## Regulating, Supervising, and Handling Distress in Public Banks (rshdpbea)

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### Key messages
- Effective regulation, supervision, and crisis management frameworks for public banks are as important for financial stability as those for private banks.
- Deposit-taking public banks that directly compete with private banks should be subject to the same expectations and requirements of governance, regulation, and supervision as private banks.
- Arm’s-length distance between government owners and bank management, explicit remuneration for policy lending, and supervisory and resolution autonomy are central reform priorities.
- Main recommendations target public banks with a retail element (deposit-taking from the general public) that directly compete with commercial banks, even if they have mixed mandates.

### Role, prevalence, and trends
- As of end-2016, public banks represented 14 percent of banking system assets worldwide.
- In advanced economies, public banks’ market share rose from 5 percent in 2005 to 12 percent in 2016.
- In emerging market and developing economies, public banks’ market share declined from 25 percent in 1999 to 16 percent in 2016.
- Public banks exist across a spectrum:
  - Non-deposit-taking development banks or specialized financial institutions (funded by wholesale borrowings with explicit state guarantees; often engaged in second-tier lending or subsidy disbursal).
  - Government-owned commercial banks (funded primarily by retail deposits and competing with commercial banks).
  - Many public banks combine elements of both types.

### Risks and systemic implications
- Public banks are vulnerable to political interference, producing unsound lending practices and inefficiencies, and often underperform private banks on financial soundness indicators.
- Where public banks dominate a system or hold monopolies over critical banking services, their distress can disrupt credit provision and payment/settlement flows.
- Privileged access to markets or products and explicit or implicit guarantees create level playing field issues and can incentivize risky behavior by private counterparts.
- Weak sovereign solvency can erode confidence in public banks and trigger deposit withdrawals, with potential broader banking-system confidence effects.
- Public bank losses can affect the budget directly and, in extreme scenarios, lead to sovereign distress. Feedback channels include large direct or indirect exposures to the sovereign and state-owned enterprises and reduced government capacity to assist banks.

### COVID-19 experience and implications
- During the COVID-19 pandemic, many governments relied on public banks to boost credit to households and firms, raising concerns about adverse effects on public banks’ operations and balance sheets going forward.
- Pandemic-era public bank interventions included:
  - Injecting capital into public banks to rollover or expand credit to affected sectors and segments (Bulgaria, Chile).
  - Raising credit ceilings of public banks or setting up new credit facilities (Brazil, Germany, Korea, Hungary).
  - Setting up guarantee programs for public banks to support key sectors and segments (Italy, France, the United Kingdom, Saudi Arabia).
- Strong governance, clear mandates, accountability, and transparency are highlighted as key ingredients of successful public-bank interventions.

### Evidence on financial performance and dataset details
- Empirical findings:
  - Analysis of 2019 financial results across a sample of more than 4,000 private and public (commercial and development) banks shows that public commercial banks operate with lower liquidity, equity, and profitability than private banks; this pattern holds in both advanced economies and emerging market and developing economies.
- Dataset details:
  - Final dataset contains 4,470 banks: 4,307 commercial banks (3,966 privately owned, the rest are at least 25% owned by the government or a state-affiliated entity) and 163 development banks.
  - Ownership snapshot is as of 2018; data primarily used as of year-end of 2019. For these banks, information on 44 dimensions was collected.
- Bank-level descriptive statistics (selected, as presented):
  - Share of state ownership: Observations 1,298; Mean 7.4; Median 2; Min 0; Max 100; Std. dev. 23.43.
  - Equity to total assets: Observations 1,356; Mean 12.34; Median 10.68; Min 0.98; Max 98.63; Std. dev. 10.52.
  - Return on assets: Observations 1,356; Mean 0.01; Median 0.01; Min −0.72; Max 2.03.
  - Liquid assets to total assets (percent): Observations 1,356; Mean 14.4; Median 9.56; Min 0; Max 99.92; Std. dev. 16.58.
- Regression evidence (Annex Table 1.3, OLS and WLS; dependent variable = state-controlled share of a bank):
  - CP 2 (Independence, Accountability, Resourcing and Legal Protection for Supervisors): OLS coefficient −2.913 (1.805); WLS coefficient −11.54*** (2.746); Adjusted R2: OLS 0.2050; WLS 0.4634.
  - CP 14 (Corporate Governance in Banks): OLS coefficient −8.294*** (2.138); WLS coefficient −22.23*** (2.459); Adjusted R2: OLS 0.2127; WLS 0.4889.
  - Observations: 1,280. Significance: * p<0.10, ** p<0.05, *** p<0.01.
- Interpretation: Higher compliance ratings on corporate governance (CP14) are associated with lower levels of state ownership; CP2 points in same direction though OLS not significant. Results are correlations; endogeneity may remain.

### Corporate governance weaknesses and good-practice recommendations
- Common weaknesses:
  - Non-transparent nomination processes; politicized appointment/dismissal; boards lacking independence and professional skills; internal accountability weak; compensation constraints limiting talent.
- Recommendations (selected):
  - Establish an explicit and transparent ownership policy: define objectives, rationale for state ownership, strategic vision; review ownership policy regularly.
  - Foster arm’s-length institutional arrangements: options include a holding company to manage government stakes or a dedicated unit within a ministry of finance.
  - Ensure clear mandates and transparent remuneration for policy lending: mandates should state high-level objectives and mechanisms (such as explicit subsidies) should transparently remunerate socioeconomic activities.
  - Implement transparent, merit-based nomination processes and ensure board accountability for strategy, financial soundness, and personnel decisions.
  - Supervisors should have authority to evaluate corporate governance, ensure fitness and propriety of board and senior management, and enforce conflict-of-interest rules.
  - Require high-quality, timely, and reliable disclosures at least as comprehensive as those for private banks, including disclosures on relationships with the state, policy lending, progress on objectives, and concessions provided.

### Regulation and prudential standards (fundamental principles and specifics)
- Fundamental principle: similar risks require similar prudential requirements across all financial institutions regardless of ownership.
- Capital:
  - Public banks should comply with the same capital requirements applicable to private banks.
  - All systemically important banks, including public banks, should hold additional capital commensurate with the risks and negative externalities they pose.
  - Supervisors should have power to impose specific capital charges to address material exposures.
- Liquidity:
  - Public banks should be subject to prudent liquidity requirements; consider LCR and NSFR with proportional implementation.
- Concentration risk and large exposures:
  - Supervisory mitigants include limits on large exposures; international standard: limit exposure to a party or group of connected parties at 25 percent of a bank’s Tier 1 capital.
  - Public sector entities not treated as sovereigns should be included in large exposure limits; supervisors should monitor exposures to the sovereign and consider additional limits or capital charges case-by-case.
  - Country example: Indonesia legal lending limit for exposures to state-owned enterprises is 30 percent of the bank’s capital (Tier 1 and Tier 2) and a minimum risk weight of 20 percent for prudential purposes.
- Risk management:
  - Ensure an independent and well-resourced risk management function with direct access to the board and segregation from risk-taking functions.
  - Enforce asset classification and provisioning rules with same intensity as private banks; guard against restructuring and evergreening of NPLs.
  - Legislative frameworks should protect supervisors and resolution staff against personal liability when acting in good faith.

### Supervision — institutional setting, tools, and actions
- Institutional setting and powers:
  - Supervisors should have a full suite of powers and clear legal authority to examine, set and enforce rules, undertake corrective actions, and sanction public banks.
  - The supervisor should have full discretion to take supervisory actions even when contrary to the view of the government as shareholder.
  - Supervisors should be operationally independent with clear mandates, legal protection, and adequate resources; ownership should be separated from supervision.
- Supervisory tools and approaches:
  - Apply the same tools and approaches to public and private banks; adopt a forward-looking, risk-based approach given mixed mandates and countercyclical roles.
  - Require stress testing that captures specific risk concentrations and plausible adverse scenarios.
  - Use comprehensive supervision with proportional intensity based on risk profile and systemic importance; onsite inspections must allow full access to documentation.
  - Use peer comparisons and benchmarking to identify inefficiencies and ensure consistent classification and provisioning.
- Communication and coordination:
  - Regular communication between supervisor and public-bank boards; share supervisory findings and work with government shareholders to address material findings promptly.
- Fiscal recognition:
  - Public policy mandates should be explicitly and promptly recorded as expenditures in the government budget; governments should provide financial support for losses linked to public policy activities.
  - Supervisors should carefully assess feasibility and timeliness of government support before treating it as risk mitigating.

