**25**

> resource allocation; when-as in state-owned banks-these incentives are weakened or absent, for political and other reasons, the results are far worse. Thus, although poorly regulated private banks have incurred large losses, some of the largest losses of recent times have been incurred by state banks. Evidence shows that state ownership tends to reduce competition through higher spreads on interest rates, leads to less stock exchange activity and non-bankn credit, and results irn

> greater concentration of credit allocation, usually to the largest 20 firms, often inefficient SCEs.

68. Persistent poor performance of state-owned baniks has led governments to turn to privatization. The experience of countries such as Argentina, Chile, Mexico and others demonstrates the special case of bank privatization-and the need to phase and coordinate such efforts with the development of regulatory frameworks (Box 5).

IEnx g: ]?rinivsammqtoim OfEBu Bank privatization has produced substantial savings and gains for a number of governments-though their experience generally reveals the complexity and difficulty of such reforms and reveals lessons on how it might be better conducted. Argentina reduced state ownership of banking assets from 50 percent in 1990 to half that by 2000, motivated mainly by the high costs of maintaining state ownership. The savings from privatizing tie provincial banks are impressive, amounting to one-third of a typical province's public expenditure. Prior to privatization the banks had a high percentage of non-performning loans (50 percent in 1991), which were removed from the balance sheet as part of a clean-up prior tQ sale. Following divestiture, the share of non-performing loans then rose again, but this time to levels comparable with the better private banks in Argentina. Moreover, costs to revenue ratios and the terms of credit extendaed to SOEs by these newly privatized entities more closely reflected that of other, better-performing, private banks.

Banks are very special cases, in that their problems can broadly affect other firms and portions of the economy. In weak regulatory environments, poorly designed and irnplemented bank privatization have provoked crises (e.g. Chile in the late 1970s, and Mexico in the early 1990s). While these rapid and insufficiently thought-out privatizations were undesirable, extended state ownership can have an equally detimental impact, as the Czech case, noted above, illustrates. The dilemma is that although hasty privatization in weak environments can lead to problems, excessive delays can undernine real sector reforns and lead to high costs.

Privatization of banks remains the preferred strategy, but it requires far more care, caution and preparation than for the normal commercial firm. The Argentine case, and that of Hungary, shows the need for sequencing the phasing out of state ownership over time with improvements in the regulatory environment. One mechanism aimed at maintaining value in the rmn-up to sale is to link manager compensation to the post privatization value of the bank (e.g. through stock options as happened in Poland). Involving reputable and experienced foreign owners is very often part of a successful strategy. They can bring the necessary skills, products and training to the host country and provide better allocation decisions.

|**SourocWorldBank 2001**|
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(m~ Tranaparaemy 69. Lack of transparency leads to allegations of corruption and provides ammunition to political and other opponents, creates backlash from investors and the public at large, and threatens to halt privatization and liberalizing reform in general. In Argentina, and Latin America