There is no doubt that on average the performance of state financial institutions around the world has been below the lowest expectations. Lack of governance, management skills, regulation, and transparency, and misguided incentives have contributed to discredit these institutions for supporting the development of local financial markets. However, the pro-active role that some state financial institutions have played in the recent crisis in allocating credit to sectors cyclically not attractive for commercial banks has brought back the question of whether some state ownership in the banking system would be preferable. This paper analyzes the experience of four state financial institutions that have performed relatively well in the past: Canada’s Business Development Bank, Chile’s Banco Estado, South Africa’s Development Bank of Southern Africa, and Finland’s Finn Vera plc. The author finds that these institutions have different checks and balances to mitigate eventual mismanagement of resources. The author also finds that little progress has been made in measuring the policy performance of these institutions.

In the past three decades the presence of State Financial Institutions (SFIs) has been highly controversial. The evidence suggests that state-owned banks have underperformed and have negatively impacted economic growth. La Porta et al. (2002) find that government ownership of banks is associated with slower subsequent financial development, lower economic growth and lower growth of productivity. Beck and Levine (2002) fail to find any positive effect of government ownership of banks on growth. Caprio and Martinez Peria (2002) show that government ownership of banks is associated with a higher likelihood of banking crises. Dinc (2005) provides evidence that state financial institutions increase their lending during an election year and that in emerging markets state financial institutions finance the government to a greater degree than do private banks. Most of the poor performance of SFIs is related to the lack of a clear mandate, and a governance system that allows the presence of weak boards of directors and management, which are subject to political intervention. Evidence provided by Caprio et al. (2004), La Porta et al. (2002), and Dinc (2005) shows that most state financial institutions around the world are characterized by lack of managerial skills and subject to government intervention in credit decisions.

This paper discusses good practices for aligning the functions of SFIs with solving market failures. Mismanagement of resources is frequently a consequence of weak board of directors and management, political interference, and lack of a clear mission of the SFI. Based on four case studies, this paper analyzes the importance of having clear and sustainable mandates, and an institutional framework able to mitigate political interference. The paper analyzes good practices for building, implementing, financing, and evaluating the mandates of SFIs, and examines the experiences of these SFIs regarding the ownership and nomination of board members.