commercial banks were required to allocate between 20 and 60 percent (depending on bank size) of their sight deposits to agriculture. In India, 50 percent of bank deposits had to be invested in government bonds at below market rates and most of the remaining funds had to be directed to priority sectors like agriculture and small enterprises, with only about 20 percent of bank resources being freely allocated. In Thailand, bank branches established outside Bangkok after 1975 were subject to “local lending requirements,” mandating them to lend at least 60 percent of their deposit resources locally (Booth et al., 2001). Many countries also established refinance schemes, which allowed commercial banks to discount loans to selected sectors at preferential rates with the Central Bank. The rationale for these interventions is similar to that for the creation of public banks discussed above: private banks cannot internalize the positive externalities generated by some investments, and therefore, without government intervention, may fail to allocate enough funds to those projects with the highest social returns.

Another commonly used tool was the regulation of interest rates. Governments often established preferential rates for commercial lending to priority sectors, which were significantly lower than those on regular loans. In Colombia, for example, interest rates on directed credit were, on average, about 12 percentage points lower than those on nonpreferential credit over the period 1983-1987 (World Bank, 1990a). In the case of Turkey, this differential reached 36 percentage points between 1980 and 1982 (World Bank, 1989). A variation of this tool was the establishment of interest rate ceilings on deposits and/or loans, which could apply across the board or vary by sector or type of loan. Interest rate controls were expected to result in lower costs of financing and greater access to credit.<sup>23</sup> The extensive regulation of the banking sector resulted in a pervasive influence of the government on credit allocation in many developing countries. In Colombia, for example, directed credit accounted on average for 62 percent of total credit provided by commercial banks and financial corporations to industry and mining between 1984 and 1987 (World Bank, 1990b). In the case of Korea, the ratio of directed credit to total credit reached 60 percent at the end of the 1970s (Booth et al., 2001). In Brazil, government credit programs represented more than 70 percent of credit outstanding to the public and private sectors in 1987 (World Bank, 1989).

Despite the theoretical advantages of government-owned banks in broadening access to credit, the general experience with public banking in developing countries has not been successful. Most empirical studies suggest that public banks tend to do more harm than good (see Barth, Caprio, and Levine, 2001; Caprio and Honohan, 2001; IADB, 2004; and La Porta, Lopez-de-Silanes, and Shleifer, 2002). In particular, these studies— typically based on cross-country regressions—find that greater government participation in bank ownership is associated with lower levels of financial development, less credit to the private sector, wider intermediation spreads, greater credit concentration, slower

> 23 Broadening access to credit was not the only reason for the imposition of interest rate controls and directed lending requirements. Strict control and regulation of the banking system was also supposed to give monetary authorities a better control over the money supply and provided the government with easily accessible resources to finance public expenditures (see Roubini and Sala-i-Martin, 1992).

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