The Non-Sensitivity of Public Development Banks to Key Stability Performance of the Banking Sector: The Lessons for Policymakers

Abstract

Public development banks are mission-oriented financial institutions whose purpose is to finance investments on behalf of the policymakers. After the last global financial crisis and the changes in the regulatory framework, the lending activities of commercial banks have declined, and their business models have shown a strong pro-cyclical character. On the other hand, public development banks are gaining considerable importance in maintaining the supply of credit in the event of disruptions in the financial system. Because the activity of public development banks is policy-driven, their credit supply is not affected by the GDP rate movement. The paper not only links the credit activity of public development banks with the indicator of financial stability of commercial banking before and after the establishment of the new banking regulatory framework but also examines the quality of the loan portfolio of public development banks and the movement of the ratio of non-performing loans of the commercial banking sector. The empirical analysis was conducted on a panel sample of EU27 countries using the publicly available database of the World Bank and the Bloomberg database for the 10 largest public development banks in the European Union in the period from 2005 to 2021. A research model with dynamic panels and a systematic one-step GMM estimator was employed. The results of the research confirmed and supported the basic research hypothesis that lending by public development banks is negatively related to the stability of the banking system, which indicates the contribution of public development banks in providing access to finance during the banking system crisis. Furthermore, research results showed that public lending by development banks is not related to GDP growth. The results of the research also confirmed an additional research hypothesis that the quality of lending by public development banks is significantly inversely proportional to the share of non-performing loans in the banking system as a whole. Accordingly, it is associated with a stable business model during economic cycles, solid credit standards, disclosure obligations, and public interest monitoring to avoid adverse shocks. Finally, the research result has confirmed the positive role of European public development banks in case of an increase in the probability of banking system distress due to efficient risk management and credit standards. Its conclusion is that the policymakers need to continue to promote the importance of public development banks in contributing to policy objectives and extending financial inclusion, both during the periods of financial stability and in the periods of indications of financial uncertainties and crises.

Keywords

• EU public development banks
• stability performance of the banking sector
• regulatory framework for commercial banks
• dynamic panel models