### Resolution and crisis management — principles and operational guidance
- General principles:
  - Resolution frameworks should be available for all banks that could be systemically significant if they were to fail, including those owned by the state.
  - Public banks taking retail deposits should be subject to the same prudential standards, early intervention regimes, and deposit insurance arrangements as private banks.
  - Recovery and resolution planning should be required for systemic public banks; supervisors must analyze and oversee recovery plans.
  - Access to central bank emergency liquidity assistance should be on the same terms as for private banks, with conditions to demonstrate solvency, provide adequate collateral, and ensure appropriate pricing.
- Recapitalization and state support:
  - Government recapitalization may be appropriate but should be conditional, transparent, based on accurate assessments and credible restructuring plans, and scrutinized by supervisor and shareholder ministry/agency.
  - Supervisors should be able to withdraw licenses and trigger resolution if recapitalization does not occur.
- Common challenges:
  - Allocating losses to creditors is legally and politically challenging and may affect sovereign creditworthiness depending on liabilities and guarantees.
  - In severe crises, government support costs may threaten sovereign debt sustainability, potentially forcing creditors of public banks to bear larger losses.
  - Resolution may change post-resolution ownership and governance; governments should plan for whether public policy functions remain essential and how to fund them.
  - Coordination across layers of government must be clarified in advance to avoid deadlock and delays.

### Specialized Financial Institutions (SFIs) — considerations
- If SFIs are pure policy vehicles, fully wholesale funded, contagion risk may be lower, but governance and budgetary oversight remain important.
- Prudential supervision is good practice and necessary if SFIs are systemic by size, services, or interconnectedness.
- Capital and liquidity frameworks may need adaptation to SFI business models (examples: China Development Bank; EU application to KfW).
- Supervisory focus should include foreign exchange liquidity risk, bond issuance rollover risk, seasonality in lending (agricultural banks), and concentration risks inherent to mandates.

### Policy priorities and concluding recommendations
- Policy gaps where reform is most needed:
  1. Give public banks clear and well-defined mandates.
  2. Adopt best practices in corporate governance and risk management.
  3. Provide supervisors with clear mandates, operational independence, and legal protection for supervisory actions on public banks.
  4. Enable full supervisory powers over public banks.
  5. Adapt and align regulation and supervisory tools with risk profiles.
  6. Implement safeguards against political intervention (including ownership policy).
  7. Reduce market distortions to create a level playing field for public and private banks.
- Supervisory priorities and actions:
  - Close gaps in regulatory and supervisory frameworks in countries with significant public-bank presence.
  - Adopt a more proactive supervisory stance post-COVID-19 as asset quality and profitability are stressed, especially for public banks that expanded credit to hard-hit sectors.
  - Prioritize fixing public banks with impaired balance sheets; delays in remedial actions aggravate positions and market distortions.
  - Ensure public banks receive the same access to financial support or guarantees as private banks—no preferential treatment.
  - Make state recapitalization transparent and based on credible asset valuations and business plans to minimize taxpayer risk.
  - Make resolution planning and tools available for all public banks whose failure could have systemic implications, notably those attracting retail deposits.
  - Strengthen legal regimes and independent resolution authorities to prevent problems from lingering.

*IMF Departmental Paper — Regulating, Supervising, and Handling Distress in Public Banks (rshdpbea)*

### Executive Summary ................................................................................................v

### Executive Summary

### Key messages
- Effective regulation, supervision, and crisis management frameworks for public banks are as important for financial stability as those for private banks.
- Deposit-taking public banks that directly compete with private banks should be subject to the same expectations and requirements of governance, regulation, and supervision as private banks.
- Arm’s-length distance between government owners and bank management, explicit remuneration for policy lending, and supervisory and resolution autonomy are central reform priorities.
- Public banks are heterogeneous; the main recommendations target public banks with a retail element (deposit-taking from the general public) that directly compete with commercial banks, even if they have mixed mandates.

### Role, prevalence, and trends
- As of end-2016, public banks represented 14 percent of banking system assets worldwide.
- In advanced economies, public banks’ market share rose from 5 percent in 2005 to 12 percent in 2016 (reversing an earlier decline).
- In emerging market and developing economies, public banks’ market share declined from 25 percent in 1999 to 16 percent in 2016.
- Public banks exist across a spectrum:
  - Non-deposit-taking development banks or specialized financial institutions (funded by wholesale borrowings with explicit state guarantees; often engaged in second-tier lending or subsidy disbursal).
  - Government-owned commercial banks (funded primarily by retail deposits and competing with commercial banks).
  - Many public banks combine elements of both types.

### Risks and systemic implications
- Public banks are vulnerable to political interference, producing unsound lending practices and inefficiencies, and often underperform private banks on financial soundness indicators.
- Where public banks dominate a system or hold monopolies over critical banking services, their distress can disrupt credit provision and payment/settlement flows.
- Privileged access to markets or products and explicit or implicit guarantees create level playing field issues, potentially undermining competitiveness and incentivizing risky behavior by private counterparts.
- Weak sovereign solvency can erode confidence in public banks and trigger deposit withdrawals, with potential broader banking-system confidence effects.

### COVID-19 experience and implications
- During the COVID-19 pandemic, many governments relied on public banks to boost credit to households and firms, raising concerns about adverse effects on public banks’ operations and balance sheets going forward.
- Examples of pandemic-era public bank interventions included:
  - Injecting capital into public banks to rollover or expand credit to affected sectors and segments (Bulgaria, Chile).
  - Raising credit ceilings of public banks or setting up new credit facilities (Brazil, Germany, Korea, Hungary).
  - Setting up guarantee programs for public banks to support key sectors and segments (Italy, France, the United Kingdom, Saudi Arabia).
- Strong governance, clear mandates, accountability, and transparency are highlighted as key ingredients of successful public-bank interventions.

### Main policy recommendations
- Governance and mandates
  - Public banks should have well-defined mandates, sound governance structures, and practices that safeguard against political intervention.
  - Ensure a properly functioning, independent board; transparent nomination and dismissal processes for board members and senior management; and consistent nomination of knowledgeable and experienced professionals.
  - Ownership arrangements should avoid conflicts of interest; good practices include establishing a holding company to manage government stakes on an arm’s-length basis or creating a dedicated government unit to advise on public-bank issues.

- Regulation and prudential standards
  - The regulatory framework applying to public banks should be no less stringent than that for private banks: similar risks require similar capital and other prudential requirements across all financial institutions.
  - Apply the principle of proportionality—prudential and administrative standards should be commensurate with institutions’ risk profiles.
  - Each public bank’s operations and risk appetite should be commensurate with its capacity to manage risks; supervisors should ensure capability to understand portfolio risk-return profiles and manage material risks effectively.
  - Require credible recovery plans to enhance resilience and minimize fiscal support needs.

- Supervision and institutional settings
  - The legal framework should endow supervisors with provisions and tools necessary to exercise full authority over public banks.
  - Supervisory intensity should be proportionate to risk profile and systemic importance; systemically important public banks warrant enhanced prudential requirements, more intensive supervision, and effective crisis-management arrangements.
  - Promote supervisory independence and clear mandates so supervisors can take timely corrective actions without intimidation by owners.

