Bank Performance, Efficiency and Ownership in Transition Countries

John P. Bonin Wesleyan University Iftekhar Hasan Rensselaer Polytechnic Institute Paul Wachtel Stern School of Business, New York University

Banking Developments in Transition Countries

    Rapid evolution from planned economy era Fall in government ownership Greenfield banks Foreign participation – High compared to other emerging markets – Dramatic increase in late 1990s

Hypotheses explored

 Banking sectors are becoming more efficient – Spillover effects of foreign participation  Foreign-owned banks perform better  Ownership matters – – Government vs. Private Foreign vs. Domestic

Related literature

 On efficiency improvements in transition banking – Buch (1997) and (2000), Fries and Taci (2002), Fries, Neven and Seabright (2002), Drakos (2002), Claessens, Demirguc-Kunt, and Huizinga (2001)  On importance of ownership – IMF(2002), Nikiel and Opiela (2002), Hasan and Marton (2003)

Data

 Bankscope bank data – – – – 11 advanced transition countries (Eastern Europe and the Baltics) Financial statements 1996-2000 Ownership information 1999 Exclude non-bank intermediaries  Total of 830 bank-year observations with financial data and ownership information – Country coverage   Poland, Croatia, and Hungary ~ 45% Baltics ~ 13%

Ownership Characteristics (of bank observations)

    Majority Foreign – 59% Less than one-half in Croatia, Slovenia and Latvia Majority government – Largest in Slovakia 14% 10% Majority private domestic – 31% Only Croatia, Slovenia and Latvia above one-half

Participation of international institutional investor 10%

–

Bulgaria, Estonia, Romania above 20%

Balance Sheet Characteristics

Log of Assets Loan / Asset Deposit / Asset Non-int. expend / Assets

Aggregate 12.72

0.4254

0.7623

0.0689

Majority Foreign 13.06

0.4370

0.7763

0.0604

Majority Govt. 13.30

Majority Private

International

11.90

13.40

0.3339

0.7399

0.0802

0.4317

0.7433

0.0813

0.4198

0.7526

0.0687

Efficiency Estimation

 Stochastic Frontier analysis  Profit and Cost efficiency functions – Standard translog specification  Efficiency measures – – Raw efficiency – distance from frontier Relative efficiency – distance relative to mean for all same country bank observations

Performance compared to overall mean

Bulgaria Croatia Czech Rep.

Estonia Hungary Latvia Lithuania Poland Romania Slovenia Slovakia + + + -

ROA

+ + + + +

Profit

+ + + + + + + -

Cost

+ +

Performance Measures

ROA

Aggregate 0.0091

Raw Cost Efficiency

0.4437

Raw Profit Efficiency

0.8905

Majority Foreign 0.0118

0.4005

0.8887

Majority Govt. 0.0004

Majority Private

International

0.0070

0.0273

0.7034

0.8868

0.4133

0.4180

0.8934

0.8931

Regression analysis of Performance measures

 Independent variables – Log of asset in constant $ – – Fixed effects for year Dummy variables for ownership characteristics  Additional robustness tests – Balance sheet ratios effects on ROA Ratios to assets of loans, deposits, non-interest expenditures – Real GDP growth

Explanations of Performance

 ROA declines over time – banking becoming more competitive  Efficiency improves after 1998  Better bank performance in countries with higher growth  Larger banks generally less efficient  Banks with larger deposit base (retail banks) have lower ROA

Ownership effects on performance

 Govt. banks less efficient than private  Foreign-owned banks more efficient than other private banks in same country  Presence of international institutional investors (most frequently EBRD) has important impact – – Higher ROA More profit efficient but not more cost efficient

Why do international institutional investors matter?

 Cherry-picking – They successfully choose the most profitable banks for their investment portfolios  Technology and Knowledge Transfer – Transfers facilitate the development of banks  Signaling or Screening – – Investments provide information about quality of banks Imprimatur of ‘official’ investors attracts customers

Size and year effects

(Table 6, cols. 1 & 2)

Log assets 1997 1998 1999 2000 Other variables Adjusted R 2 ROA 0.001

-0.003

-0.026* Raw Profit Efficiency -0.002* -0.001

-0.001

-0.015

-0.014# 0.002+ 0.002# Constant, Foreign, Govt. and Intl.ownership dummies 0.0349

0.1993

Ownership Effects

(Table 6, columns (1)-(3)) Foreign Government International Other Variables Adjusted R 2

ROA 0.004

Raw Profit Efficiency -0.001

Relative Profit Efficiency 0.001# -0.004

0.019* -0.002+ 0.005* -0.002# 0.002* Constant, log of Assets, Fixed effects for years 0.0349

0.1993

0.0881

Additional Tests

(Table 7, columns (1),(3) and (6))

Foreign Government International Loan / Asset Loan / Deposit Non-int exp / Asset GDP growth Additional variables

Adjusted R 2 Raw Profit Efficiency

(1) -0.001

-0.001

0.006*

Raw Cost Efficiency

(3) -0.094# 0.174# -0.080

ROA

(6) -0.001

-0.007

0.013# -0.008

0.001* -0.047* -0.005* Constant, log assets, year dummies 0.2401

0.0944

-0.031# -0.268* 0.1273

Conclusions

 Increased foreign participation leads to more efficient and competitive banking sectors in advanced transition countries  Private banks are more efficient than govt. owned banks   Foreign owned banks are more efficient than private banks International institutional investors ‘cherry-pick’

Things to do

 Differentiate foreign greenfield operations from foreign ownership of formerly state owned banks  Additional dummies for country clusters, e.g., Baltics, Northern-tier (Czech R., Hungary, and Poland)  Relative to maximum efficiency in country vs. average efficiency  Random effects estimation