But these banking systems have also had substantial participation of publicly owned banks. Such institutions rarely exhibit the dynamism and innovation that many private banks have employed for their, and their economies’ prosperity. Government participation often distorts the allocation of capital to its most productive uses and undermines the reliability of price signals.
But at times when market adjustment processes might have proved inadequate to prevent a banking crisis, such a government presence in the banking system can provide implicit guarantees of resources to keep credit flowing, even if its direction is suboptimal. In Germany, for example, publicly controlled banking groups account for nearly 40 percent of the assets of all banks taken together.