- Crisis management and resolution
  - Resolution should be a credible option for all failing banks, including public banks; exemptions undermine level playing field and impede restructurings.
  - Public banks should be full members of the deposit insurance system, subject to the same resolution powers as private banks, and eligible for emergency liquidity assistance at the discretion of the central bank on the same terms as private banks.
  - Strong, well-developed resolution regimes with a broad range of powers wielded by operationally independent agencies promote timely responses.
  - Where mandates are mixed and policy lending occurs, create mechanisms to transparently and adequately remunerate such activities (for example, explicit subsidies) so as not to dilute resilience and operational capacity.

### Institutional and political considerations
- Achieving arm’s-length governance and effective supervisory independence often requires sustained political will toward reform of public banks.
- Legal carve-outs or exemptions in law or regulation for public banks, and practical constraints on supervisors, must be addressed to avoid regulatory forbearance and delayed corrective action that increase losses and fiscal costs.
- Failure to address public-bank weaknesses can undermine overall supervisory effectiveness, weaken market discipline, and provoke industry pressure for similar treatment of private banks.

### Objective of the paper
- Raise awareness of gaps in the regulation, supervision, and crisis management of public banks and encourage authorities to undertake reforms to mitigate risks to financial stability posed by public banks—especially deposit-taking institutions that directly compete with private banks.
- A comprehensive policy response is required, including legal and institutional reforms; sound corporate governance and risk management; comprehensive, forward-looking supervision with adequate regulatory backing; and adequate crisis preparedness.

*IMF Departmental Paper — Regulating, Supervising, and Handling Distress in Public Banks (Executive Summary)*

### 2. Public Banks: Key Features and Outcomes

### 2. Public Banks: Key Features and Outcomes

### Overview: heterogeneity and scope
- Public banks range from non-deposit-taking specialized development banks to state-owned or controlled commercial banks that collect deposits from retail customers and compete directly with private banks.
- Main recommendations in this paper target public banks that collect deposits from retail customers and compete with private banks, though advice applies to all deposit-taking public banks (including deposit-taking development banks).
- Some development banks have retail exposures on the liability or asset side; some state-owned commercial banks have policy objectives committing them to serve specified sectors or state-owned counterparts.
- Specific considerations for non-deposit-funded specialized financial institutions are discussed separately (Box 3).

### Business model characteristics that affect risk appetite and risk management
- Socioeconomic mandates:
  - Most public banks are de jure or de facto mandated to pursue socioeconomic goals (policy lending to specific sectors/regions, provision of deposit/payment services to public bodies).
  - Mandates vary in strength and may be inconsistent with financial viability if they do not generate appropriate returns (directly or through subsidies).
  - Where mandates are mixed, business lines pursuing socioeconomic objectives should be subsidized separately by fiscal authorities or via second tier development banks to avoid diluting profitability goals.
- Complex portfolios and countercyclical role:
  - Public banks often fund high-risk projects and support lending during stress, creating risk-management challenges.
  - Long-term, large-scale infrastructure or project financing commonly represent a large share of public banks’ portfolios, carrying substantial credit and market risks.
  - Exposure to concentration risk and lending to state entities (possibly on concessional terms) may create politically sensitive provisioning and weak insolvency/enforcement credibility.
  - Countercyclical lending in downturns increases credit risk.
- Ownership structure and political interference:
  - Public banks are frequently subject to political interference, especially in countries with governance vulnerabilities.
  - They can be used to pursue short-term political goals that deviate from long-term commercial and socioeconomic objectives, causing resource misallocation.
  - Vested interests may resist governance and risk-management improvements.

### Evidence on financial performance and market effects
- Empirical findings:
  - Analysis of recent (2019) financial results across a sample of more than 4,000 private and public (commercial and development) banks shows that public commercial banks operate with lower liquidity, equity, and profitability than private banks.
  - This pattern holds in both advanced economies and emerging market and developing economies, with significant variation across performance dimensions.
  - Literature cited: Micco and others (2004); Cornett and others (2010); Berger and others (2005); IMF (2019); IMF (2020b); evidence of improved performance after privatization cited in Verbrugge, Megginson, and Owens (1999); Bonin, Hasan, and Wachtel (2003); Kausar and others (2014).
- Dataset details:
  - Final dataset contains 4,470 banks: 4,307 commercial banks (3,966 privately owned, the rest are at least 25% owned by the government or a state-affiliated entity) and 163 development banks.
  - Ownership snapshot is as of 2018; data primarily used as of year-end of 2019. For these banks, information on 44 dimensions was collected.
- Competitive distortions:
  - Public banks typically benefit from implicit, and at times explicit, government guarantees that shield creditors from losses or are perceived to do so, providing an advantage in collecting funds.
  - State-owned enterprises and civil servants tend to deposit cash balances in public banks; in some countries they are captive sources of funds, lowering funding costs relative to competitors.
  - During stress, public banks can benefit from a “flight to quality.”
  - Multiple large public banks in a jurisdiction could reduce competition if they collude formally or informally.

### Sovereign–bank feedbacks and fiscal risks
- Public bank losses can affect the budget directly if government capital replenishment is required and could, in extreme scenarios (failures of systemic public banks), lead to sovereign distress.
- Large public bank losses that raise sovereign default risk can spill over to all banks and the broader economy.
- Fiscal constraints and inability/unwillingness to privatize have produced chronically undercapitalized or insolvent public banks in some countries.
- Increases in sovereign risk feed back into public banks through:
  - Direct or indirect exposures to the sovereign and state-owned enterprises (typically large).
  - Reduced government ability to assist banks, affecting funding costs and availability (sovereign credit rating influences banks’ credit ratings).
- Potential liquidation or resolution of a public bank can adversely affect perceived sovereign creditworthiness and propagate confidence shocks, especially where the government controls multiple banks.

### Corporate governance weaknesses in public banks
- Common weaknesses:
  - Nomination processes for senior management and board members often lack transparency; appointment/dismissal may be politicized or not merit-based.
  - Government officials as shareholders may intervene in day-to-day operational decisions (lending terms, branch locations, pricing).
  - Boards may lack independence, professional skills, and experience; internal accountability may be weak.
  - Public banks may be subject to government personnel rules limiting compensation, reducing the pool of qualified candidates.
- Correlation evidence:
  - Countries with higher shares of state ownership in banks are often associated with less effective supervision of corporate governance, as measured by compliance with principle 14 of the Basel Core Principles (Figure 3 and Annex 1).
- Implication:
  - Improving corporate governance quality in public banks should be a key goal of country authorities.

### Recommendations and good practices
A. Ownership Structure and Mandates
- Establish an explicit and transparent ownership policy for public banks and other state-owned enterprises as applicable:
  - Define overall objectives, rationales for state ownership, and a strategic vision for public banks.
  - Base the state’s role as owner on principles of sound commercial practices, good corporate governance, and competitive neutrality.
  - Review the ownership policy at regular intervals and include information on policy and implementation in regular reporting.
- Foster arm’s-length institutional arrangements:
  - Options include a holding company-type structure to manage government ownership interest, or a separate unit within a government ministry (often the Ministry of Finance) to advise on ownership matters.
  - Holding companies can provide institutional separation, professional oversight, and protection from undue political interference.
  - A dedicated unit within a ministry may better integrate oversight with the budget process and fiscal risk assessment.
- Ensure clear mandates and transparent mechanisms to secure long-term financial viability:
  - Mandates should succinctly state high-level, long-term objectives aligned with the rationale for state ownership.
  - Mechanisms (such as explicit subsidies) should adequately and transparently remunerate activities aimed at socioeconomic goals so they do not jeopardize bank viability.

