POLICY RE SEARCH WORKING PL"APER 2325 Banking 'Systems Aroun(d Empirical results highlight the downside of imposing certain the G lobe regulatory restrictions on commercial bank activities. DoReg t and Ownership ff Regulations that restrict banks' ability to engage in securities Performance and Stability? activities and to own nonfinancial firms are closely James R Bath associated with more Gerard Caprio, Jr., instability in the banking Ross Levine sector. And keeping commercial banks from engaging in investment banking, insurance, and real estate activities does not appear to produce positive benefits. The World ]Bank Development Research Group Finan ce U I POLICY RESEARCH WORKING PAPER 2325 Summary findings Barth, Caprio, and Levine report cross-country data on argue confidently that restricting commercial banking commercial bank regulation and ownership in more than activities benefits - or harms - the development of 60 countries. They evaluate the links between different financial and securities markets or industrial regulatory/ownership practices in those countries and competition. both financial sector performance and banking system There are no positive effects from mixing banking stability. and commerce. They document substantial variation in response to * Countries that more tightly restrict and regulate the these questions: Should it be public policy to limit the securities activities of commercial banks are substantially powers of commercial banks to engage in securities, more likely to suffer a major banking crisis. Countries insurance, and real estate activities? Should the mixing of whose national regulations inhibit banks' ability to banking and commerce be restricted by regulating engage in securities underwriting, brokering, and dealing commercial bank's ownership of nonfinancial firms and - and all aspects of the mutual fund business - tend to nonfinancial firms' ownership of commercial banks? have more fragile financial systems. Should states own commercial banks, or should those * The mixing of banking and commerce is associated banks be privatized? with less financial stability. The evidence does not They find: support admonitions to restrict the mixing of banking There is no reliable statistical relationship between and commerce because mixing them will increase restrictions on commercial banks' ability to engage in financial fragility. securities, insurance, and real estate transactions and a) * On average, greater state ownership of banks tends how well-developed the banking sector is, b) how well- to be associated with more poorly developed banks, developed securities markets and nonbank financial nonbanks, and stock markets and more poorly intermediaries are, or c) the degree of industrial functioning financial systems. competition. Based on the evidence, it is difficult to This paper - a product of Finance, Development Research Group - is part of a larger effort in the group to examine the effects of financial sector regulation. Copies of the paper are available free from the World Bank, 1818 H Street NW, Washington, DC 20433. Please contact Agnes Yaptenco, room MC3-446, telephone 202-473-1823, fax 202-522-1 1S5, email address ayaptenco@worldbank.org. Policy ResearchWorking Papers are also posted on theWeb atwww.worldbank.org/ research/workingpapers. The authors may be contacted at jbarth@business.auburn.edu, gcaprio@worldbank.org, or rlevineC?csom.umn.edu. April 2000. (60 pages) The Policy Research Working Paper Series disseminates the findings of work in progress to encourage the exchange of ideas about development issues. An objective of the series is to get the findings out quickly, even if the presentations are less than fully polished. The papers carry the names of the authors anzd should be cited accordingly. The findings, interpretations, and conclusions expresse-d in this paper are entirely those of the authors. They do not necessarily represenit the view of the World Banzk, its Executtive Directors, or the countnies they represent. Produced by the Policy Research Dissemination Center Banking Systems Around the Globe: Do Regulation and Ownership Affect Performance and Stability? James R. Barth, Gerard Caprio, Jr., and Ross Levine* *Finance Department, Auburn University and Capital Studies Division, Milken Institute Qbarthp.business.auburn.edu); Financial Strategy and Policy Group and Development Research Group, World Bank (czapriodworldbank.org); and Finance Department, Carlson School of Management, University of Minnesota (rlevinepcsom.umn.edu), respectively. The authors benefited from comments by Joseph Stigliiz, Mark; Gertler, Rick Mishkin, and seminar participants at the NBER Conference on Prudential Supervision: What Works and What Doesn't, January 13-15, 2000, Islamorada, Florida. We gratefully acknowledge the excellent research assistance provided by Teju Herath, Cindy Lee and Iffath Sharif 1 I. Introduction Financial systems in countries throughout the world range from fairly rudimentary to quite sophisticated amd from extremely fragile to relatively stable. A growing number of studies provide empirical evidence showing that well-functioninig financial systems accelerate long-run economic growth by allocating funds to more productive investments than poorly-developed financial systems.1 This convincing evidence has intensified calls for financial-sector reforms that improye financial-system performance and thereby promote economic development. Stable banking systems are an important componenit of well-functioning financial systems as has been vivzidly demonstrated by recent developmaents around the globe. When banking or, more generally, financial systems temporarily break down or operate ineffectively, the ability of fiims to obtain funds necessary for continuing existing projects and pursuing new endeavors is curtailed. Severe disruptions in the intermediation process can even lead to financial crises and, in some cases, undo years of economic and social progress. Since 1980 more than 130 countries have experienced banking problems that have been costly to resolve and disruptive to economic development. This troublesome situation has led to calls for banking reform by national governments and such international organizations as the World Bank and the International Monetary Fund. Apart from some fairly general proposals for reform, such as greater transparency and an international financial authority, there are relatively few proposals 'For cross-country evidlence supporting this relationship, see King and Levine (1993a,b), Levine and Zervos (1998), Beck, Levine, and Loayza (2000), and Levine, Loayza, and Beck (2000). In a similar vein, Rajan and Zingales (1998) provide cross-country, industry-level evidence. Demirguc-]Kunt and Maksimovic (1998) show that financial development increases economic growth using firm-level data, while Wurgler (1999) shows the benefits of financial development for the allocation of investment across industries based upon their growth opportunities. In a related context, Jayratne and Strahan (1996) show that liberalizing restrictions on inter-state branching in the United States has led to more rapid state growth. More generally, Gertler (1988) and Levine (1997) provide literature reviews on the importance of fimancial systems. 2 for specific structural, regulatory and supervisory reforms.2 This is understandable because there is relatively little empirical evidence to support any specific proposal. To determine specific banking reforms that will limit bank fragility and promote well- functioning financial systems requires two steps. First, one must obtain cross-country data on bank ownership, regulation and supervision. This enables one to establish the extent to which banks operate in different ownership, regulatory and supervisory environments. Only by knowing the regulatory environment can one really know what a "bank" is or what a "bank" does in different countries. Surprisingly, such information is not widely available from official sources for a wide range of countries. Yet, in practical terms, it is the regulatory environment that actually defines what is meant by the term "bank." Second, one must use such data to assess the relationships between different environments and bank performance or, more generally, financial performance. Only by doing this can one really know whether "banks" matter. In other words, such an effort enables one to better identify those bank ownership, regulatory and supervisory practices that will foster financial stability and enhance long-rum economic growth. The purposes of this paper are: (1) to collect and report cross-country data on bank regulation and ownership, and (2) to evaluate the links between different regulatory/ownership practices and both financial-sector performance and banking-system stability. In so doing our paper helps fill the gap between questions posed by policymakers about how to reform banking systems and currently available evidence on the issue produced by researchers. The paper in several respects substantially extends the preliminary investigation reported in Barth, Capiio, and 2 The most notable exception is the Basel Committee on Banking Supervision's proposed new capital adequLacy framework, which provides for more risk classes and raises the possibility of using credit ratings to set risk weights. For more information, see Caprio and Honohan (2000). 3 Levine (1999). This is done by enlarging our earlier sample of 45 countries to more than 60 countries; updating existing data; materially improving the quality of the data; adding new information on the banlking environment in different countries; and testing additional hypotheses. Documentation is provided showing the substantial cross-country variation in regulatory restrictions on various activities of banks, in legal restrictions on the mixing of banking and commerce, ancl in barnk ownership structure. Although the socio-economic determinants of regulatory cho6ces by governments are examined, the focus is on examining which types of regulatory practices and ownership structures are associated with well-functioning, stable banking systems. Motivated by a long and divisive policy debate (es,pecially in the United States) 3 over the extent to which the activities of banks should be limited, this paper examines the following questions: 1. D3o countries with regulations that impose tighter restrictions on the ability of commercial banks to engage in securities, insurance, and real estate activities have (,a) less efficient but (b) more stable financial systems? 2. IDo countries that restrict the mixing of banking and commerce - both in terms of banks owning nonfinancial firms and nonfinarncial firms owning banks -- have (a) less efficient but (b) more stable banking systems? 3. ]Do countries in which state-owned banks play a large role have more poorly iFunctioning financial systems? Those who favor restricting commercial banks to "'traditional" deposit taking and loan making argue i:hat there are inherent conflicts of interest that arise when banks engage in such activities as securities underwriting, insurance underwriting, real estate investment, and owning 3 For reviews of the literature regarding this issue, see Kwan and Laderman (1999) and Santos (1998a,b,and c). Also, see Barth, Brumbaugh and Yago (1997), Kane (1996), Kroszner and Rajan (1994) and White (1986) for discussions of some of these issues. On November 12, 1999, laws in the U.S. restricting banks from engaging in securities and insurance activities were repealed [see Barth, Brumbaugh and Wilcox (2000)]. 4 nonfinancial firms. Expanding the array of permissible activities, moreover, may provide greater opportunities for moral hazard to distort the investment decisions of banks, especially when they operate within a deposit insurance system [Boyd, Chang, and Smith 1998]. Furthermore, in an unrestricted environment, the outcome may be the existence of a few large, functionally diverse, and dominant banks that could (1) complicate monitoring by bank supervisors and market participants4 and (2) lead to a more concentrated and less competitive nonfinancial sector. Relatively few regulatory restrictions on commercial banking activities and relatively few legal impediments to the mixing of banking and commerce may therefore produce less efficient and more fragile financial systems. Those who favor substantial freedom with respect to the activities of commercial banks argue that "universal" banking creates more diversified and thereby more stable banks. Fewer regulatory restrictions may also increase the franchise value of banks and thereby augment incentives for bankers to behave more prudently, with positive implications for bank stability. Furthermore, the opportunity to engage in a wide range of activities enables banks to adapt and hence provide the changing financial services being demanded by the nonfinancial sector more efficiently. Thus, fewer regulatory restrictions on the activities of commercial banks and the mixing of banking and commerce may produce more efficient and more stable financial systems.5 The lack of appropriate cross-country data, however, has impeded the ability to examine the relationship between commercial bank regulations and both the functioning and stability of the fmancial system. 