Abstract
Does better corporate governance unambiguously improve the risk/return efficiency of banks? Or does either a re-orientation of banks’ revenue mix towards more opaque products, an economic downturn, or tighter supervision create off-setting or reinforcing effects? The authors relate bank efficiency to shortfalls from a stochastic risk/return frontier. They analyze how internal governance mechanisms (CEO duality, board experience, political connections, and education profile) and external governance mechanisms (discipline exerted by shareholders, depositors, or skilled employees) determine efficiency in a sample of Turkish banks. The 2000 financial crisis was a wake-up call for bank efficiency and corporate governance. As a result, better corporate governance mechanisms have been able to improve risk/return efficiency when the economic, regulatory, and supervisory environments are more stable and bank products are more complex.
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Notes
Balance sheet classes are chosen in accordance with the published income streams from the income statement and are defined as follows: Non-bank Loans (L) = short-term loans + medium and long term loans + follow-up loans (net); Securities (S) = trading securities + investment securities available for sale + investment securities held to maturity; Bank Loans (B) = due from banks (domestic and foreign) + other financial institutions; Money Market Securities (MM) = interbank money market placements + Istanbul Stock Exc money market placements + receivables from reverse repurchase agreement; Other Assets (OA) = cash + balances with the Central Bank + reserve deposits + permanent assets (investments and associates (net) + subsidiaries (net) + property and equipment (net)) + other receivables; Deposits (D) = demand and time deposits; Non Deposit Funds (ND) = funds borrowed from the Central Bank, banks, foreign banks and other financial institutions; Other Liabilities (OL) = interbank money market takings + (net) issued marketable securities + other resources other than total equity
In Section 4, as a robustness check, we take into account the time varying nature of the variance-covariance matrix by using a historical five-year rolling window.
The two-stage approach in which the first stage involves the estimation of technical inefficiency using the stochastic frontier production function, and the second stage involves the regression of those predicted inefficiency effects upon a vector of exogenous firm-specific variables is criticized by Kumbhakar et al. (1991); because the distributional assumptions in both steps are inherently inconsistent. Therefore, they propose a one-step stochastic frontier model in which the parameters are estimated simultaneously with the bank-specific production inefficiency effects. Wang and Schmidt (2002) provide persuasive Monte Carlo evidence explaining why both stages of the two-stage procedure are seriously biased.
For some banks we observe a change in ownership type over the sample period.
Managers and chairmen whose educational background are not available are typically in charge of relatively small institutions. The average total assets for banks where information is not available for both the manager and chairman is $198 million dollars, whereas this number is about $3,898 million dollars for banks showing the educational background for both of the position holders.
We focus on the most objective form of political connections, although there are other indirect forms of political connections (ranging from politicians’ relatives on the board to less subtle forms such as bribery or corruption) that are difficult to document.
Marginal effects are obtained as in Eq. 7. In order to compute the marginal effect of each variable on technical inefficiency, each statistically significant coefficient \( {\delta_k} \) is multiplied with the weighted average value of \( ({1} - \Lambda \lambda - {\lambda^2}) \). For example, this term equals 0.183 in column 1. The reported mean marginal effects can also be interpreted as the partial effect of \( {Z_k} \) on the total rate of return (R) since \( \partial \left[ {E\left( {{R_{i,t}}|R{K_{i,t}},Z} \right)} \right]/\partial {Z_k} = - \partial \left[ {E\left( {{u_{i,t}}|R{K_{i,t}},Z} \right)} \right]/\partial {Z_k} \),, with k = 1,…,K an index of exogenous variables.
We could not include an interaction with the politically connectedness dummy because, in the post-crisis period, no top executive exists that used to be a member of the Turkish parliament.
Off-balance sheet operations of Turkish banks expanded enormously in the 1990s as a result of the increase in repo transactions and foreign exchange hedging instruments. Because the Turkish lira was pegged, the banking sector viewed the exchange risk limited, many banks borrowed in foreign exchange and lent in domestic currency (mainly to the Treasury), thus taking advantage of the uncovered interest rate parity. The floating of the Turkish lira eventually fatally hit the sector because of the huge exposure in the forward foreign exchange market. This situation has apparently completely reversed after the crisis, resulting in improved off-balance sheet operations.
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Acknowledgements
We gratefully acknowledge the helpful comments and suggestions of the editor (Haluk Ünal), an anonymous referee, Lieven Baele, Valerie De Bruyckere, Iftekhar Hasan, Jos Meir, Rudi Vander Vennet and seminar participants at Ghent University, the UKEPAN conference held at Leicester University, United Kingdom, 14–15 November 2009, Society for the Study of Emerging Markets Euro Conference 2010 held in Milas, Turkey, 16–18 July 2010.
Financial support from the Hercules Fund is gratefully acknowledged.
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Appendix: Turkish banking sector
Appendix: Turkish banking sector
The financial liberalization process in the 1980s abolished interest rate ceilings, removed quantitative controls on lending, lifted entry barriers, and liberated the capital market. The expectation was that liberalization would urge banks to operate more efficiently and would stimulate capital inflows, both boosting economic growth. On the other hand, the increased level of competition that ensued from this premature financial liberalization has often been blamed for perverting banks’ incentives to behave in a risk-averse manner. Especially in the presence of bailout expectations, deregulation can hamper financial stability as banks are confronted with declining franchise values (the discounted stream of future expected cash flows diminishes), which distorts their incentives in the direction of excessive risk taking (Keeley 1990).