B. Board and Senior Management
- Implement transparent, merit-based nomination processes and clear responsibilities for the board and senior management:
  - Appointment and dismissal processes should be well-established and merit-based.
  - The board should be accountable for business strategy, financial soundness, and key personnel decisions and able to flag and address operational problems.
  - Board charter should define roles and terms of reference, including for government officials on the board.
  - Special attention to appointment/dismissal processes and board composition (see Annex 2 in the source).
- Supervisory role in corporate governance:
  - Supervisors should have clear authority to evaluate corporate governance in public banks.
  - Supervisors should ensure fitness and propriety of board members and senior management and enforce conflict of interest rules and confidentiality obligations aligned with those for private institutions.
  - Supervision should assess effectiveness and independence of internal audit functions, which must provide independent assurance to the board or audit committee.

C. Disclosure Requirements
- Require high-quality, timely, and reliable disclosures by public banks, at least as comprehensive as those for private banks:
  - Disclosures should enable accurate assessment of financial condition, performance, business activities, risk profile, and risk-management practices.
  - Consider expanded disclosures in sensitive areas, including:
    1. The relationship between the public bank and the state (lending to state-owned enterprises, policy or directed lending, funding from the state or state-related entities).
    2. Public banks’ activities to fulfill their mandate.
    3. Assessments of progress in achieving objectives.
    4. Any concessions provided to the bank (tax exemptions or discounts).
  - Listing public banks on the stock exchange has been used by some countries to enhance transparency and disclosures.

*Source: rshdpbea - 2. Public Banks: Key Features and Outcomes*

### Box 1. Oversight of State Ownership in Banks

### Box 1. Oversight of State Ownership in Banks

### Public bank holding company structures
- UK example:
  - UK Financial Investments (UKFI) established in 2008 as a limited company to manage Treasury’s shareholdings in Royal Bank of Scotland Group, Lloyds Banking Group, and UK Asset Resolution Ltd.
  - Framework document specified UKFI would manage investments on a commercial basis and would not intervene in day-to-day management decisions, including individual lending or remuneration decisions.
  - Board composition requirements: a private sector Chairman, the Chief Executive of the Company, up to five further non-executive private sector members, and up to two senior Government officials nominated by HM Treasury.
- Netherlands example:
  - Netherlands Financial Investments (NLFI) established in 2011 to manage holdings in ABN AMRO Bank N.V. and De Volksbank N.V., modelled on UKFI.
  - A supervision agreement described the Ministry of Finance’s relationship with NLFI, aiming to provide an additional buffer against unwanted political influence, ensure a credible exit strategy, and maintain commercial, non-political corporate governance.

### Dedicated unit in the Ministry of Finance
- Ireland example:
  - Shareholding and Financial Advisory Division (SFAD) blends private sector and government expertise.
  - Roles include oversight of state ownership in public banks, advisory and policy development, and market interaction.
  - Activities include developing and recommending strategies for returning banks to private ownership to the Minister, and monitoring bank performance and stock market trends through regular interaction with management, investors, and market participants.

*Sources: Country authorities; and UKFI and NLFI websites.*

### Ukraine: appointment process of board members in public banks
- System share and deposits as of end-September 2021:
  - State-controlled banks account for 51 percent of banking system total assets.
  - State-controlled banks account for 57 percent of household deposits.
- Legal reform timeline:
  - Independence and professionalism of state-owned banks’ supervisory boards enhanced in 2018 and operationalized in 2019.
- Article 7 of the Law on Banks and Banking (summary):
  - Supervisory board composition mandated at nine members: six independent directors and three State representatives.
  - Appointment process for independent board members involves:
    1. An executive search company recommending a board profile matrix and a long list of potential candidates.
    2. A nomination committee set up by the Cabinet of Ministers.
    3. A technical secretariat of no less than three people, selected by the nomination committee, to provide organizational and information support.
  - Strict fit and proper criteria for nomination committee members and procedures for candidate selection.
- Fitness, propriety, and impartiality requirements:
  - Board members must comply with fitness and propriety requirements of the Law on Banks and Banking.
  - Article 7 imposes additional requirements to ensure impartiality and provides criteria for independent directors.
  - Prohibitions include appointment where a conflict of interest may arise; persons with outstanding criminal records and/or administrative penalties for corruption-related offenses may not be board members of a fully state-owned bank.
  - Director criteria include:
    1. Not being, or for the last five years not having been, the top manager (except for an independent Board member) of the state-owned bank/branch/representative office/other separate subdivision or of a legal entity in which this state bank has a significant share.
    2. Not being, or having not been, an employee of the state-owned bank/branch/representative office/other separate subdivision or legal entity in which this state bank has a significant share for the last three years.
    3. Not being a related person (except for an independent Board member) of the state-owned bank.
- Implementation challenges:
  - Delays in Cabinet approval of strategies for state-owned enterprises and obstructions to renewing management boards have impaired supervisory board effectiveness, delayed restructuring, and weakened NPL recoveries.

*Source: IMF staff analysis.*

### External audit and government inspection
- Public banks should be subject to periodic independent external audit based on internationally agreed accounting and auditing standards.
- Governments typically inspect public banks regularly to monitor use of public funds and budget resources.
- External audits are important to ascertain adequacy of financial statements and operations, reinforce trust in internal systems, and validate information provided by management to the board and the public.

### Regulation — fundamental principles
- Fundamental principle: similar risks require similar prudential requirements across all financial institutions regardless of ownership; regulatory framework for public banks should be no less strict than for private banks.
- Prudential approaches may need reinforcement to address state-ownership-specific risks (for example, excessive lending to state-owned enterprises and an unlevelled playing field).

### A. Capital
- Public banks should comply with the same capital requirements applicable to private banks.
- All systemically important banks, including public banks, should hold additional capital commensurate with the risks and negative externalities they pose.
- Supervisors should have the power to impose specific capital charges to address material risk exposures from public bank operations.

### B. Liquidity
- Public banks should be subject to prudent liquidity requirements.
- Liquidity instruments to consider include the liquidity coverage ratio (LCR) and the net stable funding ratio (NSFR); proportional implementation should be considered even for banks that are not internationally active.
- Supervisors should develop liquidity risk management guidelines and monitoring tools to address concentration of funding, maturity mismatches, and foreign currency liquidity mismatches.

### C. Concentration risk and large exposures
- Mixed mandates can accentuate concentration risks (sectoral or geographic focus), generating large exposures to connected counterparties.
- Supervisory mitigants:
  - Establish limits on large exposures and enforce sound concentration risk management.
  - International standard: limit exposure to a party or group of connected parties at 25 percent of a bank’s Tier 1 capital.
  - Require policies and processes for a comprehensive bank-wide view of concentration risk and appropriate information systems for aggregation.
  - Assess public banks’ concentration risks under the supervisory review process of the Basel Pillar 2 framework and impose additional capital requirements if necessary.
- Exposures to state-owned enterprises:
  - Public sector entities that are not treated as sovereigns should be included in large exposure limits.
  - Basel standard does not require aggregation of exposures to state-owned enterprises unless they are connected for reasons other than same owner; full implementation may not prevent high exposures to the public sector broadly defined.
  - Supervisors should monitor exposures to the sovereign and on a case-by-case basis consider additional limits, restrictions, or capital charges.
  - Supervisors should monitor related-party exposures in line with Basel Core Principle 20: Transactions with Related Parties.
- Country example:
  - In Indonesia, exposures to state-owned enterprises are subject to a legal lending limit of 30 percent of the bank’s capital (Tier 1 and Tier 2 capital) and, for prudential purposes, are assigned a minimum risk weight of 20 percent.

