms tend find an adequate solution (or mitigation) of the “Sisyphus Syndrome”

5. 5 Sisyphus Syndrome: Banking vs. Social Policy Mandate The Sisyphus syndrome Social policy mandate => concentration on high risk/low return activities => systematic losses and recurrent recapitalizations => improvements in governance and supervision => re-orientation towards high return/low risk activities, in direct competition with private banks => insufficient attention to social policy mandate => political pressures to implement social policy mandate Privatization ignores social policy mandate Neither governance/supervision improvements, nor shift towards second-tier banking eliminate completely the Sisyphus syndrome

6. 6 Public Policy – The Enabling Environment Can’t go wrong in trying to improve enabling environment Attack underlying causes of shallow systems and other symptoms (abuse of collateral, short-termism, dollarization, etc.) Fiscal & monetary institutions to reduce macro volatility Contractual institutions Market-friendly regulatory and supervisory framework Financial market infrastructure Information on debtors Accounting and disclosure standards Corporate governance Contractual environment (movable collateral; shareholder & creditor rights; corporate insolvency proceedings)

7. 7 Public Policy – Intermediate Options? What to do with public sector banks? Fully separate terms of the contradiction Development bank without social policy mandate = private bank Social policy mandate without a bank => vehicle? Mixed solutions Increase emphasis on “development agency” – value functions to promote financial markets… …with non-subsidized second-tier public sector banking …exiting first-tier in asset side (e.g., Pahnal) or liability side (e.g., Financiera Rural) … and phase out lending and other banking activities as financial markets develop

8. 8 Public Policy – Development Agency Functions A “development agency”(DA) is not a bank. What is it? Flexible vehicle for focused public policy Operates principally with budgeted fiscal transfers Priorities are determined and scrutinized by Congress within the budgetary process Own evaluation criteria – e.g., benefits per unit of subsidy, subject to promotion of financial markets May or may not include risk taking Can be part of a second-tier development bank Illustrative cases The BANSEFI experiment—upgrading the cooperative sector NAFIN—creation of market for working capital through receivables FIRA—brokerage and bundling of hedges; structured finance operations; transactions cost subsidies