Financial Sector Assessment a handbook, Chapter 4 Assessing Financial Structure and Financial Development, imf and World Bank, August 2005

Box 4.4 Role of Government-Owned Banks
The disappointing performance—not only of govern-
ment-owned banks but also, more important, of sys-
tems in which the banks will play a major part—has 
been extensively documented in recent cross-country 
empirical literature (see Barth, Caprio, and Levine 
2004 and La Porta, Lopez-de-Silanes, and Shleifer 
2002). This performance does not imply that indi-
vidual countries and individual government-owned 
banks cannot perform exceptionally well along this 
dimension, but it does call for special attention to 
some dimensions along which many government-
dominated banking systems are known to underper-
form.
In the context of development assessment, the 
effect of government ownership is not simply a ques-
tion of embedded fiscal costs in a nonperforming or 
problematic loan portfolio reflecting the inheritance 
of politically or socially motivated loans. Such fiscal 
costs can imply a future national tax burden that will 
tend to slow growth. However, development assess-
ment must pay attention to subsidized and other 
loans made on other-than-commercial principles 
insofar as those loans tend to discourage private 
banks from incurring the cost of developing risk-
assessment techniques that are needed to lend into 
difficult segments, such as small and medium enter-
prises (SMEs) and rural areas. Government-owned 
banks often fail to deliver services to their stated 
target markets—with subsidies often being captured 
by large, state-owned borrowers or politically con-
nected firms—which can damage the performance of 
the sector as a whole.
The mission of government-owned banks should, 
therefore, be examined for compatibility with the 
competitive provision of financial services generally; 
their governance structures should also be scrutinized 
for consistency with the stated mission. 

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Financial Sector Assessment: A Handbook