Why Privatize? The Case of Argentina's Public Provincial Banks

Abstract

Argentina's experience suggests that bank privatization may succeed only when accompanied by a sound, incentive-compatible system of prudential regulation.

Argentina has been a leader among developing countries in restructuring its banking sector. Clarke and Cull analyze the performance of those banks before and after privatization and estimate fiscal savings associated with privatizing Argentina's banks rather than keeping them public and later recapitalizing them.

The authors describe the process of privatization, including the creation of residual entities for the assets and liabilities of public provincial banks that private buyers found unattractive and the creation of a special fund (the Fondo Fiduciario) to convert the short-term liabilities of the residual entities into longer-term obligations.

They argue that the Fondo, created through cooperation between the Argentine federal government and the World Bank, was key in making privatization of the banks politically feasible. Argentina privatized roughly half of its public provincial banks.

The Argentine experience suggests that bank privatization may succeed only when accompanied by a sound, incentive-compatible system of prudential regulation. The regulatory environment affects a bank's solvency.

Improved regulation and supervision alone does not deliver the same benefits as improved regulation and supervision combined with privatization. The provincial banks that remained in the public sector did not demonstrate the same performance gains as privatized provincial banks. The decision to maintain a public provincial bank is a costly one.

Policymakers should expect privatization to pass through some or all of the following steps:

With respect to preprivatization audits, expect losses hidden in these banks to be larger than those indicated in prior audits.

If residual entities are created, expect them to hold a large share of the assets and liabilities of the old public provincial bank, if the quality of its loan portfolio was low.

Do not expect the price paid for the privatized entity (the so-called good bank) to be great, at least compared with assets and liabilities in the residual entity.

If the residual entity is large, the province will be confronted with substantial short-term liabilities. But with assistance and an aggressive asset recovery strategy, governments should be able to navigate their way through short-term difficulty.

The costs of privatization are less than the costs of future recapitalization, even if the near-term management of the residual entity does not go well.

This paper - a product of Regulation and Competition Policy, and Finance, Development Research Group - is part of a larger effort in the group to investigate the causes and consequences of bank privatization. The authors may be contacted at [e-mail] or [e-mail].