In Chapter 1 it is argued that government banks provide policy alternatives for economic management and social inclusion while retaining competitive advantages over private and foreign banks. This chapter turns to evidence from Brazil since price stability, transition from military rule and liberalization of the industry. In April 1994, the Real Plan ended over a decade of inertial inflation and launched then Finance Minister Cardoso to win the presidency for the coalition between the Partido da Social Democracia Brasileira (Party of Brazilian Social Democracy, PSDB) and Partido da Frente Liberal (Liberal Front Party, PFL) in the first national elections held since transition from military rule. In 1995, President Cardoso's coalition government reduced protection of domestic banking set in the 1988 Constitution, permitted foreign participation in privatization auctions and provided incentives for foreign investment in financial industries. From 1994–2002, foreign investment in banking and finance reached US$19.8 billion (15 per cent of total direct foreign investment). However, instead of leading to the predominance of foreign and private banks, a new division of financial labour emerged. Privatizations reduced the presence of state government banks. Liberalization increased the importance of foreign banks. However, the anomaly for liberal theory is that federal banks 1) were capitalized 2) were challenged to pursue new strategies and policies and 3) have provided policy options and competed successfully since opening the industry.

This chapter explores in turn these elements of anomaly.

Since Adam Smith, liberal economists have remained sceptical about government banking. Smith rejected government banks as a source of public revenue, but his arguments anticipate those of recent critics. Government banks are mercantilist and interfere with free market relations. Government banks are subject to mismanagement ranging from ‘slothful and negligent profusion’ under monarchies in times of peace to ‘thoughtless extravagance’ under democracies in times of war.

The Anomaly

This book began when I opened the morning paper in São Paulo on 21 June 2001. Finance Minister Pedro Malan and Central Bank President Arminio Fraga had capitalized Brazilian federal banks to meet Bank for International Settlement (BIS) Basel II Accord guidelines for capital risk. The image of a US-trained economist and advocate of liberalization and privatizations aside a former emerging markets trader at the Soros Fund announcing the capitalization and reform of government banks seemed very odd. Was this another bailout of bureaucrats? Why did reformist President Fernando Henrique Cardoso capitalize rather than privatize these banks after seven years in office, just a year before a decisive campaign to elect his successor? Was this a return to Brazilian statism? Did private banks somehow conspire or acquiesce to keep out foreign competitors (having acquired state government banks and large market shares themselves)? Were Brazilian federal government banks simply too big to fail or too broke to privatize? A mental experiment came to mind. What would a US president do with three big banks? President Henry Jackson's veto of the Second Bank of the US in 1832 made it hard to imagine a US federal bank (I later learned of Abraham Lincoln's advocacy of a National Bank and the US Postal Bank, 1945–8). But the experiment stuck. It seemed impossible that having three big banks under government ownership and control made no difference for policy and political economy.

The BNDES is a paradigmatic development bank. The trajectory of the BNDES involves a sequence of policies and business practices that have shaped Brazilian development. During the 1950s, the BNDE supplied directed credit for transportation, electric energy, infrastructure and steel production. During the 1960s, the bank diversified under financial reforms. During the 1970s, the BNDE helped complete state-led import substitution industrialization by channelling foreign finance and forced savings into capital goods, project lending and regional development programmes. During the 1980s, the bank shifted away from public investment because of fiscal crisis and foreign debt. During the 1990s, the BNDES became agent for privatization of state owned enterprises. The bank remained virtually the only domestic source of long-term finance during a decade of financial crises in emerging markets (1994–2003).

The Banco do Brasil was founded before Brazil. Since 1808, government (and national) banks with this name have dominated banking, money management and economic policy. Until creation of the Central Bank in 1965, the Banco do Brasil supervised banks, managed the money supply, promoted exports, controlled imports, provided lending of last resort to banks, brokers and private firms and managed foreign exchange operations and national reserves. Until reforms in the 1980s, the Banco do Brasil remained executor of federal government budgets and retained free access to funds at Treasury to settle accounts. The modernization of Brazilian government and the development of specialized agencies for banking, money and finance policy is a story of extricating prerogatives from the Banco do Brasil. The gradual transfer of monetary policy to SUMOC (1945), central banking to the Central Bank (1965) and fiscal management to Treasury (1986) and Senate as determined by the 1988 Constitution has produced fundamental change at the bank. Since opening the industry in the 1990s, policymakers and Banco do Brasil executives have adopted market oriented policies and corporate governance reforms inspired by private banking to meet competition.

Government banks make sense. As banks, they retain competitive advantages because of greater client confidence and unbeatable brand names such as the Banco do Brasil. As policy instruments, they provide branch offices, automated teller machines and mobile services over cellular phones to reach citizens. Their staff can manage complex information about local needs, measure costs, benefits and risks, and assert contractual control to correct public policies before they run astray. Government banks provide large policy levers for political leaders and social forces. These institutions are often large enough to provide countercyclical credit to avert or ameliorate recessions. Federal banks may implement reforms such as privatizations and public sector modernization through ‘IMF-like’ conditional loans to sub-national governments. In the past, directed credit from government banks drove rapid industrialization in late-developing countries. Such policies continue in many emerging, transition and developing nations. But government banks do much more than direct industrial change. Government savings banks have served local communities across Europe, some for centuries, to emerge after liberalization of the industry and monetary union with increased market shares and renewed social mandates. Brazilian federal banks have also emerged from military rule, abuse by traditional elites during prolonged transition, monetary disorder and financial crises to shape development and democracy. Three big banks, a commercial-investment bank, a savings bank and a development bank provide over a third of domestic credit in twenty-first-century Brazil.