Public Sector Presence in the Banking System and its Impact on the Private Sector: Evidence from Developing Countries

This dissertation studies how government's involvement in the banking sector crowds out private investment by negatively affecting the supply of credit to the private sector. It also estimates the impact of government's involvement, through ownership of banks on their performance. The dissertation contributes to the previous literature on state interventions in financial sector and in particular banking sector by providing more robust estimates of crowding out of private sector credit and investment, and performance of state-owned commercial banks.;When governments in developing countries borrows one dollar more from their domestic banking sector, how much does it reduce private credit? There is surprisingly no reliable estimate in the literature on this. I provide robust estimates of the causal effect of government borrowing on private credit using panel data on 60 developing countries and instruments based on the structure of political system. The point estimates indicate that an additional ;The consequences of government borrowing from domestic banking sector can go beyond the financial sector and can impact the real sector. Focusing on private investment, which is considered to be one of the main drivers of growth of the real sector, chapter three of my dissertation studies the crowding-out impact of government borrowing on private investment. I provide robust estimates of the causal effect of government borrowing on private investment, through its impact on private credit using panel data on 60 developing countries. Using a two stage estimator recently developed by Lewbel (2012) that relies on heteroskedasticity for identification, the estimates indicate that each additional dollar that government borrows from the domestic banking sector it reduces private investment by approximately 16 cents.;The role of state-owned commercial banks has decreased sharply around most emerging regions in the last three decades, owing mostly to their poor performance. However, in South Asia and Middle East and North Africa regions, despite losing market share, state-owned banks retain an important role. Using a bank-level panel dataset from these two regions for the period 2001 to 2009, the fourth chapter of the dissertation provides evidence of a causal relationship between ownership of banks and their performance. Using two stage estimators that rely on heteroskedasticity for identification, the results reported in the paper show a negative effect of state-ownership of banks on their performance. The analysis done in the paper improves upon the robustness of the estimates provided by previous researchers by taking into account the endogeneity of ownership. The results suggest that government interventions through (the ownership of) banks come at a cost. Hence there is scope for improving their performance and reducing their share in countries where they still hold significant market share of the banking sector.