### D. Risk management
- Ownership structure and loan portfolios pose additional risk management challenges: policy roles, political pressures, complex project financing (including infrastructure), and countercyclical lending mandates increase risk.
- Key supervisory and internal controls:
  - Ensure an independent and well-resourced risk management function with direct access to the board and segregation from risk-taking functions.
  - Risk exposures should be reported directly to the board and senior management and reviewed regularly by internal auditors.
  - Ensure risk appetite is consistent with mandate and capacity to manage risks; require well-functioning risk management committees and experienced chief risk officers.
  - Boards, senior management, and chief risk officers should establish risk governance frameworks and risk appetite statements aligned with long-term strategy and capital position; risk management committees should engage in capital planning and set risk parameters.
  - Enforce asset classification and provisioning rules with the same intensity as for private banks; guard against restructuring and evergreening of NPLs.
  - Legislative frameworks should protect supervisors and resolution authority staff against personal liability when acting in good faith to enable remedial actions (for example, sales of NPLs to asset management companies, securitization, debt/equity swaps).
- Country-specific note:
  - In India, public banks offering concessions to borrowers could fall within the scope of provisions in the Criminal Code and the Prevention of Corruption Act, which may discourage remedial actions despite concessions not necessarily being unlawful.

*IMF DEPARTMENTAL PAPERS • Regulating, Supervising, and Handling Distress in Public Banks*

### 5. Supervision

### 5. Supervision

### A. Institutional Setting — Supervisory powers and independence
- Public banks’ links to the government pose practical challenges for effective supervision: political pressures may result in forbearance and gaps in the institutional framework often hamper effective supervision.
- Deposit-taking development banks in some cases are not subject to prudential supervision, or supervisors may be constrained in their capacity to conduct onsite inspection and impose corrective actions, sanctions, and enforcement.
- Evidence from IMF assessments indicates supervisory powers related to licensing, fitness and propriety, lending standards, major acquisitions, changes in business operations, capital level, and senior management may be weakened by state ownership.
- Specific weaknesses observed include:
  - onsite inspections are performed by the government only to verify compliance with applicable laws and regulations (not safety and soundness);
  - supervisors’ inspections require coordination with the state, and the state can set guidelines on the duration and number of onsite activities;
  - inspections can only be carried out at the request of the bank;
  - supervisors have limited capacity to require the bank to reclassify loans as nonperforming;
  - supervisors can only impose corrective actions through the ministry in charge of the specific bank.
- Common practical constraints:
  - key personnel or senior managers of public banks may be selected by ministries without supervisory approval or fit and proper assessment;
  - supervisors may not be able to effect changes in lending policies when lending is directed by the government;
  - public banks have been used to acquire other failing financial institutions without satisfying supervisory approval requirements;
  - supervisors may lack legal powers to remove government-appointed board members or management, force a merger of weak public banks, suspend or revoke licenses, or trigger resolution of public banks.
- Recommended supervisory powers and actions:
  - supervisors should have a full suite of powers and clear legal authority to examine, set and enforce rules, undertake corrective actions, and sanction public banks;
  - the supervisor should have full discretion to take any supervisory actions or decisions on public banks—even when it goes against the view of the government as shareholder;
  - the supervisor should be able to sanction managers who ignore recommendations and escalate measures;
  - the range of possible actions should include restricting activities of public banks, suspending dividend payments, requiring fresh capital, restricting certain individuals from management, and replacing or restricting the powers of directors.
- Independence, mandate, and accountability issues:
  - government-appointed executives and board members may intimidate supervisors and hamper independent judgment, especially regarding mismanagement or a weak board;
  - supervisors may find it difficult to require additional capital or adjust asset classification where such actions impact dividends to the state or the state lacks fiscal means to inject capital;
  - unclear mandates, government influence over supervisors, and absence of suitable powers are frequently found in countries with a large presence of public banks.
- Empirical indication of lack of independence (Figure 4):
  - Title: Lack of Independence (Percent of BCP-assessed countries)
  - Categories on chart: Industry influence; Lack of budget autonomy; Gov’t influence; Appointments and dismissal
  - Two series labels: Public banks’ banking assets <25% of total banking assets; Public banks’ banking assets >25% of total banking assets
  - Axis markers shown: 0, 25, 50, 75, 100
- Institutional measures to strengthen supervision:
  - Separating ownership from supervision: the shareholder of a public bank should not be designated as prudential authority; supervisory authorities (including central banks) should not be owners of banks.
  - Ensuring de jure and de facto operational independence of supervisors from government: governance frameworks and funding mechanisms should not compromise operational independence; the government should not be represented on the supervisory board of the supervisory agency (or, if represented, should not have voting rights on prudential matters).
  - Establishing an institutional framework that promotes the supervisor’s willingness to act: key elements include clear mandates, operational independence, transparent accountability, legal protection for supervisory actions taken in good faith, and sufficiency of powers, skills, and resources.
- Notes on ownership and conflicts:
  - Ownership interests in banks should be the responsibility of the finance ministry (or a specialized agency).
  - Central banks as owners create conflicts of interest given their roles as managers of liquidity and sometimes supervisors and their primary mandate of preserving price stability.
  - Resolution authorities may temporarily control a bridge bank during resolution; such potential conflicts should be mitigated by the resolution authority being sufficiently independent and aiming for prompt disposal of any bridge bank.

### B. Supervisory tools and approaches
- Supervisors should apply tools and approaches equally to public and private banks; supervisory objectives (identification of risks and timely supervisory actions to secure soundness and protect depositors) are the same.
- Supervisory approach should depend on the activity undertaken, but:
  - a forward-looking, risk-based approach is even more important for public banks given their mixed mandates and potential countercyclical role;
  - supervisors should have processes to understand the bank’s risk profile both at a point in time and on a forward-looking basis;
  - systemic risk analysis focused on interconnectedness between public banks and the rest of the financial system should be conducted regularly to identify risk transmission channels.
- Stress testing and risk capture:
  - banks should be required to include specific risk concentrations in their stress testing programs;
  - supervisors should ascertain that stress testing programs capture all material sources of risk of public banks and adopt plausible adverse scenarios.
- Supervisory techniques and intensity:
  - supervision should be comprehensive and use an appropriate range of techniques and tools;
  - intensity and frequency of supervisory activities should be proportionate to each bank’s risk profile and significance in the domestic financial system;
  - onsite inspection should provide independent verification that governance arrangements, risk management, and internal control systems are adequate;
  - supervisors should have full powers to access all requested documentation and information.
- Offsite monitoring and benchmarking:
  - peer comparisons are critical when analyzing financial conditions, business models, and cross-sectoral issues and linkages;
  - comparative analysis can help identify sources of inefficiency (for example, cost structures) and benchmark asset quality of the same borrower against peers for proper classification and provisioning.
- Communication and coordination:
  - regular communication between the supervisor and the board of the public bank is key;
  - the supervisor should share supervisory findings (especially weaknesses) and good practice guidance with the bank’s board;
  - the board should stay up-to-date on supervisory findings and concerns, including through individual meetings with independent board members, to help the supervisor assess board and senior management quality.
  - coordination with the government as shareholder is critical to ensure supervisory findings are addressed without delay; the government should be aware of material supervisory findings, concerns, and emerging risks raised during examinations and work with the supervisor to address them in a timely manner.
- Fiscal recognition and government support:
  - public policy mandates of public banks should be explicitly and promptly recorded as expenditures in the government budget.
  - governments should provide financial support to these banks for incurred losses associated with activities undertaken in pursuit of public policy objectives.
  - in some cases, ex post compensation (including recapitalization), or ex ante subsidies for below-market activities, are stipulated in law or other arrangements.
  - supervisors should carefully examine the feasibility and timeliness of potential government support before recognizing them as risk mitigating factors, given numerous cases where support has not been forthcoming in a timely manner.
  - the quality of capital and Basel III eligibility criteria (if applicable) should be closely examined and observed.
  - Example note: if part of the capital component from government is a “contribution in kind,” its fair value should be accurately calculated.

