NCPA - National Center for Policy Analysis

Insolvent Developing Country Banks Cost Taxpayers $1 Trillion

March 24, 2004

Most banks in developing countries are nothing more than pyramid schemes financing nonperforming loans, according to former World Bank economist Robert Anderson. The result is a banking crises of macroeconomic proportions:

  • About 66 percent of the 140 developing countries have experienced at least one banking crisis since 1976; rich countries have also experienced a proportionate number of banking crises, but not as severe.
  • Taxpayers have spent over $1 trillion bailing out insolvent banks; Chile spent 40 percent of its gross domestic product GDP covering banks that failed after a 1972 privatization movement.
  • China may be next in the list of fatalities, with an estimated $500 million in bad loans from China banks that will probably never be repaid.

Lax regulations and declining deposits are largely to blame for failing banks. In fact, deposit insurance is faulted in reducing the incentive for banks to avoid pitfalls resulting in their insolvency. Indeed, in the United States, Congress bowed to pressure from small, high-risk banks to provide deposit insurance after the Great Depression.

Anderson recommends an approach similar to that used by New Zealand in helping to prevent banking crises in poor countries:

  • Privatize banks to prevent politicians from using state-owned banks to finance cronies and state-owned enterprises.
  • Allow competition from the foreign bank market so depositors have an option if they don't trust their domestic banks.
  • Regulate bank deposits through a regulatory agency which would require financial disclosure.
  • Do not government-insure bank deposits; instead, treat them like stocks and bonds and let the "depositor beware."

Source: Robert E. Anderson, "Don't Bank On It," Tech Central Station, February 25, 2004.

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