Research on bank nationalisation contributes to management of banking crises
Submitting InstitutionUniversity of Leicester
Unit of AssessmentEconomics and Econometrics
Summary Impact TypeEconomic
Research Subject Area(s)
Economics: Applied Economics, Econometrics
Commerce, Management, Tourism and Services: Banking, Finance and Investment
Summary of the impact
Since the financial crisis of 2007-8, many failing banks have had to be
rescued. Rescue has taken different forms, including acquisition by
rivals, public subsidies, and nationalisation.
Research at University of Leicester contributed to the changing of
perceptions on the relative merits of these options, by showing that the
cost of bank nationalisation had previously been over-estimated. This work
paved the way for a wave of bank nationalisations that occurred during the
financial crisis of 2007-8. Demetriades directly applied the
findings of his research in the rescue of the crisis-hit Cypriot banking
sector, following his appointment as Governor of the Central Bank of
Cyprus and member of the European Central Bank governing council in 2012.
The privatisation of banks has long been a key ingredient of the so
called "Washington consensus" — a set of policies promoted by the World
Bank and the IMF around the world as key to economic development and
The main works that allegedly backed this claim are La Porta et al
(2002) and Sapienza (2004). In particular, La Porta et al provide
empirical evidence that the degree of government ownership in the banking
system is negatively correlated to subsequent financial development and
economic growth, and positively correlated with financial instability. The
estimated effects were quite large: a 10 percentage points rise in the
share of government ownership of banks would reduce the growth rate by
approximately 0.25% per annum.
Research carried out by Andrianova, Demetriades and
Shortland has challenged the views underlying the Washington consensus
both theoretically and empirically. It has highlighted that while the
Washington consensus posits a causal relationship between government
ownership of banks and financial development, all that La Porta et al
demonstrate is just a statistical correlation, which can be interpreted in
different ways. Furthermore, even the statistical correlation is not very
In particular, in [Ref 1] Andrianova, Demetriades and Shortland develop a
theoretical model in which public ownership of a bank depends on the
quality of institutions and financial development rather than causing
them. The model provides a rationale for government ownership of banks,
and shows that publicly owned banks may be especially important as a means
to prevent contagion in a financial crisis.
[Ref 1] also provides empirical evidence that supports a different
interpretation of the observed correlation: government ownership of banks,
that is to say, does not cause financial under-development and
instability, but is caused by them. This suggests that state banks will
die a natural death when they are no longer useful, but may be crucial
while financial instability is a key concern.
Follow-on research (see [Ref 2], [Ref 3] and [Ref 4]) suggests that the
concern that governments may be unable to run nationalised banks
efficiently may also have been exaggerated. In particular, [Ref 4] shows
that the results in La Porta et al (2002) are fragile to inclusion
of more fundamental determinants of growth. It also reveals that during
the period 1995-2007, government ownership of banks was robustly
associated with higher, not lower growth rates.
In sum, this research strongly suggests that the costs of bank
nationalisation had been over-estimated. The implications for policy are
evident. When a bank has to be rescued, and policy-makers must choose
among different forms of intervention, they must explicitly or implicitly
make a comparison between the costs of different policy options. By
showing that bank nationalisation is not as costly as previously thought,
this research laid the intellectual foundation for the wave of bank
nationalisations that occurred during the financial crisis of 2007-8 and
the on-going Euro crisis.
The research was carried out by Panicos Demetriades (University of
Leicester since 2000) and Svetlana Andrianova (University of Leicester
since 2003) in collaboration with Anja Shortland (Brunel University) and
Chenggang Xu (University of Hong Kong).
References to the research
1. S. Andrianova, P. Demetriades and A. Shortland "Government ownership
of banks, institutions and financial development", Journal of
Development Economics 85 (2008), 218-252. (published online 4
2. S. Andrianova and P. Demetriades "Finance and Growth: What We Know and
What We Need to Know", in C.A.E. Goodhart (ed.), Financial Development
and Growth: Explaining the Links, Palgrave Macmillan, 2004, 38-65.
3. S. Andrianova, P. Demetriades and C. Xu "Political Economy Origins of
Financial Development in Europe and Asia", World Development, Vol.
39 (2011), 686-699.