*Source: rshdpbea - 5. Supervision*

### 6. Resolution and Crisis Management

### 6. Resolution and Crisis Management

### A. General Principles
- Public banks can face financial distress; the state must promptly address problems to meet its responsibility as shareholder and protect financial stability.
- Public banks generally benefit from strong implicit or explicit government guarantees, raising questions about limiting moral hazard and fiscal risks.1
- Different crisis management approaches are needed for different types of public banks; public banks attracting retail funding should be subject to the same framework as privately owned banks.
- The bank resolution framework2 should be available for all banks that could be systemically significant if they were to fail, including those owned by the state.3
- Bank resolution is a process to effect an orderly restructuring or winddown of an institution at, or likely to reach, the point of non-viability with objectives to protect depositors, preserve financial stability, and minimize losses through actions such as taking over management, overriding shareholder rights, transferring assets and liabilities, or initiating liquidation proceedings.
- Best practice: enable resolution before balance sheet insolvency (before assets fall below liabilities) at the point of non-viability; recognize losses on the balance sheet with corresponding write-downs of capital and, when large enough, liabilities.
- Public banks taking retail deposits should:
  - Be subject to the same prudential standards and early intervention regime as private banks.
  - Be subject to supervisory early intervention powers and an “intervention ladder,” moving from supervisory corrective actions to more intrusive crisis measures on the basis of clear but flexible triggers.
  - Be members of the deposit insurance scheme (DIS), subject to the same coverage level and deposit insurance levies as private banks.
- Risks if public banks are not DIS members:
  - Public banks may benefit from implicit state guarantees and offer safe deposits without paying DIS fees, creating funding cost advantages over private banks.
  - If public banks are a significant part of the system and not contributing members, the financial strength of the DIS and its ability to cover losses would be undermined.
  - “Flight-to-quality” dynamics could intensify, with creditors withdrawing from private banks to public ones, precipitating confidence crises in private banks.
- Recovery and resolution planning should be required (at a minimum) for systemic public banks; boards and senior management should plan to deal with financial stress without government support.
  - Supervisory authorities must analyze and assess recovery plans and have oversight to ensure timely implementation to mitigate management “gambling for resurrection.”
  - Supervisors should plan early intervention measures, recapitalization, or resolution actions if management fails to act.
- Access to central bank emergency liquidity should be provided on the same terms as for private banks; conditions include regulation status, demonstration of solvency and long-term viability, funding plans with repayment assurances, appropriately valued collateral with suitable haircuts, and adequate pricing to discourage overuse.
- Government recapitalization:
  - May be appropriate but should carry conditions and not be a blank check.
  - Supervisors normally expect shareholders to take responsibility for addressing weaknesses, including recapitalization and restructuring.
  - The state cannot adopt different expectations for its own banks without undermining supervision of other banks.
  - For commercial public banks with no policy mandates operating at arm’s length, governments may limit support to what a reasonable private investor would provide (see impact on sovereign creditworthiness).
- Recapitalization design:
  - Should be based on accurate and up-to-date assessments of soundness and viability.
  - Must identify origins of problems (for example, nonviable business model), support diagnosis with credible projections, plans for business model restructuring, and changes to management and governance.
  - Should have clear governance and oversight, be scrutinized by the banking supervisor and government shareholder ministry or agency, be transparent and prompt.
  - Supervisors should be able to withdraw banking licenses and/or trigger resolution if recapitalization does not occur.4

### B. Common Challenges in Crisis Management for Public Banks
- Allocating losses to creditors in resolution raises specific challenges.
- Independence of the resolution authority may be harder to maintain; legal frameworks may need amendment to strengthen powers over public banks and de jure independence with appropriate accountability (for example, to national parliaments).
- Resolution of public banks where creditors bear losses may impact sovereign creditworthiness:
  - Legal clarity depends on nature of liabilities, cross-default clauses, and explicit or implicit government guarantees.
  - Perceptions that creditors do not recover full claims may negatively affect sovereign credit standing, increase risk premiums on sovereign and state-owned entity debt, affect sovereign ratings, and impair access to international capital markets.
  - Risks are highest for public banks perceived to benefit from strong implicit guarantees.
  - Indirect impacts arise if events disrupt financial stability through contagion to other banks.
  - Some public banks and specialized financial institutions may rely on wholesale funding from abroad, including international financial institutions whose creditors may have characteristics (for example, preferred creditor status) that need consideration.
- In severe financial crises, government support costs for public banks may compromise sovereign debt sustainability and government solvency:
  - If protecting creditors of a public bank threatens sovereign debt sustainability, feedback loops between public banks and sovereign risk intensify and problems exceed typical resolution/restructuring of the bank.
  - Authorities may lack capacity or political support to recapitalize failing public banks; scarce fiscal resources may be directed to income support or social programs.
  - Creditors of the public bank may have to bear greater losses, even if this increases systemic risk, to reduce probability of sovereign default.
  - In sovereign debt restructuring, feedback loops occur between haircuts on sovereign assets held by banks and losses borne by bank shareholders and creditors; authorities must weigh trade-offs between bailing-in bank creditors, bailing-in sovereign creditors, and cutting government spending.
- Post-resolution ownership and governance may require changes to mandates, legal status, and business models:
  - Resolution can change ownership—ownership may transfer to another bank or creditors; new owners often private, potentially ending majority state ownership.
  - Private new owners may be unwilling to pursue government objectives; governments need to review whether public policy functions remain essential and be prepared to explicitly fund or transfer them.
  - Legal status of public banks may need change to allow private ownership.5
- Many public banks have pre-existing vulnerabilities (for example, financially nonviable socioeconomic mandates, elevated NPL levels, weak governance) limiting recourse to certain resolution or restructuring options; inadequate loss-absorbing capacity reduces resolvability.
- Restructuring public banks affects state-owned enterprises (SOEs):
  - Governments should develop comprehensive plans addressing financial sustainability of SOE borrowers and eliminate unfunded demands for directed lending, easing of debt service, or services.
  - Loans to SOEs should be properly priced, with subsidy elements made explicit and provided by fiscal authorities.
- Coordination among layers of government can be challenging:
  - Regional or local owners may disagree with national authorities on crisis management.
  - In-crisis responsibilities should be clarified in advance to avoid deadlock.
  - Disagreements can delay addressing problems and pressure to extend central bank emergency liquidity imprudently, increasing overall societal costs.

### Box 3. Considerations for Specialized Financial Institutions (SFIs)
- If SFIs (including development banks) are pure policy vehicles, fully wholesale funded, drawing on explicit or implicit state guarantees or direct budget transfers:
  - Potential for contagion to other financial entities and financial stability risks may be lower.
  - Prudential framework is less relevant from a financial stability perspective, but rigorous regulation and supervision remain beneficial for SFI operation and the government budget by fostering health, sound governance, risk management, transparency, and accountability.
  - A sound prudential framework becomes necessary if SFIs are systemic by size, services, or interconnectedness.1
- Prudential supervision of SFIs is good practice to be carried out by the financial supervisor.2
  - Government ministries may lack expertise to monitor financial risks of SFIs.
  - Conflict of interest can delay corrective actions and disclosures, increasing fiscal burdens if failures occur.
  - Applying bank regulatory and supervisory frameworks tends to strengthen the SFI sector.
- Corporate governance:
  - Mandates and operations of SFIs are challenging due to multiple government agencies involved (for example, ministries of finance, housing, industry, agriculture).
  - Public officials on boards should be limited in number, meet fit and proper criteria, and have the same obligations as other board members.
  - Transparent nomination processes for senior management and board members are critical.
- Capital:
  - Absence of deposit funding should not exempt SFIs from sound capital requirements similar to banks to safeguard financial strength and capacity to carry out mandated operations.
  - Example: China Development Bank is one of the largest 10 banks in China and has been subject to the same capital adequacy rules as commercial banks since 2018.
  - EU example: the capital adequacy regime in the European Union Capital Requirements Regulation has been applied by analogy to German development bank KfW since early-2016 (regulation adopted in 2013).
- Liquidity:
  - SFIs’ long-duration investments and few short-term liabilities may make LCR and NSFR less binding, but other liquidity risks (concentration, maturity mismatches, currency mismatches) exist.
  - Supervisory monitoring and regulations requiring sound liquidity risk management remain important.
- Large exposures:
  - SFI mandates may be incompatible with BCBS large exposures limits when concentration risks are inherent to business models, requiring alternative prudential approaches.
  - Close supervisory monitoring, enforcement of sound risk management, and proper risk accounting in capital requirements become more important.
  - Regulations should ensure material concentrations are regularly reviewed and reported to the board.
  - Country practices:
    - German development bank KfW and most African development banks are compliant with the large exposures framework (ADB 2013).
    - Turkey’s non-deposit-taking development banks are not subject to large exposures limits, but concentration risk management guidelines apply.
    - Brazil’s systemic development bank, BNDES, is in a transition regime that exempts certain exposures from large exposures limits until 2027.
- Supervisory approach:
  - Supervisory tools may need adjustment to reflect SFIs’ characteristics, including methodologies, supervisory focus, and key risk indicators.
  - Examples:
    - SFIs rely heavily on long-term bond issuance (local or foreign currencies) and interbank funding; supervisors should focus liquidity analysis on bond issuance planning and rollover risk.
    - Agricultural development banks providing seasonal financing need particular emphasis on short-term liquidity management.
    - Export-import banks (government-backed export credit agencies) raise additional liquidity and risk considerations.