4As Camdessus (1997) states: "... the development of new types of financial instruments, and the organization of banks into financial conglomerates, whose scope is often hard to grasp and whose operations may be impossilble for outside observers - even (sic!) banking supervisors - to monitor." 5 Mishkin (1999 p.686), furthermore, states that "The benefits of increased diversification opens up opportunities for reform of the banking system because it makes broad-based deposit insurance less necessary and weakens the political forces supporting it." 5 This paper attempts to rectify this situation arnd in so doing provides the following answers to the questions posed above. First, we do not find a reliable statistical relationship between regulatory restrictions on the ability of commercial banks to engage in securities, insurance, and r eal estate activities and (i) the level of banking sector development, (ii) securities market and nonbank financial intermediary development, or (iii) the degree of industrial competition. Indeed, based on the cross-country evidence, it would be quite difficult for someone to argue confidently that restricting commercial banking activities impedes -- or facilitates -- financial dLevelopment, securities market development, or industrial competition. We do, however, find that regulatory restrictions on the ability of banks to engage in securities activities tend to be associated with higher interest rate imargins for banks.6 Thus, even though there may be some negative implications for bank efficiency due to restricting commercial bank activities, the main message is that there is little relatiornship between regulatory restrictions on banking powers and overall financial development and industrial competition. Second, in terms of stability, we find a strong and robust link to the regulatory environment. Countries with greater regulatory restrictions on the securities activities of commercial banks have a substantially higher probability of suffering a major banking crisis. More specifically, couxntries with a regulatory environmLent that inhibits the ability of banks to engage in the businesses of securities underwriting, brokering, dealing, and all aspects of the mutual fund business tend to have more fragile financial systems. The positive link between regulatory restrictions and major or even systemic banking crises, moreover, does not appear to be due to reverse causation. 6 Tis may reflect the fact that in such a situation banks are limitecl to the extent they can cover costs with fee income. 6 Third, we find no beneficial effects from restricting the mixing of banking and commerce. We specifically examine (1) the ability of banks to own and control nonfinancial firms and (2) the ability of nonfinancial firms to own and control commercial banks. There is not a reliable relationship between either of these measures of mixing banking and commerce and the level of banking sector development, securities market and nonbank financial intermediary development, or the degree of industrial competition. Fourth, restricting the mixing of banking and commerce is associated with greater financial fragility. Whereas restricting nonfinancial firms from owning commercial banks is unassociated with financial fragility, restricting banks from owning nonfinancial firms is positively associated with bank instability. We find that those countries that restrict banks from owning nonfinancial firms have a robustly higher probability of suffering a major banking crisis. Thus, one of the major reasons for restricting the mixing of banking and commerce - to recluce financial fragility - is not supported by the cross-country evidence presented in this paper. This finding is particularly notable in the wake of the East Asian crisis and the haste with which many have concluded that all things Asian - including close ownership links - lead to crises. Besides the fact that for decades such links did not produce crises, our research shows that neither concerns about financial sector development nor financial fragility should prompt calls for a more restrictive environment.7 Fifth, greater state ownership of banks tends to be associated with more poorly developed banks, non-banks, and securities markets. In an independent study using alternative measures of bank ownership, La Porta, Lopez-de-Silanes, and Shleifer (1999) also examine the relationship between government ownership and financial development. They convincingly 7 For a view on ownership links that is relatively unfashionable today, see Lamoreaux (1994). 7 show that government ownership retards financial development. Thus, even though the proponents of state ownership of banks argue that it helips overcome informational problems and better directs scarce capital to highly productive projects, the data assembled here and by La Porta, Lopez-de-Silanes, and Shleifer (1999) tell a different story. On average, greater state ownership of banks tends to be associated with more poorly operating financial systems. Besides (iocumenting the substantial cross-country variation in commercial banking regulations and. ownership, our analysis of the data highlight some negative implications of imposing regulatory restrictions on the activities of conmmercial banks. Specifically, regulations that restrict the ability of banks to (a) engage in securities activities and (b) own nonfinancial firms are closely associated with greater banking sector instability. The analyses, moreover, suggest no countervailing beneficial affects from restricting the mixing of banking and commerce or from restricting the activities of banks in the areas of securities, insurance, and real estate. The research upon which this paper is based is still ongoing, so our paper should be viewed as a progress report. We are collecting considerably more information about bank structure, regulation and especially supervision, and t]he samnple of countries is being enlarged. The new cross-country data that we are collecting on the supervisory environment will permit us - and others - to investigate more fully the interrelated issues of regulatory and supervisory practices or policies. Nonetheless, our efforts to date represent substantial progress on understanding what a "bank" does in different countries and whether it matters. By publishing the existing data anid reporting the empirical results, we are lhoping both to contribute to the ongoing debate over appropriate banking reforms and to facilitate further research on this important topic. 8 II. Bank Regulations & Ownership vs. Financial Development & Industrial Competition The first section in this part examines the relationship between commercial banking regulations and state ownership of banks on the one hand and the level of financial sector development and the degree of industrial sector competition on the other. The objective is to assess whether governments that (1) restrict the activities of banks, (2) inhibit the mixing of banking and commerce, and (3) own a substantial fraction of the banking sector tend to have (a) more or less efficient and developed banks, (b) better or worse functioning securities markets and nonbank financial intermediaries, and (c) greater or lesser competition in the nonfinancial sector. To examine all these issues, we have constructed an extensive data set. The section's first subsection introduces the regulatory and ownership variables. We define the variables, briefly describe their construction, and present summary statistics. The second subsection briefly describes the various measures of financial sector development and industrial competition that are employed. The final subsection presents our regression results and a summary of our conclusions. A. Regulatory Restrictions and Ownership 1. Data Collection and Definitions We have constructed indices on the degree to which govermnent regulators permit commercial banks to engage in securities, insurance, and real estate activities. We have also constructed indices on the degree to which regulators permit commercial banks to own nonfinancial firms and vice versa. Furthermore, we have obtained information on the degree of state ownership of commercial banks. We have assembled this data and checked its accuracy 9 through a number of different channels. Specifically, we have obtained the data used in this paper primarily frorn irternational surveys conducted independently by the Office of the Comptroller of the Currency (OCC) and the World Bank. We have confirmed the responses for as many countries as possible using information from Barth, Nolle, and Rice (2000), the Institute of International Bankers (Global Survey, various years), Euromoney (Banking Yearbook, various years), and various central bank and bank regulatory agency publications. When inconsistencies have arisen, we have - through the OCC and 'World Bank - attempted to communicate with Ihe relevant national regulatory authorities to resolve them. While some remaining problems urndoubtedly exist, we nonetheless believe we have assembled the most accurate and comprehensive data on commercial bank regulatory policies to date. Bank activities: We use measures of the degree to which national regulatory authorities allow commercial banks to engage in the following three "nontraditional" activities: Securities: the ability of commercial banks to engage in the business of securities underwriting, brokering, dealing, and all aspects of the mutual fund industry. Insurance: the ability of banks to engage in insurance underwriting and selling. Real Estate: the ability of banks to engage in real estate investment, development, and managerment. We have assessed each country's regulations concerning these activities and rated the degree of regu]Latory restrictiveness for each activity frcm 1 to 4, with larger numbers representing greater restrictiveness. The definitions of the 1 through 4 designations are as follows: 10 (1) Unrestricted - A full range of activities in the given category can be conducted directly in the commercial bank. (2) Permitted - A full range of activities can be conducted, but all or some must be conducted in subsidiaries. (3) Restricted - Less than a full range of activities can be conducted in the bank or subsidiaries. (4) Prohibited - The activity cannot be conducted in either the bank or subsidiaries. Mixing banking and commerce: We have constructed two measures of the degree of regulatory restrictions on the mixing of banking and commerce. Again, we have rated the regulatory restrictiveness for each variable from I to 4. The variable definitions and the definitions of the 1-4 designations are as follows: Nonfinancial Firms Owning Banks: the ability of nonfinancial firms to own and control banks. (1) Unrestricted - A nonfinancial firm may own 100% of the equity in a bank. (2) Permitted - Unrestricted with prior authorization or approval. (3) Restricted - Limits are placed on ownership, such as a maximum percentage of a bank's capital or shares. (4) Prohibited -No equity investment in a bank. Banks Owning Nonfinancial Firms: the ability of banks to own and control nonfinancial firms. (1) Unrestricted - A bank may own 100% of the equity in any nonfinancial firm. (2) Permitted - A bank may own 100% of the equity in a nonfinancial firm, but ownership is limited based on a bank's equity capital. (3) Restricted - A bank can only acquire less than 100% of the equity in a nonfinancial firm. (4) Prohibited - A bank may not acquire any equity investment in a nonfinancial firm. 11 State ownership: We also have data on the degree of state ownership of banks: Stateowned Bank Assets: State-owned bank assets as a share of total commercial bank assets. In terms of timing, the data represent the regulatory environment in 1997. In an earlier study, we collected information on these regulations for a smaller sarnple of countries in 1995. Even though there were very few regulatory changes, some of our assessments changed, as more information became available. We discuss the issue of regulatory change as it relates to our findings in greater detail below when we examine the linkages between the regulations and banking crises. 