MD’s Keynote Speech—National Development Bank in Lithuania: Aims and Effective Governance
July 2, 2020
As prepared for delivery
Laba diena! (Good day!)It’s a pleasure to join you virtually in Vilnius, Lithuania.
I thank President Nausėda for the invitation to join you today to discuss the Lithuanian financial sector and weigh the pros and cons of establishing a public bank.
Context—a crisis like no other
Let me begin by briefly taking stock of where the world is.
Last week we updated our World Economic Outlook report. As you may have seen in the media, our report underlines that this is a crisis like no other—one that is more severe, more complex, and more global than anything we have seen in living memory.
The recession will be deeper in 2020 and the recovery slower in 2021 than we projected in April. We expect GDP to shrink by 4.9 percent this year and grow by 5.4 percent in 2021.
This is truly a global crisis—with nearly 95 percent of countries projected to face negative per capita income growth this year.
Lithuania has not been hit as hard as other countries in Europe, but there has still been a tragic loss of life and decline in economic activities. My deepest sympathy to all who have been affected—you can count on me and my team at the IMF to work with you on charting the right pathway through this highly unusual crisis.
The good news is that we have seen a response like no other, which has helped to put a floor under the global economy.
Globally, fiscal actions now amount to about $10.7 trillion, while major central banks have helped prevent a credit crunch via interest rate cuts, massive and swift asset purchases, and other extraordinary measures.
Lithuania has benefited from the ECB’s supportive policies but also has undertaken its own impressive response to the crisis, including fiscal support for households and businesses and accommodative financial measures.
Your action as a government was underpinned by a stable macroeconomic framework and years of prudent policies—so Lithuania is on a much stronger footing than during the Global Financial Crisis.
Unlike in 2009, today Lithuania enjoys euro area membership, fiscal space, and no significant macroeconomic imbalances, all of which underpinned a swift response when the crisis set in.
Lithuania’s financial system: Progress and Challenges
Let me now turn to the issue that has brought us here today—the role of public banks.
The development of a modern financial system in Lithuania, integrated in the euro area and linked to the world, has been a key contributor to economic development.
Lithuania’s banking system is profitable, well capitalized, and subject to a strong regulatory and supervisory framework at both the European and national levels, with Lithuania’s central bank appropriately and proactively using all macroprudential and supervisory powers at its disposal.
Still, the financial sector faces some important challenges, and it is in this context that a discussion on a national development bank is taking place. I would like to focus on three central areas.
First is the high degree of concentration. Lithuania’s three largest banks represent three-fourths of total assets. Our analysis suggests that, so far, concentration has not resulted in a lack of competition, and that banks’ strong profitability seems to reflect high efficiency. But this does not mean that high concentration cannot turn into a problem of inefficiency. In this context, your efforts to develop a vibrant fintech sector will continue to add welcome competitive pressure.
Second is small and medium enterprises’ inadequate access to finance. This is a common challenge given the higher risk of these companies and the tightened financial regulation to avoid excess risk-taking. Many European countries have opted to address this problem through public development institutions such as INVEGA in Lithuania that provide direct lending or loan guarantees.
Third is countercyclicality and the inability of banks to provide enough credit during downturns. Many central banks, including the Bank of Lithuania, try to counteract this trend with the active use of countercyclical buffers and macroprudential policy.
Public banks—benefits and risks
State-owned banks can play an important role in the financial system. They can fulfill functions that are not performed by private banks, provide financing for projects that benefit the wider economy, and provide countercyclical lending—increasing their loan book when the economy is weak.
During the two most recent crises, COVID-19 and the global financial crisis, public banks have played an active role in both advanced economies such as France, Germany, and Japan, and emerging markets such as Brazil, Turkey, and Saudi Arabia.
But, public ownership of banks does not come without risks.
First, public banks have implicit or explicit government guarantees, which is what leads to their low funding costs but could represent significant fiscal risks. To minimize these risks, any decision to use public banks to achieve social goals should be preceded by rigorous, comprehensive, and transparent analysis on the implications for public finances.
Second, to preserve financial stability, support programs through public banks should be appropriately funded in a transparent manner, and the government should stand ready to backstop these banks including through timely recapitalizations when needed.
Third, incentives for efficient management are sometimes lacking, and this can result in inefficient banks with weak governance. To avoid this, strong governance independent of political influence and robust regulation and supervision are key.
Careful design is needed
The broader international experience highlights the importance of creating safeguards to avoid undue political interference, keeping mandates explicit and narrow, ensuring effective monitoring and transparency to avoid losses, and delivering a level playing field between state-owned banks and private banks.
We will hear next from the German development bank, KfW—a great example of how design features can mitigate risks, starting with a limited and clearly established mandate. It is prohibited by law to distribute profits to its shareholders.
It channels funds predominantly through the German banking system, which reduces risks.
Moreover, the access of KfW to international and domestic capital markets also helps ensure high standards of transparency.
Build on your achievements
Overall, careful attention should be given to the pros and cons. A well-designed state-owned bank in Lithuania could help support sustained growth and deliver higher living standards for all Lithuanians, but to achieve this objective, risks must be transparently assessed and dealt with.
It is also important that you build on your recent achievements and complement your efforts to create a vibrant fintech sector.
Any reform in the financial sector should reinforce the macroeconomic and financial stability that has allowed Lithuania to prosper in recent years, and should help serve the goal of continued convergence with living standards in Western Europe. Addressing well-identified structural challenges—including social disparities, poverty, and the implementation of education and healthcare reforms—will speed Lithuania’s progress.
You have important decisions ahead of you—and you must act fast in the current crisis context while also weighing the pros and cons of your policy choices.
This brings to mind a proverb I learned is as popular in Lithuania as it is in my own country: “Measure three times… but cut only once.”
And with this I wish you a fruitful discussion.
Thank you.
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