*IMF DEPARTMENTAL PAPERS • Regulating, Supervising, and Handling Distress in Public Banks — Chapter 6*

### Box 3. Considerations for Specialized Financial Institutions (continued)

### Box 3. Considerations for Specialized Financial Institutions (continued)

### Supervision and liquidity risk
- Foreign exchange liquidity risk management and foreign currency bond issuance should be a focus of supervision.
- Different liquidity risk metrics or thresholds in the supervisory risk assessment methodology could be applied based on the specific funding model.
- The profitability-related component of the supervisory rating framework may be given lower priority in the case of SFIs.
  - Supervisors use selected indicators (for example, return on assets, net interest margin, net operating income) to assess adequacy of earnings and gauge capacity to maintain sound profitability.
  - Profit maximization is typically not a goal of SFIs beyond what is necessary to cover expenses and credit losses; profitability of SFIs is expected to be lower than for commercial banks.
  - The risk matrix and assessment thresholds may be adjusted down to reflect expectations on profitability and earning power.
- Footnote: In some countries, export-import banks are not subject to the LCR standard (Japan, United Kingdom, United States).

### Crisis management for SFIs
- Lack of deposit funding and specialized business models imply specific features of bank resolution regimes will typically be less relevant for SFIs.
- Distressed SFIs should still be dealt with promptly:
  - Identify and allocate losses where necessary.
  - Develop a plan to restore long-term viability to prevent further deterioration of financial condition.

### Conclusions (policy findings and recommendations)
- Public banks can mitigate market failures and broaden access to finance, but ownership structure, mandate, and characteristics can create unique risks to financial stability and public finances.
- Common problems: political interference (particularly in weak governance environments), dubious lending practices, weak balance sheets, market inefficiencies, and underperformance relative to private banks on standard metrics.
- Policy gaps where reform is most needed:
  - (1) Give public banks clear and well-defined mandates.
  - (2) Adopt best practices in corporate governance and risk management.
  - (3) Provide supervisors with clear mandates, operational independence, and a transparent system of accountability and legal protection for supervisory actions on public banks.
  - (4) Enable full supervisory powers over public banks.
  - (5) Adapt and align regulation and supervisory tools with risk profiles.
  - (6) Implement safeguards against political intervention (including ownership policy).
  - (7) Reduce market distortions to create a level playing field for public and private banks.
- Supervisory priorities and actions:
  - Countries with significant public-bank presence should close gaps in regulatory and supervisory frameworks.
  - The COVID-19 pandemic will significantly stress asset quality and profitability of banks, especially public banks that expanded credits to hard-hit sectors, requiring a more proactive supervisory stance.
  - Supervision and regulation should increase focus on financial stability, governance structure, transparency, and appropriateness of mandate and supervisory powers.
  - Authorities should prioritize fixing public banks with impaired balance sheets; delay in remedial actions aggravates positions and market distortions.
  - Public banks should receive the same access to financial support or guarantees from government, central bank, or deposit insurance system as private banks—no preferential treatment.
  - State recapitalization should be transparent and based on credible asset valuations and business plans to minimize taxpayer risk.
  - Resolution planning and tools should be made available for all public banks whose failure could have systemic implications—notably those attracting retail deposits.
  - Strong legal regimes and independent resolution authorities are critically important to ensure problems are not allowed to linger.

### Annex 1. Econometric analysis — model and variables
- Regression equation (OLS):
  - Zij = b0 + b1 X1j + b2 X2ij + b3 X3j + εij
  - i indicates a bank; j indicates a country.
  - Zij = state-controlled share of a bank.
  - X1j = compliance score on a specific Basel core principle in country j (main explanatory variable).
  - X2ij = vector of bank characteristics.
  - X3j = vector of country characteristics.
- Main explanatory variable (X1j):
  - BCP compliance grade on 1-4 scale (Non-Compliant /NC/=1, Materially Non-Compliant /MNC/=2, Largely Compliant /LC/=3, Compliant /C/=4).
- Controls:
  - Bank level (X2ij): bank size (total assets), capitalization (equity ratio), profitability (return on assets - ROA), cost efficiency (overhead costs to total assets), liquidity (liquid assets to total assets).
  - Country level (X3j): country size (GDP), development level (GDP per Capita and GDP per Capita Growth), inflation, rule of law (World Bank’s WGI database).
- Focus: Core Principles CP 2 and CP 14.

### Data and sample
- Data sources: IMF Standards and Codes Database (Basel Core Principles assessments 2013–2017); Fitch Connect (bank financial indicators); IMF World Economic Outlook; World Government Indicators.
- Sample restrictions: commercial, savings and development banks (robustness check dropping development banks, results do not change significantly).
- Resulting sample: 1,356 banks from 39 countries.
- Robustness check: dropping US banks (which account for 47 percent of the sample) — direction and strength of relationship remain the same.
- Note: Fitch Connect provides the state-controlled share as of June 2018.

### Annex Table key descriptive statistics (selected)
- Sample size and country coverage:
  - Total observations reported in regressions: 1,280 (Annex Table 1.3) and sample size references of 1,356 banks from 39 countries.
  - Country sample totals: Tot al 1,357 100.00 (Annex Table listing shows United States 64 147.24; these figures are presented as in source).
- Bank-level descriptive statistics (Annex Table 1.2):
  - Share of state ownership: Observations 1,298; Mean 7.4; Median 2; Min 0; Max 100; Std. dev. 23.43.
  - Bank size (millions of US dollars): Observations 1,356; Mean 4 3,16 01,7305.684,309,000241, 20 0 (values presented as in source).
  - Equity to total assets: Observations 1,356; Mean 12.34; Median 10.68; Min 0.98; Max 98.63; Std. dev. 10.52.
  - Return on assets: Observations 1,356; Mean 0.01; Median 0.01; Min −0.72; Max 2.03.
  - Overhead costs to total assets: Observations 1,356; Mean 0.03; Median 0.02; Min 0; Max 0.80; Std. dev. 0.04.
  - Liquid assets to total assets (percent): Observations 1,356; Mean 14.4; Median 9.56; Min 0; Max 99.92; Std. dev. 16.58.
- Country-level descriptive statistics (Annex Table 1.2):
  - GDP (millions of US dollars): Observations 39; Mean 1,350,000; Median 14,300,000; Min 11,9 702; Max 1,430,000; Std. dev. 9,837,000 (values presented as in source).
  - GDP per capita (US dollars): Observations 39; Mean 50,001.64; Median 6,5297.52; Min 1,071.05; Max 81,993.73; Std. dev. 25,714.92 (values presented as in source).
  - GDP growth: Observations 39; Mean 2.05; Median 2.16; Min −1.2; Max 57.60; Std. dev. 1.31.
  - Inflation rate: Observations 39; Mean 2.48; Median 1.81; Min 0.36; Max 15.18; Std. dev. 2.69.
  - Rule of law index: Observations 39; Mean 1.13; Median 1.46; Min −1.0; Max 5.19; Std. dev. 9.80 (values presented as in source).
  - CP 2 compliance: Observations 39; Mean 3.15; Std. dev. 324.89 (value presented as in source).
  - CP 14 compliance: Observations 39; Mean 2.96; Std. dev. 324.38 (value presented as in source).

