Delegation and Delay in Bank Privatization

Abstract

The paper explains why bank privatization in transition economies is frequently delayed in comparison to privatizing non-financial firms. In the model, the government inherits a distressed bank with bad loans to a representative non-financial firm. The firm will only abstain from wasteful opportunistic behavior if there is a credible to signal that its future budget constraint will be hard. If the government takes over the state-owned bank directly or re-capitalizes and privatizes it immediately, then signaling leads to excessive liquidation. Delay in privatization allows delegating the signaling and can be beneficial because the signaling distortion can be shifted across "types". The analysis assumes a political constraint to sell the state-owned bank to a domestic investor (shallow pockets), but shows also that a Pareto improvement can typically be achieved if a buyer with a deep pocket can be found (foreign investor), Policy implications concerning timing and scope of bank privatization are discussed.