2. Summary Statistics Table 1 lists ithe numerical values for each of ihe six indictors for the regulatory environment. We also compute a summary index of the first four indicators of the regulatory restrictions imposed on banks. Specifically, Restrict equals the average of Securities, Insurance, Real Estate, and Barks Owning Nonfinancial Firms. Table 2 presents summary statistics indicating the extensive cross-country variation in the data. For example, there were nine countries with very restrictive regulatory systems (Restrict > 3): Japan, Mexico, Rwanda, Ecuador, Barbados, Botswana, Indonesia, Zimbabwe, arnd Guatemala. The value for the United States is 3. There were nine countries that pennitted wide latitude in terns of commercial banking activities (Restrict < 1.75): Switzerland, Suriname, South Africa, the Netherlands, Luxembourg, United Kingdom, New Zealand, Austria, amd Israel. Furthermore, there is substantial representation in terms of both geographical location and income level of the sample countries. Besides ihe 24 OECD countries, there are 14 Latini American countries, 11 countries 12 from Sub-Saharan Africa, and 12 from Asia, as well as 5 countries from northern Africa and (non-OECD) Europe. At the outset, we expected to observe that governments that restricted banking activities in one area, say securities activities, would also restrict banking activities in other areas, like real estate activities. We therefore expected extremely large, positive correlations among the Securities, Insurance, Real Estate, Banks Owning Nonfinancial Firms, and Nonfinancial Firms Owning Banks variables. There is clearly a positive association among the different regulatory variables, but it is not extremely high. Table 3 shows the correlations among the six regulatory/ownership indicators. While Securities and Real Estate are significantly correlated with three of the four other regulatory indicators at the 0.05 significance level, Insurance and Banks Owning Nonfinancial firms are significantly correlated with only two of the four other indicators, and Nonfinancial Firms Owning Banks is not significantly correlated with any of the others. Furthermore, the correlation coefficients on the statistically significant relationships are all below 0.50. Thus, there is cross-country diversity in the individual regulatory restrictions. This suggests that it is important to examine each of the regulatory variables individually, rather than only using a single index such as Restrict to capture the regulatory environment. Thus, even though we report the results on Restrict, we focus our discussion almost entirely on the individual regulatory variables because they provide much more information. B. Financial Sector Performance and Industrial Competition: Definitions This subsection describes the paper's indicators of bank development, securities market development, and industrial competition. For each category, we considered a wide array 13 of measures. We highlight the measure presented in the tables as well as mention the other measures that were stucdied. 1. Bank Development Net Interest Margin equals net income divided by total assets and is the average value over the 1990-95 period (source: Beck, Demirguc..Kunt, and Levine 1999). While recognizing that: many iFactors influence interest rates besides the degree of efficiency of bank operations, we include this in our measures of bank development because of its wide use in the literature and its empirical availability. Private Credit equals claims on the private sector by deposit money banks and other financial institutions as a share of GDP and is the average value over the 1980-95 period (source: Levine, Loayza, and Beck 2000). This is a general and widely used measure of financial sector development. We also used such other measures as: (a) claims by deposit money banks on the private sector, (b) liquid liabilities, and (c) total assets of the commercial banking sector relative to GDP in 1997. These alternative measures do not alter any of the conclusions, however. Bank Concentration equals the share of total assets of the three largest banks and is the average value over the 1990-95 period (source: Beclk, Demirguc-Kunt, and Levine 1999). This variable captures the degree of concentration in the banking industry. We also used such measures as the: nurnber of banks per capita and the share of total assets of the single largest bank. These alternative measures produced similar results, hiowever. 2,. Securities Development Totall Value Traded equals the value of donmestic equities traded on domestic exchanges divided by GDP, averaged over the 1980-95 period (source: Beck, Demirguc-Kunt, 14 and Levine 1999). Levine and Zervos (1998) show that stock market liquidity is important for economic growth. They further note that it is liquidity per se, not equity market capitalization, that is crucial. We also used measures of primary market activity and bond market activity. Specifically, we collected information on the (i) total amount of outstanding domestic debt securities issued by private or public domestic entities as a share of GDP, (ii) total equity issues as a share of GDP, and (iii) private, long-term debt issues as a share of GDP. While these alternative measures yield similar results, they are available for far fewer countries. Nonbank Credits equals nonbank financial institution claims on the private nonfinancial sector as a share of GDP and is the average value over the 1980-95 period (source: Beck, Demirguc-Kunt, and Levine 1999). To assess the robustness of our findings, we also used direct measures of the size of particular nonbank financial institutions, including insurance companies, mutual funds, and private pension funds. Again, these alternative measures produced similar findings, but they are available for far fewer countries. 3. Industrial Competition Industrial Competition is based upon a survey question in which respondents indicate the degree to which they agree with the following statement: "market domination is not common in your country" (source: Dutz and Hayri 1999). To examine whether commercial bank regulatory restrictiveness is associated with industrial competition, we also examined such measures as: (i) the degree of business freedom and competition, (ii) the percentage of economic activity controlled by the 30 largest companies, and (iii) the perceived effectiveness of antitrust policy. These alternative measures produced similar results, however. 15 C. Empirical Results The objective here is to present a rudimentary, first-cut empirical evaluation of the relationship between: 1. bank regulatory restrictions (a) bank development 2. mixing banking and commerce and (b) securities development 3. state ownershlip of banks (c) industrial competition. Future work will deal more rigorously with specific hypotheses about such relationships as well as with numercus methodological issues. Toward ihis end, we first present the simple correlations between each of the measures of the regulatory/ownership environment and the indicators of bank development, securities development, and industrial competition. We then present regression results in which we control for economic development (i.e., the level of real per capita GDP) and an index of the quality of governnent. More specifically, Development equals the logarithm of real per capita GDP in 1980 (source: Penn World Tables). Good Governmentt equals the summation of three variables: (i) risk of expropriation by the government, (ii) degree of corruption, and (iii) law and order tradition of the country, with greater values signifying less risk of expropriation, less official corruption, and a greater law and order traditioji (source: LaPorta, Lopez-de-Silanes, Shleifer, and 'vishny (henceforth LLSV) 1999). It is important to control for other features o:f the environment in evaluating the relationship between the commercial bank regulatory/ownership regime with financial development and indutstrial competition. For instance, there may be countries in which corrupt governments that clo riot enforce the rule of law and tend to expropriate private property have 16 selected policies that have led to both poor economic performance and underdeveloped financial systems. If such governments also uniformly enact certain types of commercial bank regulations, we would not want to interpret a significant correlation between bank regulations and financial development as representing an independent link unless we control for the quality of the government. We therefore use the simple measures described immediately above to control for some natural characteristics of the policy environment in assessing whether there is an independent link between the commercial bank regulatory/ownership structure and the financial/industrial system more generally. These variables to some extent also serve as a proxy for the overall quality of bank supervision. Heteroskedasticity-consistent standard errors are reported for these regression results. The empirical findings are startlingly under-whelming as summarized in Tables 4-10. First, it would be very difficult for someone to argue confidently that restricting the activities of commercial banks adversely affects financial development, securities market development, or industrial competition. At the same time, it would be very difficult for someone to argue confidently that easing restrictions on commercial banking activities facilitates greater financial development, securities market development, or industrial competition. Specifically, although countries with more restrictive regulations tend to have less well-developed banking sectors and securities markets as well as lower levels of industrial competition, the correlations are frequently not statistically significant nor do they retain their values when controlling for oither factors in a regression context. Indeed, Securities, Insurance, and Real Estate do not enter any of the regressions significantly when one includes Private Credit, Bank Concentration, Industrial Competition, Total Value Traded, or Non-Bank Credits. As discussed above, these conclusions 17 are robust to a wide assortment of measures of banking sector development, industrial competition, and securities market development. Second, it would be very difficult to argue that restricting the mixing of banking and commerce - either by restricting bank ownership of norfinancial firms or by restricting nonfinancial firm ownership of banks -- impedes or facilitates overall financial development or industrial competition. Banks Owning Nonfinancial Firms and Nonfinancial Firms Owning Banks do not enter any of the regressions significantly. These findings hold when using alternative measures oi banking sector development, industrial competition, and securities market development. Third, there is some evidence that restricting commercial banks from securities and real estate activities tends to raise net interest margins. Thus., restricting commercial banks from securities and real estate activities may have some negative implications for bank efficiency. Taken as a whole, however, the analysis of the data indicate little link between the restrictiveness of commercial bank regulations and the mixing of banking and commerce on the one hand and financial development (taken broadly) and industrial competition on the other. Fouith, in terms of state ownership, the empirical evidence suggests a negative relationship between t]he degree of state ownership of banks and financial development.8 Countries with greater state ownership of banks tend ta have less developed banks and nonbanks. It shouLd also be notedL in this context that underdeveloped financial systems tend to exert a negative influence on long-run growth [see Levine, Loayza, and Beck (2000) and Levine (1999)]. Although considerably more research needs to be done before a causal interpretation 8 In this regard, Cetorelli and Gambera (1999, p.23) in a study assessing the relevance of the market structure for the "finance-growth relationship" state that "it would be interesting to investigate whether it matters if banks are privately-or state-owned." 18 can be given to these findings, it may justify some concern among policymakers in countries where state banks play a major role in credit allocation. In this sample alone it appears that about half the world's people live in countries with banking systems that are a majority state- owned (Brazil, China, Egypt, India, Pakistan, and recently Indonesia), which underscores the importance of this concern. In sum, the lack of a close and reliable link between the regulatory environment and overall financial development and industrial competition is robust to various alterations in the conditioning information set and to redefinitions of the regulatory indicators. In the analysis, however, the regulatory variables take values ranging from one through four. This particular scaling may create an interpretation problem because the difference between a two and a three may not be the same as the difference between a three and a four, or a one and two. We therefore examine the sensitivity of the empirical results to this scale in three ways. First, we created a new regulatory indicator that assumed values of one through three, rather than one through four. This new variable equals one if the original indicator equals one; the new variable equals two if the original indicator equals two or three; and the new variable equals three if the original indicator equals four. Second, we created an additional regulatory indicator for each category (Securities, Insurance, Real Estate, Banks Owning Nonfinancial Firms, and Nonfinancial Firms Owning Banks) with values of either one or zero. The additional regulatory indicator takes the value one if the original indicator was one or two, and zero otherwise. Finally, we also used separate dummy variables for each value between one and four. In this case, we created four dummy variables -- Securities 1, Securities2, Securities3, and Securities4. Securitiesl equals one if Securities equals one and zero otherwise; Securities2 equals one if Securities equals two and zero otherwise; and so on. We created these new variables for all the 19 regulatoiy indicators. Using these alternative indicators, however, did not change this section's conclusions. The results are robust to changes in the other regressors too. Also, it is important to note that these conclusions are robust to the inclusion of reg;ional dummy variables. Thus, the results are not simply reflecting regional differences in regulatory policies. Furthermore, we