### Regression estimation results (Annex Table 1.3)
- CP 2 (Independence, Accountability, Resourcing and Legal Protection for Supervisors)
  - OLS: Compliance with CP 2 −2.913 (1.805)
  - WLS: Compliance with CP 2 −11.54*** (2.746)
  - Adjusted R2: OLS 0.2050; WLS 0.4634
- CP 14 (Corporate Governance in Banks)
  - OLS: Compliance with CP 14 −8.294*** (2.138)
  - WLS: Compliance with CP 14 −22.23*** (2.459)
  - Adjusted R2: OLS 0.2127; WLS 0.4889
- Observations: 1,280
- Standard errors in parentheses. Significance: * p<0.10, ** p<0.05, *** p<0.01.
- Note: Dependent variable is state share of a bank ownership. Additional controls included ln[Total Assets], equity ratio, Return on Assets, overhead costs to total assets, liquid assets to total assets, and country controls GDP, GDP per capita, GDP growth, inflation, rule of law.

### Interpretation of results and robustness
- Estimated coefficients represent correlations rather than causal relationships; endogeneity issues may remain (omitted variable bias, reverse causality).
- Results suggest an association between CP14 (corporate governance) compliance rating and the share of state ownership in a bank: higher compliance ratings tend to be associated with lower levels of state ownership. This result is statistically significant and robust.
- Results for CP2 point in the same direction but are not statistically significant in OLS; WLS results show stronger significance.
- Heteroscedasticity concerns: Breusch-Pagan test and residual plots indicate heteroscedasticity may be present; authors employ a Weighted Least Squares (WLS) model with bank’s total assets as weights as a robustness check.
- Country-level robustness check: using average state-owned share per country trends in same direction but may lose statistical significance due to small sample limitations and inability to control for bank-level variation.

_Italic: Source: IMF staff analysis and data as presented in the content unit._

### References

### References

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### Lending behavior, crises, and systemic risk
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- Brei, Michael, and Alfredo Schclarek. 2013. “Public Bank Lending in Times of Crisis.” Journal of Financial Stability 9 (4): 820–30.
- Jimenez, Gabriel, Jose-Luis Peydro, Rafael Repullo, and Jesus Saurina. 2018. “Burning Money? Government Lending in a Credit Crunch.” Working Paper, Center for Economic Policy Research, Washington, DC.
- Cull, Robert, and Maria Soledad Martínez Pería. 2013. “Bank Ownership and Lending Patterns during the 2008–2009 Financial Crisis: Evidence from Latin America and Eastern Europe.” Journal of Banking & Finance 37 (12): 4861–78.
- Dobler, Mark, Marina Moretti, and Alvaro Piris Chavarri. 2020. “Managing Systemic Banking Crises—New Lessons and Lessons Relearned.” IMF Departmental Paper No. 20/05, International Monetary Fund, Washington, DC.
- Jimenez et al. 2018 (see above).
- Qu, Qiuying. 2018. “Zombie Firms and Political Influence on Bank Lending in China.” Working Paper, Department of Economics, Columbia University, New York.
- Tan, Yuyan, Yiping Huang, and Wing Thye Woo. 2016. “Zombie Firms and the Crowding Out of Private Investment in China.” Asian Economic Papers 15 (3): 32–55.
- Cole, Shawn. 2009. “Fixing Market Failures or Fixing Elections? Agricultural Credit in India.” American Economic Journal: Applied Economics 1 (1): 219–50.

### Regulation, supervision, and resolution frameworks
- Basel Committee on Banking Supervision (BCBS). 2014. “Supervisory Framework for Measuring and Controlling Large Exposures.” Basel.
- Basel Committee on Banking Supervision (BCBS). 2015. “Corporate Governance Principles for Banks.” Basel.
- Basel Committee on Banking Supervision (BCBS). 2017. “The Regulatory Treatment of Sovereign Exposures.” Discussion Paper, Basel.
- Basel Committee on Banking Supervision (BCBS). 2020. “Regulatory Consistency Assessment (RCA) Programme Assessment of Basel Large Exposures Regulations – Indonesia.” Basel.
- Financial Stability Board (FSB). 2014. “Key Attributes of Effective Resolution Regimes for Financial Institutions.” Basel.
- Fiechter, Jonathan L., and P. H. Kupiec. 2004. “Principles for Supervision.” In The Future of State-owned Financial Institutions, edited by Gerard Caprio, Jonathan L. Fiechter, Robert E. Litan, and Michael Pomerleano. Washington, DC: Brookings Institution Press.
- International Monetary Fund (IMF). 2014. “Cross-border Bank Resolution: Recent Developments.” Policy Paper, Washington, DC.
- International Monetary Fund (IMF). 2018. “Managing the Sovereign-Bank Nexus.” Policy Paper, Washington, DC.
- Narain Aditya, and Lev Ratnovski. 2007. “Public Institutions in Developed Countries—Organization and Oversight.” IMF Working Paper WP/07/227, International Monetary Fund, Washington, DC.

### Fiscal risk, state ownership governance, and state-owned enterprises
- International Monetary Fund (IMF). 2016. “Analyzing and Managing Fiscal Risks – Best Practices.” Policy Paper, Washington, DC.
- International Monetary Fund (IMF). 2019. “Reassessing the Role of State-Owned Enterprises in Central, Eastern and Southeastern Europe.” IMF Departmental Paper, Washington, DC, June.
- Organisation for Economic Co-operation and Development (OECD). 2015. “OECD Guidelines on Corporate Governance of State-Owned Enterprises.” Paris.
- Organisation for Economic Co-operation and Development (OECD). 2018. “OECD Ownership and Governance of State-Owned Enterprises: A Compendium of National Practices.” Paris.
- Organisation for Economic Co-operation and Development (OECD). 2020. “Organizing the State Ownership Function.” Paris.
- Fiechter and Kupiec 2004 (see above).
- Levy-Yeyati et al. 2004 (see above).

### Development finance and financial inclusion
- African Development Bank (AfDB). 2013. “African Development Finance Institutions: Unlocking the Potential.” Working Paper No. 174, Abidjan.
- Agence Française de Développement (AFD). 2020. “Finance in Common Summit.” Booklet. Paris.
- Anson, Jose, Alexandre Berthaud, Leora Klaer, and Dorothe Singer. 2013. “Financial Inclusion and the Role of the Post Office.” World Bank Policy Research Working Paper no. 6630, World Bank, Washington, DC.
- World Bank. 2013. Global Financial Development Report. Washington, DC.
- McDonald, David A., Thomas Marois, and Diana Barrowclough. 2020. “Public Banks and Covid-19—Combatting the Pandemic with Public Finance.” Municipal Services Project (Kingston), UNCTAD (Geneva) and Eurodad (Brussels).
- International Monetary Fund (IMF). 2020a. “Public Banks’ Support to Households and Firms.” Special Series on COVID-19, Washington, DC, April.
- International Monetary Fund (IMF). 2020b. Fiscal Monitor. Washington, DC, April.
- D’Souza, Errol, and Jay Surti. 2020. “Government Subsidies, Credit Allocation and the Investment Cycle.” Unpublished.

*Regulating, Supervising, and Handling Distress in Public Banks, DP/2022/010*

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_Source: https://www.imf.org/-/media/files/publications/dp/2022/english/rshdpbea.pdf_