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Bank Nationalization Explained

written by: Kantha Wijeratne•edited by: Donna Cosmato•updated: 4/14/2011

What is meant by nationalization of a bank? Under what circumstances does a government decide on such a policy? This article answers these questions and explains how nationalization of a bank can impact the public.

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    Nationalization of banks has been a much discussed topic following the recent financial crisis faced by some banks. Both in the United States and Europe, there are those who point to the favorable outcomes that can be expected from nationalizing banks, at least on a temporary basis. There are other opponents who are also very much against it. They cite it as a socialist move that runs counter to the free-market principles promoted by Western governments. The concept of nationalization of banks is best understood by examining some of these arguments.

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    What Is a Nationalized Bank?

    Nationalization refers to the process where a government takes over a monopoly or other sector to operate them so as to benefit the public. This process aims to take away any special financial or other advantage enjoyed by a specific group at the cost of the taxpayers and the public at large. Nationalization aims to reduce economic costs.

    In the case of a nationalization of a bank, public takeover means the government or Treasury functions as the bank's source of credit. Funds would be channeled for productive enterprises. Businesses and households can expect an easing of the heavy debt burden they face as a result of the lending practices of private banks.

    The top management personnel of a bank that is taken over is replaced by government appointees who are committed to implementing policies and practices aimed at restoring solvency and public confidence in such institutions.

    A noted feature of nationalized banks, particularly in developing countries, has been the tendency to lend to specific sectors. Credit has been targeted to economically or socially deprived sectors leading to more inclusive banking.

    Historically, governments in various countries have nationalized banks when such institutions faced bankruptcy or operated fraudulently. The rationale for nationalization includes protecting depositors, replacing inefficient or corrupt top management, and ensuring the institutions return to stable and profitable operations. Notably, such banks have been re-privatized once they reach this stage.

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    What Are the Favorable Outcomes Expected from Nationalization of Banks?

    Public banks are subject to closer supervision thus ensuring greater transparency in operations. Bank managers, as well as their regulators, share the same objectives for its operation. This leads to a better flow of information that can stem any weakness in the system. Sometimes nationalized banks tend to subordinate the profit motive to pursue social objectives by subsidizing certain sectors or industries. Governments use these banks to implement its development policies.

    Nationalization of banks signals stability for the financial sector. Depositors know their funds are secure. It also provides a financial structure in areas that are under-developed and under-banked.

    One of the oft cited success stories is the nationalization of banks in Sweden in the 1990s. Swedish banks experienced a crisis similar to that faced by the US in recent times following the bursting of their own real-estate bubble. The action taken by the Swedish authorities required these banks to write down their losses wiping out shareholder value. This was followed by re-capitalization where the government invested in ownership of shares. In the years that followed, the government was able to recover its investment by selling off assets while the banks turned profitable. Most of the banks were re-privatized with the government making good on its investment.

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    Disadvantages of Bank Nationalization

    Critics of nationalization point to how nationalization of banks has spawned inefficient bureaucracies prone to political favoritism. The objectives of public banks can differ from private ones where employment and subsidies to a targeted sector can lead to corruption, losses, and lax corporate governance. Such losses require periodic re-infusion of capital by the State. Lack of competition prevailing in nationalized banks is cited as reasons for poor customer service and reduced motivation to provide innovative and creative solutions.

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    One of the main arguments offered against nationalization of banks at the present time is that it would adversely affect the free-market system enjoyed by society in the West. This statement needs closer scrutiny. A free market is understood to be one that is free of monopoly power, political, or business insider dealing, fraudulent business practices, or where a select class enjoys special rights or privileges.

    People working in a free market expect to earn wealth fairly by the effort they put into their businesses. Above all, a free market aims for a level playing field where economic efficiency is maximized. Needless to say, such an environment can only be achieved with regulatory supervision. A government’s move to nationalize banks has to be viewed in this light.

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    Resources

    1. Dougherty, Carter. “Stopping a Financial Crisis, the Swedish Way”, http://www.nytimes.com/2008/09/23/business/worldbusiness/23krona.html?_r=1

    2. Gandel, Stephen. “Nationalized Banks: Why They Might Work”, http://www.time.com/time/business/article/0,8599,1883418,00.html

    3. Rasmus, Jack. “The Many Faces of Bank Nationalization”, http://www.globalresearch.ca/index.php?context=va&aid=13497

    4. Knowledge@Wharton. “Has the Time Come to Nationalize Struggling Banks? Yes but Carefully”, http://knowledge.wharton.upenn.edu/article.cfm?articleid=2166