conducted the analysis using the individual components of Good Government instead of the conglomerate index. This modification also did not alter' the results. Lastly, we confirmed our empirical results using indexes of bureaucratic efficiency, government red tape, and the degree to which governments repiudiate contracts. III. Regulatory Restrictions, Ownership, and Banking Crises This section evaluates the relationship between banking crises and (i) regulatory restrictions on the activities of commercial banks, (ii) regulatory restrictions on the mixing of banking and cormrmerce, and (iii) state ownership of banks. Allowing banks to engage in a wide range of activities may increase bank fragility by expancling the set of external risks affecting banks and by allowing banks themselves to choose amoong a broader assortrnent of risky ventures. On the otlher hand, allowing banks more freedom mray lower bank fragility through greater diversification of the sources of profits for banks. This paper assesses which of these two opposing forces tends to dominate. In terms of state ownership of banks, we believe the links will be more opaque. State-owned banks that encounter difficulties may receive subsidies through various channels, so that the banks are never identified as being in a crisis. Nonetheless, we conduct the analysis with the information available. After describing our definition of whether a country experienced a banking crisis or not, vwe present probit regressions incorporating the regulatory/ownership variables and a wide array of factors to control for other 20 potential influences on bank fragility. We find that regulatory restrictiveness is positively linked with financial fragility. We then present evidence suggesting that this result is not due to reverse causation. A. Definition of a Crisis To investigate the relationship between the regulatory/ownership environment and financial fragility, we use two measures of whether a county's banking system suffered a crisis during the last 15 years. Systemic is based upon Caprio and Klingebiel's (1999) determination as to whether a country experienced a systemic banking crisis. The variable takes the value one if there was a systemic crisis and zero otherwise. They define a systemic crisis as meaning all or most of the banking system's capital was eroded during the period of the crisis. The assessments are made for countries from the late 1970s into early 1999. Major equals Systemic except for two adjustments. First, the Caprio and Klingebiel (1999) indicator of systemic banking crises is expanded to include countries that experienced major, though perhaps not systemic, banking crises over the 1985-97 period. This results in. the addition of: Canada (15 members of Canadian Deposit Insurance Company failed), Denmark (cumulative loses of 9 percent of loans), Hong Kong (9 out of 18 banks failed over the period), India (nonperforming loans estimated as 16 percent of total loans), Italy (58 banks accountinig for 11 percent of total loans were forcibly merged), and the United States (estimated savings and loan clean-up costs of 3.2 percent of GDP). Second, we exclude two countries (Israel and Spain) from the Caprio/Klingebiel list of systemic banking crises because their crises occurred in lhe late 1970s and therefore are outside our sample period. We report the results using Major, but 21 reach similar conclusions using Systemic. The values of Major and Systemic are listed in Table A3. B. Empiical Results The empirical results indicate that countries that restrict commercial banks from engaging in securities activities and countries that restrict comlmercial banks from owning nonfinancial finns have a higher probability of suffering a major banking crisis. Table 11 summarizes these findings. Besides simple correlations, we present probit regressions that control for other characteristics of the national environment. Specifically, we control for the level of economic development (Development) and the qjuality of the government (Good Government) in the probit regressions. As shown, counltries with greater regulatory restrictions on commercial bank securities activities and the ability of banks to own and control nonfinancial firns have a higher probability of experiencing major bEnking sector distress. The positive and significant relationship between financial fragility and regulatory restrictions on the securities activities of banks and restrictions on commercial bank ownership of nonfinancial firms is; robust to a number of alterations in the econometric specification. First, we obtain the same results using a logit estimation procedure. Second, we obtain similar results when controlling for the degree of private property righis protection, the degree to which regulations restrict the opening and operation of businesses, a measure of bureaucratic efficiency, the rate of economic growth, inflation, the existence of a deposit insurance scheme, and the size of the financial intermediary sector (Private Credit). Thus, wve control for the standard variables used in the large and growing empirical literature that tries to explain banking crises. The coefficients on Secutrities and Banks Owning Nonfinancial Firms remain significantly positive in 22 the crisis regressions (when also including Development and Good Government). Third, as noted above, we obtain similar results when using Systemic instead of Major as the indicator of whether a country experienced a banking crisis or not. Fourth, we obtain similar results when using the alternative measures of Securities and Bank Ownership of Nonfinancial Firms as discussed above. Specifically, we also use the regulatory measures based on (i) values frorn one through three, (ii) values of zero or one, and (iii) values of individual dummy variables for each of the values one through four. These alternative specifications do not alter the findings. F iffth, these conclusions are robust to the inclusion of regional dummy variables; the results are not driven by regional factors. Sixth, since the degree of securities market development may influence financial fragility, we also included measures of the degree of securities market development. Specifically, we used measures of: (i) equity market liquidity, (ii) the issuance of equity (in the primary market) as a share of GDP, and (iii) the issuance of long-term bonds (in the primary market) as a share of GDP. This modification did not alter the results and these securities market indicators enter the crisis regressions insignificantly. Similarly, we also tried controlling for the net interest income of banks (Net Interest Margin), the degree of banking sector concentration (Bank Concentration), and a measure of the degree to which the financial system is primarily bank-based or market-based (Structure).9 These additional variables did not enter the crises regressions significantly. Moreover, including these measures did not alter this section's major conclusion: there is a positive, significant and robust relationship between bank fragility and regulatory restrictions on securities market activities and bank ownership of nonfinancial firms.'0 9 For a detailed discussin and analysis of bank-based vs. market-based financial systems, see Allen and Gale (forthcoming) and Levine (2000). The source of the additional variables used in this analysis is Beck, Demirguc-Kunt, and Levine (1999). 23 C. Endogeneity Endogeneity is an issue that merits further coinsideration. Countries that experience banking crises might have responded to them by adopting regulatory restrictions on the activities of banks. If this situation actually happened, it would be inappropriate to interpret the results in Table 1 I as suggesting that regulatory restrictions increase the probability of a crisis occurring. To control for poten,tial simultaneity bias, we have used a two-step instrumental variable estimator. The differernt instruments that are employed are presented in an appendix. Using instrumental variables did not alter the main results: countries in which banking systems face greater regulatory restrictions on securities activities andl on owning nonfinancial firms have a higher probability of suffering a major crisis (see Barth, Caprio, and Levine 1999). However, because the instrumental variables are not very good predictors of regulatory restrictions (see Appendix), we decided to examine the issue of endogeneity using a more laborious - albeit less statistically rigorous - procedure. Table 12 presents the results of this effort. As the lable indicates, for those countries in our sample experiencing a crisis, information is provided regarding the dates of the banking crises, the scope of the problems, and the estimated cosis of resolution. In addition, information is provided as to whether or not there was any change irI regulations with respect to securities, insurance, and real estate activities as well as to the mixing of banking and commerce during or shortly after a banking crisis occurred. For some countries and for some time periods, the required regulatory information has not yet been obtained. But for the majority of our countries such information was available from publications of the Institute of International Bankers, materials from ihe Office of the Comptroller of the Currency, and the World Bank Survey. 24 Banking crises generally did not induce governments to enact more restrictive regulations. Indeed, the overall indication is that there was no change in these regulations: of the 250 possible entries in the table, 141 showed no subsequent change at all - neither during nor immediately after the crisis, 14 showed a change in the direction of fewer restrictions (only 2 of which could be linked to a crisis), and only 3 showed greater restrictions post-crisis; in 92 cases we have no data. So even in the relatively few cases in which there was a change during or after a crisis, it was in the direction of broader powers for banks, meaning that we were using fewer restrictions than actually existed. This biases the results against the conclusion that greater restrictions increase the likelihood of a crisis. Governments generally do respond to banking crises, but the response has typically been in the direction of limiting the bank safety net or raising its cost, as in the cases of the early crises from the 1980s in Argentina and Chile, rather than attempting to restrict banks' powers. Interestingly, both countries in fact have moved in the other direction, providing added powers to banks, which is consistent with the general trend toward broader powers. More generally,, any concern about the endogeneity in the crisis regressions would appear to be unwarranted. " l Re- estimating the probit regressions in Table 11 with the data from Table 12, moreover, does .not produce any significant changes. Thus, although the analysis does not fully resolve the endogeneity issue, the results clearly suggest that greater regulatory restrictions on the ability of commercial banks to engage " The inability to make limits on powers stick may be one reason for this trend. Bandiera, Caprio, Honohan, and Schiantarelli (1999) characterized financial reforms as a vector of variables pertaining to changes over long periods of time in interest rate regulation, reserve requirements, directed credit, bank ownership (moves toward privatization), liberalization of securities markets, prudential regulation, and intemational financial liberalization. They did not include changes in banks' powers insofar as there were so few changes. Note also that in the particular case of the U.S. banks were allowed to underwrite corporate debt in 1989 and corporate equity in 1990 through subsidiaries, but subject to a revenue restriction. In 1999 there were more than 40 banking organizations that had established such subsidiaries. 25 in securities activities and the ability of commercial banks to own and control nonfinancial firms tend to increase the probability that a country will experience a major banking crisis.'2 IV. Summary and 'Conclusions The purposes of this paper have been twofold. The first is to present comprehensive and detailed inform.ation on the regulatory environment and ownership structure of commercial banks in a large number of countries around the world. [t is found that there is substantial variation among the more than 60 countries in our sample as to what banks are allowed to do with respect to securities, insurance and real estate activities. A "bank" in one country, in other words, is not necessarily the same as a bank in another country. As a result of all the banking crises in different countries in recent years, there have been nuamerous calls for banking reforms. Yet, they typically fail to address the issue as to exactly which regulatory environment is most appropriate for simultaneously promoting bank performance and stability. The information presented here helps one to address this issue by initially recognizing the substantial cross- country variation in bank regulation that exists. This variation occurs, moreover, in countries that differ in terms of geographical location and level of' economic development, among other ways. At the same time, it is found that state ownership of banks varies from a high of 80 percent to a low of zero percent in our sample of countri.es. The second purpose is to assess whether or not it matters as to what a bank is permitted to do with respect to securities, insurance and real e state activities. As summarized in Table 13, it malters most as to whether restrictions are placed on securities activities. The tighter 12 In this respect, Kwan and Laderman (1999, p.24) in a review of ]iterature pertaining to the U.S. state that "On the effects of securities activities on banking organizations safety and soundness, the bulk of empirical evidence indicated some potential for risk reduction in expanding banks' securities powers." 