Even after abolishing the financial constraints the government continued to put indirect pressure on the sector until the 2000–2001 crisis. Banks, instead of channeling deposits from the general public to the real private sector, continued to finance the government’s large budget deficits at high interest rates. For the Turkish banking sector, the period after the 1989 financial liberalization can be characterized as follows: in the period before the 2000–2001 crisis, banks operated in a very volatile environment characterized by severe boom and bust cycles that resulted in a major banking crisis at the end of 2000 and early 2001 (see e.g. Alper and Öniş (2003) and Tanyeri (2010) for a detailed discussion). However, in the period after this crisis, the sector has improved its performance as a result of solid restructuring, recapitalization, and supervision and remained largely unfazed in the face of the recent global economic downturn.
The 2000–2001 crisis was a classic twin crisis caused by growing macroeconomic imbalances. Ultimately, the government was forced to abandon the euro-dollar crawling peg it had primarily initiated to tackle high inflation and had to face the collapse of the banking system. In reaction, the government adopted a comprehensive reform program supported by the World Bank and IMF. An important part of this program was the redesign of the Banking Regulation and Supervision Agency (BRSA) that became more effective with prudential supervision and regulation and the appropriate enforcement power, credibility, and autonomous structure in the post-crisis period. Private banks were forced to strengthen their equity capital, either independently or through mergers and acquisitions, and about 20 fragile banks that failed to comply were transferred to the State Deposit Insurance Fund. The sector now has much stronger fundamentals and remains largely unfazed despite the recent global financial downturn.
Turkish commercial banks operate as universal banks (offering a broad range of products and services such as deposit-taking, commercial lending, trading financial instruments, insurance, leasing and investment banking) that are to a great extent homogenous. After the liberalization of the market, the number of banks operating in the Turkish banking sector increased significantly because of new entrants, big and profitable public borrowing, and a full blanket deposit guarantee. Table A illustrates that, in the aftermath of the financial crisis, the number of banks dropped sharply from more than 50 to 31 in 2009. This shake-out occurred through the liquidation of banks with a weak capital basis and through voluntary mergers and acquisitions. Despite decreasing bank numbers, the banking assets grew massively after the crisis from $118 billion in 2002 to about $518 billion in 2009.
With regard to ownership, commercial banks can be classified as public, domestic, or foreign banks. The Turkish banking landscape changed after the liberalization of the market because of mergers and acquisitions, new entries, and privatizations.
A snapshot of the Turkish banking industry
1990 | 1995 | 2000 | 2002 | 2005 | 2009 | |
Number of banks: | 56 | 55 | 50 | 38 | 33 | 31 |
- state-owned | 8 | 5 | 4 | 3 | 3 | 3 |
- domestic | 25 | 32 | 28 | 20 | 17 | 11 |
- foreign | 23 | 18 | 18 | 15 | 13 | 17 |
Total Assets (mln dollars) | 53,084 | 63,869 | 135,097 | 118,267 | 284,875 | 518,191 |
- state-owned (%) | 0.49 | 0.41 | 0.39 | 0.35 | 0.33 | 0.32 |
- domestic (%) | 0.47 | 0.56 | 0.54 | 0.62 | 0.62 | 0.54 |
- foreign (%) | 0.04 | 0.03 | 0.06 | 0.03 | 0.05 | 0.14 |
Assets/GNP (%) | 42.9 | 52.2 | 82.9 | 77.3 | 81.6 | 83.8 |
Number of employees | 151,982 | 138,894 | 144,950 | 112,443 | 127,462 | 166,802 |
Number of branches | 6,543 | 6,219 | 6,734 | 5,884 | 6,227 | 8,982 |
Source: Banks Association of Turkey
This table shows that, as of 2009, 31 deposit taking banks existed of which 3 were state owned, 11 were private domestic banks, and 17 were foreign banks. Despite the fact that the number of banks dropped heavily, the average number of branches per bank and staff per bank rose to record levels. Although the share of public banks in terms of total assets continues to decline gradually, its impact is still relatively high compared to EU averages. The presence of foreign banks used to be limited because of the unstable environment and entry barriers. However, the sector has recently beckoned the interest of foreign banks because of the strong growth potential and the solid economic recovery. The Turkish banking system still offers strong growth potential compared with EU countries. In fact, the ratio of Turkish banks’ assets to GNP was around 83% at the end of 2009, well below the EU average of more than 300%. In the future, the environment of sustainable growth potential, relatively high margins, low inflation, and declining intermediation costs are expected to support further growth in total assets, commercial loans, and deposit volumes of the banking system.
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De Jonghe, O., Disli, M. & Schoors, K. Corporate Governance, Opaque Bank Activities, and Risk/Return Efficiency: Pre- and Post-Crisis Evidence from Turkey. J Financ Serv Res 41, 51–80 (2012). https://doi.org/10.1007/s10693-011-0115-x
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DOI: https://doi.org/10.1007/s10693-011-0115-x