Charlie and Nachiket Mor raise very good points about the problems posed by public banks. India illustrates many of these difficulties—there is much too much political interference, regulations are designed to help state banks, and so forth. But India’s mix of banks is about four-fifths state-owned and only one-fifth privately owned. I’m suggesting precisely the inverse: about one-fifth of the banking sector would be state-owned and four-fifths would be privately owned. Reducing the share of state-owned banks to this minimal level should help alleviate many of the political economy issues. The state-owned commercial banks would need to compete with private banks in normal times as discussed in the blog and this should also act as a constraint on the problems.
The real advantage would come when there is a crisis. Rather than having central banks intervene in commercial credit markets where they have little expertise, the state-owned commercial bank can temporarily expand its role both in terms of assets and loans. This should considerably improve the functioning of the economy and overcome some of the credit crunch problems that Charlie has identified in his research and discusses in his post. The government should also find it easier to avoid bailouts and allow private banks to fail, which is an issue that recurs with every financial crisis. The most recent crisis is a clear case in point: at the moment large banks are not really privately owned. Large banks are privately owned until they get into trouble, at which point the state takes over ownership.
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