26 the restrictions placed on this activity, on average, the more inefficient are banks and the greater the likelihood of a banking crisis. The likelihood of a banking crisis is also greater, on average, the tighter the restrictions placed on bank ownership of nonfinancial firms. Perhaps surprisingly, none of these restrictions produce any beneficial effects with respect to financial development, nonbank sector and stock market development, or industrial competition. Nor is it found that any of them lessen the likelihood of a banking crisis or enhance bank efficiency. At the same time, the greater the share of bank assets controlled by state-owned banks, on average, the less will be financial development as well as the development of the nonbank sector and the stock market. It is important to emphasize that this paper is the product of an ongoing research project. Thus, as more information is collected and analyzed, the findings and conclusions reported here may be modified. This means that the paper actually represents a progress report on a timely and important public policy issue. Much more work remains. We are in the process of collecting and analyzing information on supervision. Optimal regulatory restrictions may depend importantly on the type of supervisory regime. Indeed, the choice of regulatory restrictions may be importantly influenced by the efficiency of supervision. We plan to explore these relationships in future research. The bottom line, however, is that the paper presents new cross-country data and analyses on what a bank is and whether or not it matters. And for now it does indeed matter what a bank is permitted to do. The imposition of tight restrictions on some activities of banks appears not to be beneficial but, worse yet, downright harnful in some important ways. 27 REFERENCES) Allen, F., and I)ouglas Gale, Comparing Financial Systems, forthcoming. Beck, T.; A. Demirguc-Kunt, and R. Levine, 1999, "A New DataBase on Financial Development and Structure," Washington, D.C.: World Bank Policy Research Working Paper 2146. Beck, T.; R. Levine, and N. Loayza, 2000, "Finance and the Sources of Growth," Journal of Financial Economics, forthcoming. Barth, J. R.; R. D. Brumbaugh, Jr., and G. Yago, 1997, "Breaching the Walls Between Banking and Cornmerce," Banking Strategies (July/Augutst) 47-52. Barth, J. R.; G. Caprio Jr., and R. Levine, 1999, Financial Regulation and Performance: Cross- Country Evidence, Santa Monica, CA: Milken Institute, and World Bank Policy Research Working PaLper 2037. Barth, J. R.; D. E. Nolle, and T. N. Rice, 2000, "Commercial Banking Structure, Regulation, and Performance: An International Comparison," in Dimitri B. Papadimmitriou, ed., Moder izingFinancial Systems, MacMillan Press and St. Martin's Press, 119-251. Barth, J. R.; R. D. Brumbaugh, Jr., and J. A. Wilcox, 2000, "Glass-Steagall Repealed: Market Forces Compel A New Bank Legal Structure," Journal of Economic Perspectives, forthcoming. Calomiris, C. W., and G. Gorton, 1991, "The Origins of Banking Panics: Models, Facts, and Bank Regulation," in R. G. Hubbard, ed., Financial Markets and Financial Crises, (University of Chicago Press, Chicago, IL) 1094174. Bandiera, Oriana, Ger,ard Caprio, Patrick Honohan, ancd Fabio Schiantarelli, "Does Financial Reformn Raise or Reduce Savings," World Bank Policy Research Working Paper 2062, February 1999. Boyd, J. H.; C. Chang, and B.D. Smith, 1998, "Moral Hazard Under Commercial and Universal Banking," Journal of Money, Credit, and Banking 30(3.2), 426-468. Camdessus, M., 1997, "The Challenges of a Sound Baniking System," in Charles Enoch and John H. Green, eds.., Banking Soundness and Monetary Policy, Washington, D.C.: International Monetary Fund, 535-539. Caprio, G. Jr.; I. Atiyas, and J. A. Hanson, 1994, Financial Reform, Theory and Experience (Cambridge University Press, New York, NY). Caprio, G. Jr., and D. Klingebiel, 1999, "Episodes of Systemric and Borderline Financial Crises," Washingtorn, D.C.: World Bank mimeo. 28 Caprio, G. Jr., and P. Honohan, 2000, "Reducing the Cost of Bank Crises: Is Basel Enough?, Washington, D.C.: World Bank mimeo. Deininger, K., and L. Squire, 1996, "A New Data Set on Measuring Income Inequality," World Bank Economic Review 10(3), 565-92. Demirgiiu-Kunt, A., and V. Maksimovic, 1998, "Law, Finance, and Firm Growth," Journal of Finance 53, 2107-2137. Easterly, W., and R. Levine, 1997, "Africa's Growth Tragedy: Policies and Ethnic Divisions," Quarterly Journal of Economics 112, 1203-50. Engerman, S., and K. Sokoloff, 1996, "Factor Endowments, Institutions, and Differential Paths of Growth," in Stephen Haber, How Did Latin America Fall Behind. Gertler, M., 1988, "Financial Structure and Aggregate Economic Activity: An Overview,'' Journal of Money, Credit, and Banking 20, 559-88. Jayaratne, J., and P. E. Strahan, 1996, "The Finance-Growth Nexus: Evidence from Bank Branch Deregulation," Quarterly Journal of Economics 111, 639-670. Kane, E.J., 1996, "The increasing Futility of Restricting Bank Participation in Insurance Activities," in I. Walter and A. Saunders, eds., Universal Banking: Financial System Design Reconsidered, Chicago: Irwin, 338-417. King, R. G., and R. Levine, 1993a, "Finance and Growth: Schumpeter Might Be Right," Quarterly Journal of Economics 108, 717-38. King, R. G., and R. Levine, 1993b, "Finance, Entrepreneurship, and Growth: Theory and Evidence," Journal of Monetary Economics 32, 513-42. Kroszner, R. S., and R. G. Rajan,, 1994, "Is the Glass-Steagall Act Justified? A Study of the US Experience with Universal Banking Before 1933," American Economic Review 84, 810- 832. Kroszner, R. S., and P. E. Strahan, 1996, "Regulatory Incentives and the Thrift Crisis: Dividends, Mutual-to-Stock Conversions, and Financial Distress," Journal of Finance 51, 1285-1320. Kwan, S. H., and E. S. Laderman, 1999, "On the Portfolio Effects of Financial Convergence - A Review of the Literature," Federal Reserve Bank of San Francisco Economic Review 2, 18-31. Dutz, M., and A. Hayri, 1999, "Does More Intense Competition Lead to Higher Growth?" Washington, D.C.: World Bank mimeo. 29 Lamoreaux, N. 1994, Insider Lending: Banks, Personal Connections, and Economic Development in Industrial New England. Cambridge University Press. La Porta, R.; F. Lopez-de-Silanes; and A. Shleifer, 1999, "Government Ownership of Commercial Banks," Harvard University mimeo. La Porta, R.; F. Lopez-de-Silanes; A. Shleifer, and R.W. Vishny, 1998, "Law and Finance," Journal of Politlical Economy 106, 1113-1155 La Porta, R.; F. Lopez-de-Silanes; A. Shleifer, and R.W. Vishny, 1999, "The Quality of Governrent," Journal of Law, Economics, and Organization 15, 222-279. Levine, R., 1997, "Financial Development and Economic Growth: Views and Agenda," Journal of Economic Literature 35, 688-726. Levine, R., 1999, "Napoleon, Bourses, and Growth: Wilh A Focus on Latin America," in Omar Azfar and C]harles Cadwell, eds., Market Augmenting Government Washington, D.C.: IRIS, forthcoming. Levine, R., 2000, "Blank-based or Market-based Financial Systems: Which is Better?" Carlson School of ManaLgement mimeo. Levine, R., and S. Zervos, 1998, "Stock Markets, Banks, and Economic Growth," American Economic Review 88, 537-558. Levine, R.; N. Loayza, and T. Beck, 2000, "Financial Intermediation and Growth: Causality and Causes," Journal of Monetary Economics, forthc:oming. Mishkin, F. S., 1999, "Financial Consolidation: Dangeis and Opportunities," Journal of Bpnkin;an Finance, 23, 675-691. Rajan, R. G., and L. Zingales, 1998, "Financial Dependence and Growth," American Economic Review 88, :559-586. Santos, J.A.C., 1998, "Banking and Commerce: How Dloes the United States Compare to Other Countries?" Federal Reserve Bank of Clevelancl Economic Review, 4th Quarter. Santos, J. A. C., 1998a, "Commercial Banks in the Securities Business: A Review," Journal of Financial Services Research, 35-60. Santos, J. A. C., 1998b, "Mixing Banking with Commerce: A Review," Bank for International Settlements, mimeo. Whalen, Gary, 1998, "The Securities Activities of the Foreign Subsidiaries of U.S. Banks: Evidence on Risks and Returns," Office of the Comptroller of the Currency, Working Paper 98-2. 30 White, E., 1983, The Regulation and Reform of the American Banking System. Princeton, N.J.: Princeton University Press. White, E., 1986, "Before the Glass-Steagall Act: An Analysis of the Investment Banking Activities of Commercial Banks," Explorations in Economic History 23, 33-55. Wugler, J., 2000, "Financial Markets and the Allocation of Capital," Journal of Financial Economics, forthcoming. 31 Tables 32 Table 1 Country Data on Bank Regulations and State Ownership of Bank Assets SECURITIES INSURANCE REAL BANKS OWNING RESTRICT NONFINANCIAL STATE- ESTATE NONFINANCIAL FIRMS OWNING OWNED BANK FIRMS BANKS ASSETS Argentina 3 2 2 3 2.50 1 0.305 Australia 1 2 3 2 2.00 3 0.000 Austria 1 2 1 1 1.25 1 0.044 Barbados 3 4 3 4 3.50 2 0.195 Belgium 2 2 3 3 2.50 1 0.000 Bolivia 2 2 4 4 3.00 1 0.000 Botswana 2 4 4 4 3.50 2 0.000 Brazil 2 2 3 3 2.50 1 0.510 Canada 2 2 2 3 2.25 3 0.000 Chile 3 2 3 3 2.75 3 0.238 Colombia 2 2 2 4 2.50 1 0.19 Cyprus 2 2 4 3 2.75 3 0.034 Denmark 1 2 2 2 1.75 1 0.000 Ecuador 2 4 4 3.33 Egypt, Arab Rep. 2 2 3 3 2.50 0.666 El Salvador 2 2 4 4 3.00 2 0.069 Fiji 2 3 4 2 2.75 3 0.085 Finland 1 3 2 1 1.75 1 0.411 France 2 2 2 2 2.00 2 0.145 Gambia 2 4 2 4 3.00 2 0.000 Germany 1 3 2 1 1.75 1 0.429 Ghana 2 1 4 2 2.25 2 0.388 Greece 2 3 3 1 2.25 1 0.628 Guatemala 4 4 4 3 3.75 2 0.051 Guyana 1 3 3 3 1.75 3 0.233 Hong Kong 1 2 2 3 2.00 3 0.000 Iceland 2 2 4 3 2.75 1 0.644 India 2 4 4 2 3.00 2 0.800 Indonesia 2 4 4 4 3.50 1 0.415 Ireland 1 4 1 1 1.75 1 0.000 Israel 1 1 1 1 1.00 1 Italy 1 2 3 3 2.25 3 0.250 Japan 3 4 3 3 3.25 3 0.000 Jordan 2 4 3 2 2.75 1 0.000 Korea, Republic of 2 2 2 3 2.25 3 0.000 Lesotho 2 4 3 3 3.00 2 0.720 Luxembourg 1 3 1 1 1.50 3 0.000 Madagascar 2 4 3 3 3.00 2 0.220 Malaysia 2 2 3 2 2.25 2 0.096 Malta 1 3 3 3 2.50 4 0.475 33 Table 1 (continued) Country Data on Bank Regulations and Sitate Ownership of Bank Assets SE'CURITIES INSURANCE REAL BANKS OWNING RESTRICT NONFINANCIAL STATE- ESTATE NONFINANCLAL FIRMS OWNING OWNED BANK _____________ FIRMS BANKS ASSETS Mexico 3 4 3 3 3.25 2 0.415 Netherlands 1 2 2 1 1.50 1 0.000 New Zealand I 1 1 2 1.25 2 0.000 Nigeria 1 2 2 2 1.75 0.130 Norway 2 2 2 2 2.00 2 0.376 Pakistan 2 4 3 1 2.50 1 0.501 Peru 2 2 2 2 2.00 2 0.000 Philippines 1 2 2 3 2.00 3 0.198 Portugal 1 2 3 2 2.00 1 0.170 Rwanda 1 4 4 4 3.25 1 0.000 Seychelles 2 2 2 2 2.00 2 0.364 Singapore 2 2 2 3 2.25 1 South Africa 2 2 1 1 1.50 2 0.000 Spain 1 2 3 1 1.75 2 0.019 SriLanka 2 2 2 2 2.00 3 0.580 Suriname I 1 1 3 1.50 3 0.277 Sweden 4 2 3 3 3.00 1 0.000 Switzerland I I 1 3 1.50 1 0.151 Tanzania 2 3 4 3 3.00 2 0.501 Thailand 2 2 2 3 2.25 3 0.290 Turkey 3 2 4 3 3.00 1 0.365 United Kingdom 1 2 1 1 1.25 1 0.000 United States 3, 3 3 3 3.00 3 0.000 Uruguay 2 3 4 3.00 0.455 Venezuela 2 2 3 3 2.50 3 0.072 Zimbabwe 2 4 4 4 3.50 2 0.246 34 Table 2 Summary Statistics for Regulatory and State-Ownership Variables RESTRICT SECURMIES REAL INSURANCE BANKS OWNING NONFINANCIAL STATE-OWNED ESTATE NONFINANCIAL FIRMS OWNING BANKS ASSETS FIRMS BANKS Mean 2.40 1.85 2.67 2.55 2.55 1.92 0.21 Median 2.38 2 3 2 3 2 0.15 Maximum 3.75 4 4 4 4 4 0.80 Minimum I 1 1 1 1 1 0 Std. Dev. 0.67 0.75 0.98 0.95 0.97 0.86 0.23 Skewness 0.00 0.69 -0.18 0.47 -0.26 0.31 0.80 Kurtosis 2.12 3.39 2.03 2.01 2.09 1.84 2.55 Jarque-Bera 2.13 5.71 2.93 5.13 2.94 4.48 7.21 Probability 0.35 0.06 0.23 0.08 0.23 0.11 0.03 Observations 66 66 66 66 65 62 63 35 Table 3 Correlations for Regulation and State-Ovwnership Variables RESTRICT SECURITIES INSURANCE REAL BANKS OWNING NONFINANCIAL STATE- ESTAT E NONFINANCIAL FIRMS OWNING OWNED FIRMS BANKS BANKS ASSETS Restrict 1.00 0.70 0.64 0.81 0.72 0.05 0.18 (0.00) (0.00) (0.00) (0.00) (0.52) (0.17) Securities 1.00 0.25 0.43 0.42 0.00 0.11 (0.04) (0.00) (0.00) (0.97) (0.38) Insurance 1.00 0.41 0.18 -0.03 0.13 (0°.°0 (0.16) (0.85) (0.32) Real Estate 1.00 0.49 0.04 0.26 (0.00) (0.74) (0.04) Banks Owning 1.00 0.19 0.01 Nonfinanciial (0.14) (0.96) Firms Nonfinancital 1.00 -0.09 Firms Owning (0.51) Banks State-owned 1.00 Banks Assets Note: P-value is in paientheses. 36 Table 4 Relationship Between Bank Regulatory Restrictiveness and Alternative Measures of Financial Development Net Interest Private Bank Industrial Total Value Non-Bank Margin Credit Concentration Competition Traded Credits A. Correlations Restrict 0.365 -0.299 -0.182 -0.324 -0.249 -0.068 (P-value) (0.005) (0.020) (0.174) (0.032) (0.070) (0.671) B. Regressions Restrict 0.007 -0.016 -0.101 -0.163 -0.022 0.067 (P-value) (0.020) (0.832) (0.046) (0.422) (0.480) (0.188) Number of Countries 57 60 57 44 54 41 R-square 0.28 0.47 0.12 0.29 0.18 0.46 Note: Regressions include a constant, the logarithm of real per capita GDP, and the variable GOOD GOVERNMENT, which combines measures of expropriation risk, the law and order tradition of the country, and the level of corruption. Note: RESTRICT equals the average of regulatory restrictions on the ability of banks to engage in (a) securities activities, (b) insurance activities, (c) real estate activities, and (d) the ownership of non-financial firms. 