1. 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

2. 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

3. 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

4. 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)

5. 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%

6. Ownership Characteristics (of bank observations) Majority Foreign 59% – Less than one-half in Croatia, Slovenia and Latvia Majority government 10% – Largest in Slovakia 14% Majority private domestic31% – Only Croatia, Slovenia and Latvia above one-half Participation of international institutional investor 10% – Bulgaria, Estonia, Romania above 20%

7. Balance Sheet Characteristics AggregateMajority Foreign Majority Govt. Majority Private International Log of Assets 12.7213.0613.3011.9013.40 Loan / Asset 0.42540.43700.33390.43170.4198 Deposit / Asset 0.76230.77630.73990.74330.7526 Non-int. expend / Assets 0.06890.06040.08020.08130.0687

8. 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

9. Performance compared to overall mean ROAProfitCost Bulgaria++- Croatia-++ Czech Rep.--+ Estonia-++ Hungary--- Latvia-++ Lithuania-++ Poland+-+ Romania+-- Slovenia+++ Slovakia---

10. Performance Measures AggregateMajority Foreign Majority Govt. Majority Private International ROA0.00910.01180.00040.00700.0273 Raw Cost Efficiency 0.44370.40050.70340.41330.4180 Raw Profit Efficiency 0.89050.88870.88680.89340.8931

11. 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

12. 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

13. 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

14. 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

15. Size and year effects (Table 6, cols. 1 & 2) ROARaw Profit Efficiency Log assets 0.001-0.002* 1997-0.003-0.001 1998-0.026*-0.001 1999-0.0150.002+ 2000-0.014#0.002# Other variablesConstant, Foreign, Govt. and Intl.ownership dummies Adjusted R 2 0.03490.1993

16. Ownership Effects (Table 6, columns (1)-(3)) ROARaw Profit Efficiency Relative Profit Efficiency Foreign 0.004-0.001 0.001# Government-0.004-0.002+-0.002# International 0.019* 0.005* 0.002* Other Variables Constant, log of Assets, Fixed effects for years Adjusted R 2 0.03490.19930.0881

17. Additional Tests (Table 7, columns (1),(3) and (6)) Raw Profit Efficiency (1) Raw Cost Efficiency (3) ROA (6) Foreign-0.001-0.094#-0.001 Government-0.0010.174#-0.007 International 0.006*-0.080 0.013# Loan / Asset-0.008 Loan / Deposit-0.031# Non-int exp / Asset-0.268* GDP growth0.001*-0.047*-0.005* Additional variablesConstant, log assets, year dummies Adjusted R 2 0.24010.09440.1273

18. 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

19. 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