Use state banks to stabilize the business cycle

The standard way to think about banking in the business cycle is that financial frictions amplify economic fluctuations. There are various mechanisms that make this happen. For example, the lower value of collateral during a recession makes lending more difficult. Or the value of the bank's assets decreases and it can lend less due to risk regulation. But does this always have to be so?

Ata Can Bertay, Asli Demirgüç-Kunt and Harry Huizinga take the example of state-owned banks. Given their public mission, they may actually try to become more active during recessions, possibly because public guarantees allow them top take on more risk during those times, or because they are more defensive in good times when they are less needed. Whatever the reason, by just looking at the data their study finds that state-owned banks are indeed lending against the cycle, especially in high-income countries with good-governance. Expanding the role of these banks could thus be beneficial, although one has to keep in mind that state banks are not necessarily the most efficient ones or the best at identifying good lending opportunities.