37 Table 5 Relaitionkship Between Restriction of Securities Activities of Banks and Alternative Measures of FinaLncial Development Net Interest Private Bank Industrial Total Value Non-Bank Margin Credit Concentration Competition Traded Credits A. Correlations SECURITIES 0.369 -0.121 -0.199 -0.273 -0.152 0.155 (P-value) (0.005) (0.359) (0.137'p (0.073) (0.274) (0.332) B. Regressions SECURITIES 0.007 0.010 -0.065 -0.131 -0.007 0.056 (P-value) (0.016) (0.860) (0.197) (0.316) (0.809) (0.121) Numberiof 57 60 57 44 54 41 Countries R-square 0.30 0.47 0.09 0.29 0.17 0.47 Note: Regressions include a constant, the logarithm of real per capita GDP, and the variable GOOD GOVERNMENT, which combines measures of expropriation risk, the law and order tradition of the country, and the level of corruption. Note: SECURITIES: the ability of banks to engage in the business of securities underwriting, brokering, dealing, and all aspects of the mutual fund business. Larger values imply greater restrictions on bank activities. 4 = prohibited; 3 = banks (and subsidiaries) restricted in activities; 2 = permitted in subsidiaries; 1 = permitted directly in the bank. 38 Table 6 Relationship Between Restriction of Insurance Activities of Banks and Alternative Measures of Financial Development Net Interest Private Bank Industrial Total Value Non-Bank Margin Credit Concentration Competition Traded Credits A. Correlations INSURANCE -0.035 -0.194 -0.086 -0.110 -0.200 -0.031 (P-value) (0.797) (0.138) (0.527) (0.477) (0.147) ((0.845) B. Regressions INSURANCE -0.003 -0.011 -0.038 -0.010 -0.023 0.026 (P-value) (0.321) (0.843) (0.272) (0.926) (0.405) (0.382) Number of countries 57 60 57 44 54 41 R-square 0.25 0.47 0.06 0.27 0.18 0.43 Note: Regressions include a constant, the logarithm of real per capita GDP, and the variable GOOD GOVERNIM4ENT, which combines measures of expropriation risk, the law and order tradition of the country, and the level of cormption. Note: INSURANCE: the ability of banks to engage in the business of insurance underwriting and selling insurance products/services as principal and as agent.. Larger values imply greater restrictions on bank activities. 4 = prohibited; 3 = banks (and subsidiaries) restricted in activities; 2 = permitted in subsidiaries; 1 = permitted directly in the bank. 39 Table 7 Relationship Between Restriction of Reali Estate Activities of Banks and Alternative Measures of Firnanciasl Development Net Interest Private flank Industrial Total Value Non-Bank _____________ Margin Credit Concentration Competftion Traded Credits A. Correlations REAL ESTATE 0.395 -0.346 -0.068 -0.236 -0.360 -0.218 (P-value) (0.002) (0.007) (tl.617) (0.123) (0.008) (0.171) B. Regressions REAL ESTATE 0.006 -0.035 -0.045 -0.074 -0.042 0.022 (P-value) (0.021) (0.445) (Cl.181) (0.631) (0.105) (0.480) Number of Countries 57 60 57 44 54 41 R-square 0.29 0.47 0.07 0.28 0.22 0.42 Note: Regressions include a constant, the logarithm of real per capila GDP, and the variable GOOD GOVERNMENT, which combines measwres of expropriation risk, the law and order tradition of the country, and the level of corruption. Note: REAL ESTATE: the ability of banks to engage in real estate investment, development, and management. Larger values imply greater restrictions on bank activities. 4 = prohibited; 3 = banks (and subsidiaries) restricted in activities; 2 = permitted in subsidiaries; I = permitted directly in the bank. 40 Table 8 Relationship Between Restriction of Banks Owning Non-Financial Firms and Alternative Measures of Financial Development Net Interest Private Bank Industrial Total Value Non-Bank Margin Credit Concentration Competition Traded Credits A. Correlations BANKS OWNING NONFINANCIAL 0.339 -0.209 -0.081 -0.316 0.001 -0.101 FIRMS (P-value) (0.011) (0.111) (0.552) (0.037) (0.993) (0.534) B. Regressions BANKS OWNING NONFINANCIAL 0.004 0.021 -0.033 -0.102 0.027 0.049 FIRMS 0.007199 (0.066) (0.629) (0.266) (0.411) (0.270) (0.131) Number of Countries 56 59 56 44 53 40 R-square 0.26 0.47 0.06 0.29 0.19 0.46 Note: Regressions include a constant, the logarithm of real per capita GDP, and the variable GOOD GOVERNMENT, which combines measures of expropriation risk, the law and order tradition of the country, and the level of corruption. Note: BANKS OWNING NONFINANCIAL FIRMS: the ability of banks to own and control nonfinancial firms. Larger values imply greater restrictions on bank activities. 4 = prohibited; 3 = less than 100% ownership; 2 = unrestricted, but ownership is limited based on bank's equity capital; I = 100% ownership permitted. 41 Table 9 Relationship Between Restriction of Non-Financial Firms Owning Banks and Alternative Measures of Financial Development Net Interest Private BTink Industrial Total Value Non-Bank Margin Credit Concenatration Competition Traded Credits A. Correlations NONFINANCIAL FIRMS OWNINl3 -0.056 0.065 -0.130 -0.193 0.029 0.132 BANKS (P-value) (0.690) (0.996) (0.354) (0.216) (0.842) (0.429) B. RegressiDns NONFINANCIAL FIRMS OWNING -0.003 0.072 -0.032 -0.123 0.011 0.043 BANKS (P-value) (0.364) (0.165) (0.412) (0.272) (0.701) (0.139) Number of Cowutries 53 56 53 43 50 38 R-square 0.27 0.48 0.06 0.35 0.15 0.44 Note: Regressionis include a constant, the logarithm of real per capita GDP, and the variable GOOD GOVERNMENT, which combines measures of expropriation risk, the law ancl order tradition of the country, and the level of corruptioni. Note: NONFINANCIAL FIRMS OWNING BANKS: the ability of non-financial firms to own banks. Larger values imply greater restrictions on bank activities. 1 = limits placed on ownership; 0 = no limits placed on ownership. 42 Table 10 Relationship Between State Ownership of Banks Assets and Alternative Measures of Financial Development Net Interest Private Bank Industrial Total Value Non-Bank Margin Credit Concentration Competition Traded Credits A. Correlations STATE-OWNED BANK 0.216 -0.345 0.095 -0.247 -0.273 -0.380 ASSETS (P-value) (0.117) (0.009) (0.496) (0.115) (0.052) (0.017) B. Regressions STATE-OWNED BANK 0.011 -0.275 0.007 -0.414 -0.129 -0.242 ASSETS (P-value) (0.522) (0.088) (0.962) (0.562) (0.065) (0.012) Number of Countries 54 57 54 42 51 39 R-square 0.24 0.48 0.05 0.28 0.18 0.49 Note: Regressions include a constant, the logarithm of real per capita GDP, and the variable GOOD GOVERNMEhNT, which combines measures of expropriation risk, the law and order tradition of the country, and the level of corruption. STATE OWNERSHIP BANK ASSETS: Percentage of bank assets accounted for by state-owned banks. 43 Table 11 Relationship Between Bank Crises and Bank Regulations and Policies GOOD RESTRICT SECURITIES INSURANCE REAL BANKS OWNING STATE- NONFINANCIAL FINANCIAL GOVERNMENT EST-ATE NONFINANCLIL fWNED BANK FRMS OWNING STRIJCTURE FIRMS ASSETS BANKS A. Correlations BANK CRISIS -0.301 0.393 0.377 -0.006 0.298 0.418 0.217 0.188 -0.157 (P-value) (0.019) (0.002) (0.003) (0.964) (0.020) (0.001) (0.102) (0.161) (0.267) B. Simple Probit Regressions BANK CRISIS -0.056 0.689 0.584 -0.154 0.300 0.527 0.873 0.237 -0.265 (P-value) (0.372) (0.020) (0.015) (0.436) (0.123) (0.010) (0.296) (0.233) (0.643) Numberof Countries 61 61 61 61 61 60 58 57 52 Probability 0.052 0.009 0.006 0.089 0.039 0.005 0.105 0.124 0.014 I\ I Note: Simple Probit Regressions include a constant, the logarithm of real per capita GDP, and the variable GOOD GOVERNMENT, which combines measures of expropriation risk, the law and order tradition of the country, and the level of corruption. The Good Government regression includes Development only. Probability (LR statistic) is the P-value for the test that the coefficients on the (nonconstant) regressors equal zero. 44 Table 12 Banking Crises: Dates, Costs and Bank Regulatory Responses Change in Regulations for Allowable Activities: Yes or No Coding of Banking Crises Country Year of ScpEfrbe stimateof Total Bank Ownership Non-financial crsis SopeofProblem Losme/osts Securities Inurance Real Estate ofNon-financial Firm Ownership Systemic Major Firms of Banks Argentina 19S0-19S2' Morethan70 institutions 55.3 percetof N/A N/A N/A N/A N/A were liquidated or subject GDP. to central bank intervention accounting for 16 percent of assets of conmmercial banks and 35 percent of total assets of finance companies. 1989-1990' Non-performing assets Yes, since No No No No constituted 27 percent of 1991, the aggregate portfolio allowed to and 37 percent ofthe act as portfolios of state-owned underwriter banks. Failed banks held in issuing 40 percent of financial piaedb system assets p.vate debt 1995* Suspension of eight banks Direct and indirect No No No No No and coDapse of tree cost to public banks. Overall through the estimated at 1.6 end of 1997, 63 out of 205 percent of GDP. banking institutions were either closed or merged. Bolivia 1986-1987' Five banks were N/A N/A N/A N/A N/A I liquidated. Total NPLs of banking system reached 29.8 percent in 1987; in mid-1988 reported arrears stood at 92 percent of commercial banks' net worth. 1994-* Two banks with 11 No No No No No percent of banking system assets were closed in November 1994. In 1995, four out of 15 domestic banks, which accounted for 30 percent of banking system assets experienced liquidity problems and suffered from high levels of NPLs. Brazil 1990* (deposit to bond No No No No No conversion) 1994- By end 1997, the Centma In 1996, negative No No No No No ongoing Bank had intervened in, or net worts of put under the Tempoary selected state and Special administration federa funds banks Regime (RAET) system, estimated at 5-10 43 financial institutions. pereent of GDP. Also by end 1997 non- Costs of individual performing loans of the bank entire banking system had recapitalization, by reached 15 percent end 1997: Banco Economico, USD 2.9 billion. Bameridus: USD 3 bilion. Banco do Brazil, USD 8 billion. Canada 1983-1985" Fifteenmembersofthe No, but No, but No No No 0 Canadian Deposit changed changed from Insurance Corporation, from prohibited to including two banks, prohibited to peemitted in failed. pemitted in 1992. 45 Table 12 (continued) Bankinkg Crises: Dates, Costs and Bank Regulatory Responses Change in Regplatoiln for Allowable Achvities: Yes or No Coding of Banking Crib Country Year of SrDpe of F'robl Estimate of Total Bank Ownership Non-financial Crnsis Loss/Costs Securities Insurance Real Estai of Non-financial Firm Ownership Systemic Major Firms of Banks Chile 1981-1983' Authorites intervened in 1982- 1985. No, but No, butstarting N,but staing in No No, but chaiged four banks and four tion- government spent changed in 1997 banks 19!13 banks were from unrestricted bank fi ncial insitutions 41.2 percentof from were slowed to aliawedto invest to persmitted in (with 13 percent of GDP. restricted to intermediate in l estate 1993 outstanding loirns) in penmitted in (sell) insuraice through 1981. In l983, sevn 1997/8 through stasidiaries tiu banks md one financiers subsidiaries. spicialized in accourLting for 45 percent (IoUsing nd of total assets. By end- office space) 1983, 19 percent of loans leasing. were Eon-perfbrinin. Colombia 1982-1987' Central Bank intervened Costs of No No, but NI No, but chaged No in six Ibanks accounting restructrring changed firom from permitted to for 25 percent of barlking estimated to be permitted to prohibited inl994 systemi assets. round 5 percent of prohibited in GDP. 1998 Denmark 1987-1992" Cumulative lam losses No No No No No 0 1 over die periodx 1990-1992 were ! percent of loais; 40 of irhe 60 problem banks werc merged. Ecuador early 1980s' Implenentation of N/A N/A NiA N/A N/A I exchasige pro5rans (domestic for foreign debt) tr bail oet banking systet. 1996- Authirities imlrervened in N/A N/A NA N/A N/A ongoirg' severld smaller finmsicial institutions in late 1995 to early 1996 andi in the fifth largest commercial bank in 196. Seven financial instituitions, wTich accounted for 25-30 percest of coetmercial banking assess, wear closed in 19911/99. In Mares 1999. authorities declared a omne weel; bank holid ly Egypt, Arab early 1980s' Government closed Nine ste-owned N/A N/A N/A N/A N/A Rep. several large investrent commercial banks companies. recorded NPL Four public sector banks ratios of 37 percent were given estpital on average in assistance. 1989. 