Widgetized Section

Go to Admin » Appearance » Widgets » and move Gabfire Widget: Social into that MastheadOverlay zone

Is It Time For A State Bank?

The views expressed are those of the author and do not necessarily reflect the views of ASPA as an organization.

By Robert Chirinko
May 17, 2021

The former mayor of Chicago, Rahm Emmanuel, offered the following incisive observation during the 2008 Global Financial Crisis—“You never want a serious crisis to go to waste. And what I mean by that is an opportunity to do things that you think you could not do before.”

Seizing new opportunities is particularly relevant for state and local governments as they emerge from the ravishes of COVID-19. Pressures brought on by the pandemic have created an environment conducive to innovative approaches to government finance and for new ways to build capacities that will further economic development and citizens’ welfare.

One such radical innovation is the creation of a state bank. In 2021, four states—New Mexico, New York, Oregon and Washington—introduced legislation to create one. In 2019, similar legislation was enacted in California empowering local governments to establish public banks

Why state banks? Among other factors, there are long-standing concerns that private banks operating in private markets are not adequately providing financial services and credit. These concerns have been amplified by the disproportionate economic impact of the pandemic on small businesses and communities of color. A recently completed paper, written by this author for the Government Finance Research Center with the support of the Joyce Foundation, develops a framework for evaluating the merits of creating a state bank and provides relevant evidence.

As the paper finds, one sustainable motivating factor is the provision of credit for economic development, especially loans for small businesses and other underserved constituencies. Whether a state bank can meet these needs better than a private bank depends on the cost of lending. Under what circumstances can a state bank allocate credit at lower cost to the existing pool of actual and potential borrowers? Private banks may have cost advantages due to lower operating costs and a lower cost of borrowed funds. State banks may benefit from lower default rates (owing to a closer connection to borrowers) and greater access to state deposits, both of which lower its cost of lending. Thus, under some circumstances, a constructive role may exist for the creation of a state bank.

The second potentially motivating factor is the provision of financial transaction services to underserved communities in rural or urban areas. In the latter case, they are often segregated communities comprising people of color with low average incomes, and hence the question looms as to whether underservicing is directly related to racism or a response to underlying economic conditions. While discrimination in terms of disparate outcomes among communities of color is clear, the difficult question is whether discrimination is driven by animus or economics (or some combination of the two). An answer to this question is important for evaluating a potentially constructive role for a state bank. While financial transaction services have been limited in the past, this problem is being obviated by available technological developments, and thus there is little role for a state bank to provide transaction services to underserved communities.

State banking has a long history. Of particular interest is the Bank of North Dakota, which has been in existence for 100-plus years and is held by many as the prototype of a successful state bank. A review of the experiences of the North Dakota bank and U.S. states who have explored the possibility of public banking, as well as German state banks, yields five lessons: state deposits are an attractive source of funding; economic development is a key motivating factor; distress risk borne by taxpayers are not always fully appreciated; equity capital attenuates distress risk (but may strain state finances); “mission creep,” political influence, and competition with extant private banks are ongoing concerns.

Based on the above framework, the case for and the case against the creation of a state bank can be weighed. The advisability of creating a state bank hinges on four questions:

  • What are the true costs of state deposits?
  • How vulnerable are taxpayers to state bank risk?
  • Why will a state bank have better success supporting underserved communities?
  • How can a state bank be insulated from political interference?

 A straightforward approach is based on the counsel of Eric Hardmeyer, the president and chief executive officer of the Bank of North Dakota. According to Hardmeyer, “If you are going to have a state-owned bank, you have to staff it with bankers. If you staff it with economic developers you are going to have a very short-lived, very expensive experiment.”

A more radical approach appeals directly to economic interests. A state bank can be considered because there is the possibility that it will generate surplus funds that can be targeted to various social problems outside the scope of private markets.

As a result, several independently created state banks could form a consortium and engage in banking activities in their states. Their surpluses would be aggregated and divided among the members of the consortium, who would have a financial interest in maximizing the aggregate surplus. A majority of the consortium members must approve the loans of each state bank. Thus, all state banks benefit from economically-sound loans and, apart from the issuing state, each gain very little benefit from state-specific lending driven by political considerations.

Author: Robert Chirinko, a professor in the Finance Department, University of Illinois at Chicago, is a member of the Faculty Advisory Panel for the Government Finance Research Center (UIC). His research focuses on business behavior emphasizing financial markets, banking, capital formation, corporate governance and finance, macroeconomics, and taxation. He has been a visiting scholar at several central banks and universities.

1 Star2 Stars3 Stars4 Stars5 Stars (No Ratings Yet)

Leave a Reply

Your email address will not be published. Required fields are marked *