4. S. Andrianova, P. Demetriades and A. Shortland "Government Ownership
of Banks, Institutions and Economic Growth" Economica 2011, doi:
Details of the impact
In demonstrating that bank nationalisation is not as costly as had been
thought, research by Andrianova and Demetriades went
against previous orthodoxy promoted by the World Bank and the IMF. Their
new research was presented at numerous academic conferences and seminars
in the UK and around the world, including Australia, Austria, China,
France, Germany, New Zealand and the Unites States, and in a series of
papers, the first of which was published in the Journal of Development
Economics on line in 2006 (in 2008 on paper).
Their ideas spread across both the academic and practitioner communities,
and were taken up by the media and policy commentators. For example, Handelsblatt,
Germany's leading financial newspaper, ran a feature on 15 February 2010
("Are state banks better than their reputation?") comparing the findings
of the anti-nationalisation La Porta et al (2002) with those of Andrianova
et al (2008, 2011). The newspaper concluded that the findings of La
Porta et al were ideologically driven ([Source 1]). The research
was also cited by the media during the debate on proposals to privatise
Sberbank, Russia's largest savings bank. In addition, an article warning
against the risks of early de-nationalisation, citing the research, was
posted in February 2010 on VOX EU, the leading economic policy
portal in Europe.
The research played a crucial role in changing the academic and policy
climate, laying the intellectual foundation for the wave of bank
nationalisations that started in 2007 at the outset of the financial
crisis. Many bank nationalisations that have taken place since have been
directly or indirectly influenced by the research described above. The
impact of the research is most evident in two cases. These are the
nationalisation of Northern Rock in 2007-8, and the reform of Cyprus'
banking system in 2012-3.
Northern Rock is perhaps the first important episode in the great
financial crisis in the UK. The bank applied for, and was offered,
liquidity support on 17 September 2007. It was then fully nationalised on
22 February 2008. The Journal of Economic Development paper
mentioned above was presented at a seminar at HM Treasury on 14 September
2007 ([Source 2]). The seminar was attended by a large number of
government economists and officials. Many of these were directly involved
in the policy decisions that eventually led to the nationalisation of
Northern Rock. The bank's successful nationalisation in early 2008 paved
the way for further nationalisations in the autumn of the same year, both
in the UK and overseas.
Partly as a result of his influential research on bank ownership, in May
2012 Demetriades was appointed as governor of the Central Bank of
Cyprus and member of the European Central Bank's governing council. When
he took charge, the Cypriot banking sector was already in a critical
situation, having suffered huge losses because of the Greek bonds crisis.
Since January 2012, Cyprus had been relying on an emergency loan from
Russia to re-finance its maturing debt. On 13 March 2012, credit rating
agency Moody's slashed Cyprus's rating to the lowest "junk" status.
On 30 June 2012, a month after Demetriades' appointment, the Cypriot
government recapitalised the country's second-largest bank, Cyprus Popular
Bank (also known as Laiki Bank). As a result, the government acquired 84%
of the bank's equity — a de facto nationalisation.
In the spring of 2013, after long and complex negotiations between the
Cypriot Government, the Central Bank of Cyprus, the European Commission,
the European Central Bank and the IMF, Cyprus Popular Bank was shut down.
The bank's bad assets are being liquidated, and any remaining good assets
will be transferred to the country's other bank, the Bank of Cyprus. A
substantial fraction of the Bank of Cyprus' equity is therefore to be
owned by the government.
It is therefore evident that government's acquisitions played a major
role in the solution to the crisis of the Cypriot banking sector. Although
the entire process has been controversial, many commentators argue that
the solution achieves financial stability while avoiding issues of moral
hazard, by putting the burden of future bank restructuring onto creditors
and depositors rather than taxpayers in general. (Cyprus Popular Bank's
shareholder capital has been written off, and the uninsured deposits —
along with other creditor claims — will be largely lost).
In any case, the Cypriot banking sector has been stabilised, preserving
the viability of the Euro system. Given the risks of financial contagion,
failure to solve the Cyprus crisis might have had catastrophic
consequences for a number of Southern European countries.
In his capacity as Governor of the Central Bank of Cyprus, Demetriades
has actively contributed to the rescue of the Cypriot banking sector
([Source 3], [Source ). In doing so, he has implemented the ideas
developed in his academic research at Leicester, to manage one of the
world's most complex banking crises.
Sources to corroborate the impact
Handelsblatt feature, 15 February 2010.
- Correspondence related to the seminar held at HM Treasury on 14
- Statement by the Governor of the Central Bank of Cyprus.
- Statement by a senior director and member of the monetary policy
committee of the Central Bank of Greece.