1991-1995' Four public arctor banks N/A N/A M/A N/A N/A were given capital assistance. El Salvador 19899 Nine statovned N/A N/A N/A N/A N/A comtercial tbanks recorded NPI. rados of 37 percent on average in 1989. Finland 1991-1994' Savirgs banking sector Recap. costs No No No No No badly affected; amounted to II Government took control percent of GDP. of three banks that together accounted for 31 perosnt of towal system deposits. Ghana 1982-19899 Seven audited banks (out Resbrructuming coss N/A N/A NI/A N/A N/A I I of ]1) insolvent; nna mtimated at 6 banhing sectDr afficted. percent of GNP. 46 Table 12 (continued) Banking Crises: Dates, Costs and Bank Regulatory Responses Change in Regulations for Allowable Activities: Yes or No Coding of Banking Crises Country Year of of Problm Estimate of Totat Bank Ownership Non-financial Crisis Scope Losses/Costs Securities Insurance Real Estate of Non-finandal Firm Ownership Systenmic Major F'irms of Banks Ghana 1997 NPL levels increased One large No No No No No ongoing*' sharply during 1997 from investnent bank 15.5 percent of loans fails. outstanding to 26.5 Non-performing pecent Two state-owned assets of the 27 conumercial banks public sector banks accounting for 33.9 estimated at 19.5 percent of market share in percent of total bad shape. Three banks, loans and advances accounting for 3.6 percent as of end of March of market share in terms o 1995. Non- Nine Deposit Taking pesforming assets Companies failed. to total assets Seven banks or Deposit reached 10.8 Taking institutions were percent in 1993- either liquidated or taken 1994. At end 1998. over. NPLs estimated at 16 percent of total Hong Kong 1982-1983** Nine DepositTaking N/A N/A N/A N/A N/A I Companies failed. 1983-1986" Seven banks or Deposit N/A N/A N/A N/A N/A Taking Instituoions were either liquidated or taken over. 19985' One large investment bank No No No No No fails India 1993- Non-performing assets of No No No No No 0 1 ongoing" the 27 public sector banks estimated at 19.5 percent of total loans and advances as of end of March 1995. Non- perfonming assets to total assets reached 10.8 percent in 1993-1994. At end 1998, NPLs estimated at 16 percent of total loans. Indonesia 1994"' Classified assets equal to RecapiaWization Yes, a No No No No I I over 14 percent of banking cost for five state regulation system assets with over 70 banks expected to prohibiting percent in the state banks. amount to 1.8 banks from percent of GDP. underwriting securities was issued in Aug. 1995. The decree however allowed banks to act as atranger, issuer, dealer, investor or buying agent 1997- As of March 1999, Bank Fiscal costs No No No No No ongoing' of Indonesia had closed estimated to ramge down 61 banks and from 50-55 percent nationalized 54 banks, of a of GDP. total of 240. NPLs estimates for the total banking system range from 65-75 percent of total loans. Italy 1990-1995** During 1990-1994,58 No No No No, but changed No 0 I banks (accounting for 11 from prohibited to percent of total lending) restricted in 1995 were merged with other institutions. 47 Table 12 (continued) Banking Crises: Dates, Costs and Bank Regulatory Responses Change in Regulatio ns for Allowable Aeiivities: Yes or No Coding of Banking Crises Country Year f 9pe of Problm Estimate of Total Bank Ownership No-financial riss LossesCosts Securities Insurance Real Estate of Non-financial Firm Ownership Systemic Major Firms of tanks Japan 1990s' Ban-ks suffsingfrom In 1996, rescue No No Nc No No sharp decline in stock costs estimated at market and read estate over USD 100 bn. prices; official estimate of In 199S. NPLs 40 trillion Yen govrnment of (USD 469 billion) in 1995 Japan annoumced (10 pErcent of GDPWM; the Obuchi Plan unofficial estimates put which provides 60 NPLs at I trillion or 25 trillion Yen (USD perceit of GDP; for some 500 billion), about of barl loans, banks save 12.3 percent of alreadly made provisions. GDP, in public At eni 199S, intal banking funds for loan systerm NPLs estimaited at losses Yen E 7.5 brillion (USD recapitalization of 725 billion) about 1.7.9 banks and pereent of GrIP. In March depositor 1999. Hakkaido proteion Takuwnodu bank clIsed, Long Term Credit Elank nationalised, Yatsuda Trust merged with 1-uji Bank, and Mitsui Trnust merged with Chuo Trust Korea, Republic 1997- ByMarbch 1999, twa out Fisca costs of No No, but No No No of ongoing* of 26 commer cial banks crisis estimated to changed from accouiting for I Il. reach 34% in 1999. prohibited to percent of total banking peintted in systen assets natiosalized; 1995 5 barks, accountinxg for 7.S percent ot total bark'sng system assets closed. Sevun banks accoumting f*r 3S percent of banking system issets. placed under special supewvision. Overall, banking system NPL expected to peak at 30-40 percnt- Madapscar 198SS' 25 p.rcent ofbanking No No ISo N/A N/A sectCT loans deemned irrecDverable. Malaysia 19S5-49SS' Insolvent isnstitutio as Reported losses N/A N/A N/A N/A N/A account for 3.4 percent of equivalent to 4.7 finarcial sysiem deposits; percent of GNP. margi*ally capitalized and perihps insolvent instisutions account for another 4.4 percent of financial system deposits. 1997- Finance compamy sector is Net loss estimated No, but No, but 1N0 No, but changed No ongo-ng being restrctured and at USD 14.9 ba, or changed changed from from restricted to number of finance 20.5 perent of from restricted to pesrnitted in 1991 companies is to be GDP by 1999. restricted to permitted in reduced fross 39 to) 16 peimitted in 1991 throigh mergers. 'Two 1991 finawce companies were taken over by Cenwal Bank including Maf Finance, the largest independent finance company. Iwo basks, deened insolvent, accomnting Ibr 14.2 perent of financidl system assews, to be morged withi othet banks. Oveall, at end 199, NPLs estimtted between 25-:15 percnt of tDtal _________banking system asets. 48 Table 12 (continued) Banking Crises: Dates, Costs and Bank Regulatory Responses Change in Regulations for Allowable Activities: Yes or No Coding of Banking Crises Country Year of Scope ofProblem Estimate of Total Bank Ownersbip Non-financial Crisis Losses/Costs Securities Isurance Real Estate of Non-financial Firm Ownership Systemic Major Firms of Banks Mexico 1981/82 Government took over N/A N/A N/A N/A N/A (perhaps until troubled banking system. reprivatized 199O/91)' 1995- Out of 34 commercial Distressed banks No No No No No ongoing banks as of 1994, nine accounted for 3.9 banks were intervened in percent of banking and 11 more banks system assets. participated in the loan/purchase recapitalization program. These nine intervened banks accounted for 18.9 percent of total financial system assets and were deemed in 1993: insolvent banks account for 20 perent of tota assets and 22 percent of banking system deposits; 1995: almost half of the banks reported to be in financial distress. Nigeria 1990s* 1993; insolvent banks No No No No No account for 20 percent of total assets and 22 percent of banking system deposits; 1995: almost half of tie banks reported to be in financial distress 1997*" Distressed banks No No No No No accounted for 3.9 percent of banking system assets. Norway 19S7-93' Central Bank provided Recapitalization No No No No No l special loans to six banks, costs amounted to suffering from post-oil S percent of GDP. recession of 19S5-S6 and from problem real estate loans; state took control of three largest banks (equivalent toS5 percent of bankig system assets, whose loan losses had wiped out capital), partly through a Government Bank Investment Fund (Nkr 5 billion) and tie state-backed Bank Insurance Fund bad to increase capital to Nkr 11 billion. Peru 1983-1990' Two large banks failed. No No No No No The rest of the system suffered from high levels of non-performing loans and financial disintermediation following the nationalization of tie banking system in 1987. PhlDippines 1981-1987' Two public banks At its peak, cntmal N/A N/A N/A N/A N/A accounting for 50 percent bank assistance to of banking system assets, financial six private basns institutions accounting for 12 percent amounted to 19.1 of barkng system assets, bh pesos (3 percent 32 thrifts accounting for of GDP). 53.2 percent of thrift banking assets and 128 rural banks. 49 Table 12 (continued) Banking Crises: Dates, Costs and Bank Regulatory Responses Change in Regulations for Allowable Activities: Yes or No Coding of Banking Crises Country Year of ope of Problem Estimate ofTotal Bank Ownership Non-financial Crisis LoSS/Costs Secerities Inurance Real Estate of Non-financial FirmOwnership Systemic Major Flrms of Banks Philippines 1998- SinceJarmayl9°8 one Net loss estimated No No No, No No ongoing* commercial bink, seven at USD 4.0 bh, or out of 8 trifis and 40 out 6.7 percent of GDP of 750 rural banks have by 1999. been placed uider receivership. Banking systers NPLs ireached 10.8 perenit by August of 1998 and 11.4 percent by Novenber 1998 Expected to re&-ch 20 percent in 1999. SriLanka 1989-19933 State-ownedbanks Restucturingcost N/A N/A NI'A N/A N/A comprising 70 percent of amounted to 25 bn banking system estimated rupees (5 pernt to have non-performing of GDP) loan ratio of about 35 perca t Sweden 1991, Nordbanken fadGota Costof No No No Yes, chasngedfrom No I Bank insolvait, recapitelization prohibited to accotnting for 21.6 amounted to 4 restricted in percent of total baeking percent of GDP. August 1991 system assets. Spaubanken Foresta intenened, accontmig fer 24 percent of total banking system assebm Ovenal, five of six large tbanks,, accoimting for over 70 pereent of bank-ng system assets expeienced fiflcoclties. Tanzania Late 1980s; 1987: the main finndcal 1987: implied N/A N/A IN/A N/A N/A 199Ds imsitutions had armars losses amount to amnomting to half ofitheir nearly 10 percent portfolio; 1995: Tbe of GNP. Natioinal Bank of Commerce which accownted for 95 percent of baninkg systen assets, insolvent since 1990-92, possibly longer. Thailand 1983 19S7' Authorities intervened in Government cost N/A N/A TVA N/A N/A 50 fitance amd secarity for 50 finance firra & 5 commer:ial companies banks or about 25 percent estimated at 0.5 of total finanzial system percent of GNP; assets; 3 comnercial govenumnent cost bank s judged insolvent for subsidized (14. : percent of loans amoumted to commercial bankitig about 0.2 percent asscs), of GDP annualy. Thailand 1997- Up to March 1999, Bank Net losses No No No No No ongoing of TbMiland intemed in estmated at USD 70 finance companies (out 59.7 bn, or 42.3 of91) whicl together percent of GDP in acceunted foir 12.8 1999. percent of finamcial syst m assets or 7.2 percent of finance company assets. It also intervened in six banks that together had t; market shame of 12:3 percent At end 1998, banking system NPLs had reached. 46 pmerent of total lams. 50 Table 12 (continued) Banking Crises: Dates, Costs and Bank Regulatory Responses Country Year of Scope f Problem Estimate of Total Change in Regulatfons for Allowable Activities: Yes or No Coding of Banking Crises Crisis Losses/Costs Bank Ownership Non-ftnancial Securities Insurance Real Estate of Non-finandal Firm Ownership Systemic Major Firms of Blanks Turkey 1994* Three banks failed in Up to June 1994, No No No No Yes, changed from 1 1 April 1994. authorities spent unrestricted to 1. 1 percent of permitted. As of GDP. 1993, banks may only acquire shares, including bonus shares, of nonfinancial fires up to a maximum Of I5% Of fthir own fimd, and the total sum of investmenevt is these companies may not exceed 60% of the banks' tota funds. United States 1984-1991** More than 1,400 savings Cost of savings & No NO No No NO 0 & loans and 1,300 banks loanclean up failed, amounted to an estimated USD 180 billion equivalent to 3.2 percent of GDOP. Uruguay L981-19847 Affected institutions Costs of N/A N/A N/A N/A N/A accounted for 30 percent ceapitelizing of financial system assets; banks estimated at insolvent banks accounted USD 350 milion for 20 percent offinancial (7 percent of system deposits. GNP); Centra Bank's quasi-fiscal tosses associated with subsidized credit operations andn purchase of loan portfolios amounted to 24.2 percent of oGP during 1982-85. Venezuela Late 1970s Notable bask faiures: NA N/A N/A N/A N/A I I anrd 1980s Bunco Nacional de Dlescuento (1978); BANDAGRO (1 98 1); Banco de los Trabajadores de Venezuela(1982); Banon de Comerio (1985) BHCUJ (1985); BHCO (1985); Banco Lara (1986). 1994- Insolvent banks accounted No No No No No ongoing* for 30 percent of financial system deposits. Authorities inervened in 13 out of 47 banks which held 50 percent of deposits in 1994, and in five additional banks in 1995. Zimbabwe 1995- Two outof five No No No No No ongoing* commercial banks recorded high NPL ratio Note: denotes Systemic baniking crises, whereas ** denotes non- systemic banking crises. Source: Authors based upon Gerald Caprio and Daniela Klingebiel, "Episodes of Systematic and Borderline Financial Crises", May 1999, "Global Survey", Institute of Interneitional Bankers various years; and the Office of the Comptroller of the Currency. 5 1 Table 13: Summary of Enmpirical Results Bank Financial Concentration & Industrial Non-Bank & Bank Crisis Inefficiency Development Bank per capita Competition Stock Market Securities Restrictions, ++ ++ Insurance Restrictions Real Estate restrictions H- + Bank Owning Nonfinancial Firms + ++ Restrictions Nonfinancial Firms Owning Barks Restrictions State-Owned Bank Assets + "+" indicates a significant posilive correlation "++" indicates significant positive relationship, controlling for GDP per capita and govermnent quality. "-" indicates a significant negative correlation "--" indicates a significant negative relationship, controlling for GDP per capital and government quality. 