Government banks and financial development

This study examines whether government banks generally promote financial intermediation or impede it. Using a cross-country dataset, we estimate econometric models that identify the effect of government-owned banks on the overall extent of financial intermediation. To conduct our analysis, we propose and estimate a new measure of financial development. Its basic premise is that societal saving on a large scale requires financial intermediation. The gap between actual domestic saving rates of lower-income countries and the saving rates that they would have if their financial systems were developed (based on prediction out of sample from a regression estimated for higher-income countries), is our measure of financial development. We calculate this measure—which we dubbed ‘saving efficiency’—and show that it tends to be a bit smaller in lower-income countries whose banking industries are more dominated by government banks. That supports a view in which government banks in developing countries are manifestations of crony capitalism, not vehicles for overcoming market failure.