# **1. Introduction**

Privatization programs implemented over the past quarter of a century have significantly contributed to the diminished role of state-owned commercial banks (SOCBs) globally. While the median share of SOCBs over total banking assets was 40 percent in developing economies and 36 percent in advanced economies in 1995, it had declined to 18 percent and 12 percent, respectively, in 2016 (Cull et al, 2018). This is despite the wave of temporary nationalizations of privatelyowned banks that occurred in many countries after recent banking crises, when bank bailouts (e.g. through direct capital injections and purchase of banks) were a common government response.<sup>2</sup> However, government ownership of banks remains still dominant in some parts of the world. For example, the market share of SOCBs is above 50 percent in countries such as Uzbekistan, the Russian Federation, Uruguay and Qatar and exceeds 40 percent in the South Asia region.

Privatization programs around the world have traditionally been motivated by the notion that extensive government ownership in banking is problematic for financial development, which, in turn, is crucial for economic development (Megginson, 2005).<sup>3</sup> Governments around the world play many important roles when it comes to establishing a growth-promoting financial system. In many countries, and especially in developing countries, governments go beyond their roles as economic policy makers, legal and informational infrastructure providers, and regulators, and directly intervene in their banking systems through government ownership of financial institutions (Demirguc-Kunt, 2012). The literature, however, points out that government ownership of banks can be detrimental to economic welfare as it is correlated with lower financial development and economic growth and higher systemic fragility (La Porta et al., 2002). There is plenty of banklevel evidence documenting underperformance of government-owned banks in terms of profitability, especially in developing countries (Mian, 2003; Iannotta et al., 2007; Micco et al., 2007). An important contributing factor to such grim outlook is the political nature of governmentowned banks which may provide politically motivated inefficient lending―so-called ‘political view’ of banking (e.g. Sapienza, 2003; Dinc, 2005; Englmaier and Stowasser, 2017).<sup>4</sup> There is also evidence showing that fundamental determinants of economic growth, such as institutional quality are critical in the relationship between government ownership of banks and financial and economic development outcomes as the negative correlation disappears and even turns to positive when institutional development is factored in (see for example the cross-sectional analysis in Andrianova et al., 2012). This ‘developmental’ view suggests that governments have longer term developmental goals, particularly addressing market failures which can be severe due to, for example, lack of economic institutions such as informational infrastructure (World Bank, 2012). Thus, government-owned banks with various objectives beyond profit maximization may provide funding to disadvantaged segments of the society. Such credit provision may have developmental benefits, but they are also very risky due to the informational problems. Indeed,

> 2 See Igan et al. (2019) for a discussion of government response after the global financial crisis (GFC).

> 3 There is a vast literature documenting the positive relationship between financial development and real economic outcomes (Levine, 2005; Popov, 2018, Brown and Earle, 2017; Levine and Warusawitharana, 2019). Also, privatization programs and related analyses involve not just financial markets and institutions but include almost all businesses. See, for example, Magginson (2017) for an extensive survey of recent research.

> 4 See Cull et al. (2018) for a recent analysis of trends in and implications of bank ownership for bank performance and competition, financial stability, and access to finance.

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