52 Appendices 53 Appendix 1: Bank Regulations and the Socio-Economic Environrment This Appendix presents correlations between the commercial bank regulatory indicators and the degree of state ownership of banks and a variety of political, cultural, legal, and economic characteristics. These socio-economic factors may influence bank regulations and state ownership of banks. For instance, it has been found that income diversity and ethnic diversity influence many policy decisions [see Engermann and Sokoloff, (1998) and Easterly and Levine (1997)]. Consequently, we examine the associations between ethnic and income diversity and the commercial bank regulatory decisions of governments. Furthermore, LLSVr (1998) emphasize that Common Law Countries tend to provide greater protection to outside investors in firms (creditors and minority shareholders). This may influence public demand for regulation. Thus, we exatnine the relationship between the legal environment and both regulatory regime and state ownership of banks. Also, regulatory policies reflect the outcome of political decisions. Thus, it is worth examining whether countries with good public institutions tend to select particular financial sector policies. Lastly, we include the level of economic development. Not only is it worth examining whether relatively successful countries tend to have particular regulatory/ownership patterns, but economic development may be highly correlated with a variety of institutional and other national traits that are both associated with, financial sector policies and for which we do not have direct measures. The goal here is to present some summary statistics regarding the relationship between the bank regulatory environment and the socio-economic environment more generally. More specifically, the six indicators that we study are as follows: Development: Real per capita GDP in 1980 (source: Penn World Tables). Good Government: Average value of three variables: (i) risk of expropriation by the government, (ii) the degree of corruption, and (iii) the law and order tradition of like 54 country. Each variable is based on a scale from 0 to 10, where higher values signify betlter government (source: LLSV 1999). Income Diversity: Average of gini-coefficient for each country over the periodl 980- 1995 (source: Deininger and Squire 1996). Ethnic Diversity: Average value of five indices of ethnolinguistic fractionalization, with higher values denoting greater diversity. The scale extends from 0 to I (source: Easterly and Levine 1997). Common Law Country: Dummy variable with a value of one if the country has an English, Common Law, heritage, and zero otherwise (source: LLSV 1999). Legal Rights of Investors: An index of the legal riphts of creditors and minority shareholders (source: computed from LLSV 1998). Table Al. presents simple correlations (and P-lvalues for the correlations) between the regulatory/ownership indicators and the six indicators of the national environment. A few findings worth mentioning are as follows. First, legal hentage and the legal rights of investors are not strongly associated with commercial banking regulationis or state ownership of banks. Second, while ethnic diversity is not highly correlated with the regulatory/ownership environment, income diversity is strongly linked. Countries with greater income diversity tend to have more restrictions on their commercial banks with respect to (i) engaging in securities market activities and (ii.) owning nonfinancial firms. Third, governments in richer countries (and good governments - those with low corruption, a strong law and order tradition, and low risk of 13 We calculate this fromn LaPorta, Lopez-de-Silanes, Shleifer, and Vishny (1998). Specifically, for shareholder rights, we add 1 if: (1) thie country allows the shareholders to mail their proxy to the firm; (2) shareholders are not required to deposit their shares prior to the General Shareholders' Meeting; (3) cumulative voting or proportional representation of minorilies in the board of directors is allowed; (4) an oppressed minorities mechanism is in place; (5) the minimum percentage of share capital that entitles a shareholder to call for an Extraordinary Shareholders' Meeting is less than or equal to 10 percent (the sample median); or (6) shareholders have preemptive rights that can only be waived by a shareholders' vote. Then, we add I for creditor tights if: (7) the country imposes restrictions, such as creditors' consent, to file for reorganization; (8) secured creditors are able to gain possession of their security once the reorganization petition has been approved (no automatic stay); (9) secured creditors are ranked first in the distribution of the proceeds that result from the disposition of assets of a bankrupt firm; and (10) the debtor does not retain the adninistration of its property pending the resolution of the reorganization. Thus, the legal rights of investors index can potentially assume values between 0 and 10. 55 expropriation) tend to (i) impose fewer regulatory restrictions on their banks and (ii) own a small percentage of the banking industry. The level of economic development and the quality of the government are very highly correlated (0.82) 56 -- Table Al Correlations for Bank Regulations and Environment in which Banks Operate BANKS OWNING NONFINANCIAL STATE NED RESTRICT SECURITIES INSURANCE REAL ESTATE NONFINANCIAL FIRMIS OWNING SATE-OW ETS ______________________________________________________FIRMS BANKS BANK ASSET DEVELOPMENT -0.440 -0.110 -0.378 -0.450 -0.342 -0.050 -0.346 I(.000) (0.3 9) (0.002) (0.000) (0.005) (0.700) (0.005) GOOD -0.374 -0.224 -0.176 -0.374 -0.380 -0.161 -0.286 GOVERNMENT (0.003) (0.083) (0.174) (0.004) (0.003) (0.230) (0.030) INCOME 0.347 0.396 0.106 0.158 0.371 0.195 0.080 DIVERSITY (0.010) (0.003) (0.447) (0.255) (0.006) (0.171) (0.571) ETHNIC 0.092 -0.006 0.067 0.134 0.048 0.139 0.042 DIVERSITY (0.464) (0.959) (0.592) (0.285) (0.707) (0.283) (0.744) COMMON -0.060 -0.086 0.093 -0.042 -0.078 0n233 -n_049 LAW COUNTRY (0.634) (0.493) (0.458) (0.735) (0.535) (0.068) (0.744) LEGAL RIGHTS OF -0.069 -0.061 0.092 -0.035 -0.193 0.141 -0.027 INVESTORS (0.653) (0.690) (0.547) (0.818) (0.208) (0.380) (0.866) 57 Table A2 Data on Financial Development and the Political/Economic Environment GOOD NET INTEREST PRIVATE BANK INDUSTRIAL TOTAL VALUE NON-BANK __ DEVELOPMENT GOVERNMENT MARGIN CREDIT CONCENTRATION COMPETITION TRADED CREDITS Argentina 6506 12.7 0.082 0.15 0.57 3.05 0.017 0.01 Australia 12520 20.4 0.019 0.81 0.67 3.04 0.144 0.34 Austria 10509 20.8 0.019 0.87 0.72 4.03 0.040 0.04 Barbados 6379 0.0 0.033 0.40 1.00 0.003 0.08 Belgium 11109 20.9 0.023 0.37 0.62 3.93 0.034 Bolivia 1989 8.0 0.035 0.20 0.46 0.000 0.02 Botswana 1940 16.5 0.052 0.11 0.95 0.005 Brazil 4303 15.2 0.120 0.25 0.68 3.31 0.064 0.09 Canada 14133 21.7 0.018 0.77 0.58 3.90 0.153 0.28 Chile 3892 14.9 0.045 0.50 0.49 3.62 0.038 0.06 Colombia 2946 11.2 0.064 0.27 0.46 2.17 0.007 0.13 Cyprus 5295 15.7 0.067 0.77 0.88 0.015 0.21 Denmark 11342 21.7 0.049 0.42 0.75 4.76 0.064 Ecuador 3238 13.7 0.072 0.19 0.41 0.017 0.04 Egypt, Arab Rep. 1645 11.1 0.012 0.28 0.65 4.19 0.004 0.04 El Salvador 2014 8.3 0.039 0.24 0.86 0.00 Fiji 3609 0.0 0.30 0.02 Finland 10851 21.7 0.016 0.67 0.86 2.77 0.044 France 11756 20.5 0.035 0.91 0.41 3.72 0.084 0.09 Gambia, The 1017 15.0 0.16 Germany 11920 20.8 0.025 0.92 0.44 4.53 0.187 0.07 Ghana 976 10.3 0.071 0.03 0.94 0.004 Greece 5901 15.2 0.035 0.40 0.77 3.18 0.016 0.18 Guatemala 2574 8.2 0.054 0.15 0.43 0.000 0.01 Guyana 1927 7.9 0.044 0.30 1.00 0.08 Hong Kong 8719 18.3 0.020 1.36 0.80 3.88 0.506 Iceian I Itu 21.6 0.3 2.00 .5 India 882 13.0 0.030 0.27 0.42 2.87 0.048 0.03 Indonesia 1281 10.8 0.041 0.26 0.43 3.29 0.018 Ireland 6823 19.5 0.016 0.63 0.79 4.07 0.144 0.36 58 Table A2 (continued) Data on Financial Development and the Political/Economic Environment DEVELOPMENT GOOD NET INTEREST PRIVATE BANK INDUSTRIAL TOTAL VALUE NON-BANK DEVELOPMENT GOVERNMENT MARGIN CREDIT CONCENTRATION COMPETITION TRADED CREDITS Jordan 3384 12.0 0.022 0.62 0.90 2.63 0.091 0.07 Korea, Republic of 3093 14.7 0.023 0.81 nl1 33 45 0.266 0.35 Lesotho | 994 0.0 0.16 1.00 0.02 Luxer.b-urg | 11893 22.0 0.007 0.24 0.38 3.00 0.016 Madagascar I 984 11.7 0.060 0.16 0.96 Malaysia 3799 16.5 0.025 0.80 0.54 3.88 0.427 0.21 Malta 4483 14.0 0.023 0.60 0.97 0.11 Mexico 6054 13.4 0.053 0.18 0.59 2.76 0.063 0.03 Netherlands 11284 22.0 0.015 1.28 0.73 4.77 0.191 0.54 New Zealand 10362 21.7 0.025 0.54 0.77 3.40 0.080 0.13 Nigeria 1438 8.8 0.047 0.15 0.83 0.000 0.02 Norway 12141 21.9 0.031 0.89 0.85 3.47 0.061 0.40 Pakistan 1110 9.2 0.029 0.23 0.78 0.019 Peru 2875 9.9 0.072 0.10 0.72 2.94 0.014 0.03 Philippines 1879 8.6 0.042 0.29 0.47 2.67 0.053 0.07 Portugal 4982 18.5 0.035 0.63 0.45 4.27 0.021 Rwanda 757 0.0 0.044 0.08 1.00 0.01 'IMlA 1 A An Singapore 7053 19.4 0.021 0.95 0.73 4.16 0.446 0.16 South Africa 3496 14.9 0.039 0.79 0.78 2.28 0.076 0.28 Spain 7390 18.6 0.038 0.72 0.46 4.06 0.062 0.06 Sri Lanka 1635 10.2 0.051 0.19 0.83 0.013 Suriname 3737 8.6 0.37 Sweden 12456 21.4 0.027 1.09 0.89 2.86 0.137 0.64 Switzerland 14301 22.0 0.016 1.78 0.74 4.00 0.975 0.34 Tanzania 480 13.2 Thailand 2178 14.3 0.030 0.68 0.54 2.62 0.203 0.17 Turkey 2874 13.2 0.094 0.14 0.45 3.14 0.062 0.01 United Kingdom 10167 20.3 0.020 0.74 0.58 4.46 0.355 United States 15295 21.2 0.039 1.31 0.18 4.22 0.344 0.66 Uruguay 5091 12.6 0.056 0.31 0.86 0.001 Venezuela 7401 13.5 0.078 0.39 0.52 2.28 0.014 0.18 Zimbabwe 1206 11.1 0.044 0.22 0.82 2.40 0.010 0.09 59 Table A3 Banking Crises Around the Globe Systemic Major |_ |_Systemic Major Argentina 1 1 New Zealand 0 0 Australia 0 0 Nigeria 1 1 Austria 0 0 Norway 1 I Barbados 0 0 Pakistan 0 0 Belgium 0 0 Peru 1 1 Bolivia I I Philippines 1 I Botswana 0 0 Portugal 0 0 Brazil 1 1 Rwanda 0 0 Canada 0 1 Seychelles 0 0 Chile I I Singapore 0 0 Colombia 1 1 South Africa 0 0 Cyprus 0 0 Spain 0 0 Denmark 0 1 SriLanka 1 1 Ecuador 1 1 Suriname 0 0 Egypt, Arab Rep. 1 1 Sweden 1 1 El Salvador 1 1 Switzerland 0 0 Fiji 0 0 Tanzania 1 1 Finland I I Thailand I I France 0 0 Turkey 1 1 Gambia, The 0 0 United Kingdom 0 0 Germany 0 0 United States 0 1 Ghana 1 1 Uruguay 1 I Greece 0 0 Venezuela 1 1 Guatemala 0 0 Zimbabwe 1 Guyana 0 0 Hong Kong 0 1 Iceland 0 0 India 0 Indonesia 1 1 Ireland 0 0 Israel 0 0 Italy 0 1 Japan 1 1 Jordan 0 0 Korea, Republic of 1 1 Lesotho 0 0 Luxembourg 0 0 Madagascar 1 1 Malaysia 1 1 Malta 0 0 Mexico 1 1 Netherlands 0 0 60 Policy Research Working Paper Series Contact Title Author Date for paper WPS2302 Why Liberalization Alone Has Not Klaus Deininger March 2000 M. Fernandez Improved Agricultural Productivity Pedro Olinto 33766 in Zambia: The Role of Asset Ownership and Working Capital Constraints WPS2303 Malaria and Growth F. Desmond McCarthy March 2000 H. Sladovich Holger Wolf 37698 Yi Wu WPS2304 Disinflation and the Suoply Side Pierre-Richard Agenor March 2000 T. Loftus Lodovico Pizzati 36317 WPS2305 The Impact of Banking Crises on Maria Soledad Martinez March 2000 A. Yaptemco Money Demand and Price Stability Peria 31823 WPS2306 International Contagion: Implications Roberto Chang March 2000 E. Mekhova for Folicy Giovanni Majnoni 85984 WPS2307 Surveying Surveys and Questioning Francesca Racanatini March 2000 P. Sintim-Aboagye Questions: Learning from World Bank Scott J. Wallsten 37644 Experience Lixin Colin Xu WPS2308 How Small Should an Economy's Paul Beckerman March 2000 H. Vargas Fiscal Deficit 1Be? A Monetary 38546 Programming Approach WPS2309 What Drives Private Saving around Norman Loayza March 2000 E. Khine the World? Klaus Schmidt-Hebbel 37471 Luis Serven WPS2310 How Politics and Institutions Affect Mitchell A. Orenstein March 2000 M. Leenaerts Pension Reform in Three 84264 Postcommunist Countries WPS2311 The Buenos Aires Water Concession Lorena Alcazar April 2000 P. Sintim-Aboagye Manuel A. Abdala 38526 Mary M. Shirley WPS2312 Measuring Governance, Corruption, Joel S. Hellman April 2000 D. Bouvet and .State Capture: How Firms and Geraint Jones 35818 Bureaucrats 'Shape the Business Daniel Kaufmann Envikonment in Transition Economies Mark Schankerman WPS2313 How Interest Rates Changed under Patrick Honohan April 2000 A. Yaptenco Financial Liberalization: A Cross- 31823 Country Review Policy Research Working Paper Series Contact 1if.e Author Date for paper *,'-VPS2314 Technological Leadership and Beata K. Smarzynska April 2000 L. Tabada Foreign Investors' Choice of 36896 Entry Mode VVPS2315 Investment in Natural Gas Pipelines Alejandro Jadresic April 2000 M. Salehi in the Southern Cone of Latin America 37157 ,jr323,16 Distrubutional Outcomes of a Emanuela Galasso April 2000 P. Sader Decentralized Welfare Program Martin Ravallion 33902 Va,vPS2317 Trade Negotiations in the Presence of Keiko Kubota April 2000 L. Tabada Network Externalities 36896 dPS23 8 Regulatory Reform, Competition, Mark A. Dutz April 2000 H. Sladovich and Innovation: A Case Study of the Aydin Hayri 37698 Mexican Road Freign Industry Pablo Ibarra ' ;PS2319 Externalities and Production Gunnar S. Eskeland April 2000 H. Sladovich Efficiency 37698 WVRS2320 Does More Intense Competition Lead Mark A. Dutz April 2000 H. Sladovich to Higher Growth? Aydin Hayri 37698 W01PS2321 Algorithms for Purchasing AIDS David Bishai April 2000 P. Sader Vaccines Maria K. Lin 33902 C. W. B. Kiyonga WPS2322 Self-Targeted Subsidies: The Richard H. Adams, Jr. April 2000 M. Coleridge-Taylor Distributional Impact of the Egyptian 33704 Food Subsidy System v'PS2323 Globaiization and Firms' Financing Sergio Schmukler April 2000 E. Khine Choices: Evidence from Emerging Esteban Vesperoni 37471 Economies vVPS2324 Give Growth and Macroeconomic Brian Pinto April 2000 H. Mvakarenko Stability in Russia a Chance: Harden Vladimir Drebentsov 87832 Budgets by Eliminating Nonpayments Alexander Morozov