Philip Molyneux

Determinants of European bank profitability: A note

A recent study by Bourke (1989) on the determinants of international bank profitability, replicated and extended earlier research undertaken by Short (1979), and found support for the view that concentration was positively and moderately related to profitability. The results also provide some evidence for the Edwards-Heggestad-Mingo hypothesis [Edwards and Heggestad (1973) and Heggestad and Mingo (1976)] of risk avoidance by banks with a high degree of market power. Bourke uses a pooled time series approach to estimate a linear equation, regressing performance measures against a variety of internal (staff expenses, capital ratios, liquidity ratios) and external (concentration ratios, government ownership, interest rates, market growth and inflation) determinants of bank profitability. This note replicates Bourke’s methodology in order to evaluate the determinants of European bank profitability. A sample of European banks, 671 for 1986, 1,063 for 1987, 1,371 for 1988 and 1,108 for 1989, are taken across eighteen countries. (The country breakdown is shown in the appendix.) Standardized accounting data for the banks was obtained from International Bank Credit Analysis Ltd (IBCA), a

Bank ownership and efficiency.

Agency issues associated with different types of firm ownership are an area of concern in many banking systems where state-owned banks operate alongside mutual and private-sector institutions. This paper uses a variety of approaches to model cost and profit inefficiencies as well as technical change for different ownership types in the German banking market. We find little evidence to suggest that privately owned banks are more efficient than their mutual and public-sector counterparts. While all three bank ownership types benefit from widespread economies of scale, inefficiency measures indicate that public and mutual banks have slight cost and profit advantages over their private sector competitors.

A comparative study of efficiency in European banking

This paper investigates whether there has been an improvement in and convergence of productive efficiency across European banking markets since the creation of the Single Internal Market. Using efficiency measures derived from DEA estimation, the determinants of European bank efficiency are evaluated using the Tobit regression model approach. The established literature on modelling the determinants of bank efficiency is then extended by recognizing the problem of the inherent dependency of DEA efficiency scores when used in regression analysis. To overcome the dependency problem, a bootstrapping technique is applied. Overall, the results suggest that since the EUs Single Market Programme there has been a small improvement in bank efficiency levels, although there is little evidence to suggest that these have converged. The results also suggest that inference on the determinants of bank efficiency drawn from non-bootstrapped regression analysis may be biased and misleading.

Dynamics of Growth and Profitability in Banking

Dynamic panel and cross-sectional regressions are used to estimate growth and profit equations for a sample of commercial, savings, and co-operative banks from five major European Union countries during the mid-1990s. Methodologically, the paper unifies the growth and profit strands in the previous empirical literature. The growth regressions reveal little or no evidence of mean-reversion in bank sizes. Profit is an important prerequisite for future growth. Banks that maintain a high capital-assets ratio tend to grow slowly, and growth is linked to macroeconomic conditions. Otherwise, there are few systematic influences on bank growth. The persistence of profit appears higher for savings and co-operative banks than for commercial banks. Banks that maintain high capital-assets or liquidity ratios tend to record relatively low profitability. There is some evidence of a positive association between concentration and profitability, but little evidence of a link between bank-level x-inefficiency and profitability.

Competitive conditions in european banking

Abstract In this paper we utilise the Rosse-Panzar statistic to assess competitive conditions in major EC banking markets between 1986 and 1989. Although EC banking legislation has established relatively free access to member country banking systems in recent years, our results indicate no change in market conduct of banks between 1986 and 1989. The results suggest that banks in Germany, the United Kingdom, France and Spain earned revenues as if under conditions of monopolistic competition in the period. In the case of Italy, they are consistent with banks having earned revenues as if under monopoly or conjectural variations short-run oligopoly conditions. We interpret the results as indicative of a lack of integration in EC banking markets and they thus underline the importance of the Second Banking Directive, the associated supervisory arrangements, and the elimination of capital controls as to achieving full integration.

Efficiency and risk in Japanese banking

This paper investigates the impact of risk and quality factors on banks’ cost by using the stochastic cost frontier methodology to evaluate scale and X-inefficiencies, as well as technical change for a sample of Japanese commercial banks between 1993 and 1996. Loan-loss provisions are included in the cost frontier model to control for output quality, with a financial capital and a liquidity ratio included to control risk. Following the approach suggested in Mester (1996) we show that if risk and quality factors are not taken into account optimal bank size tends to be overstated. That is, optimal bank size is considerably smaller when risk and quality factors are taken into account when modelling the cost characteristics of Japanese banks. We also find that the level of financial capital has the biggest influence on the scale efficiency estimates. X-inefficiency estimates, in contrast, appear less sensitive to risk and quality factors. Our results also suggest that scale inefficiencies dominate X-inefficiencies. These are important findings because they contrast with the results of previous studies on Japanese banking. In particular, the results indicate an alternative policy prescription, namely, that the largest banks should shrink to benefit from scale advantages. It also seems that financial capital has the largest influence on optimal bank size.

Analysing the determinants of bank efficiency: the case of Italian banks

This study investigates the main determinants of Italian banks’ cost efficiency over the period 1993–1996, by employing a Fourier-flexible stochastic cost frontier in order to measure X-efficiencies and economies of scale. Quality and riskiness of bank outputs are explicitly accounted for in the cost function and their impact on cost efficiency levels is evaluated. The results show that mean X-inefficiencies range between 13 and 15 per cent of total costs and they tend to decrease over time for all bank sizes. Economies of scale appear present and significant, being especially high for popular and credit co-operative banks. Moreover, the inclusion of risk and output quality variables in the cost function seems to reduce the significance of the scale economy estimates. Following Spong et al. (1995) a profitability test is undertaken that allows for the identification of banks that are both cost and profit efficient. The results suggest that the most efficient and profitable institutions are more able to control all aspects of costs, especially labour costs. Finally, the data are pooled to carry out a logistic regression model in order to examine bank- and market-specific factors that influence Italian banks’ inefficiency. Confirming Mester (1993, 1996), inefficiencies appear to be inversely correlated with capital strength and positively related to the level of non-performing loans in the balance sheet. The analysis also shows that there is no clear relationship between asset size and bank efficiency. Finally, it is possible to infer that quoted banks seem to be on average more efficient than their non-quoted counterparts.

Evidence on the bank lending channel in Europe

Abstract This paper examines evidence for a bank lending channel in Europe. Following the approach suggested by Kishan and Opiela (2000) we use bank balance sheet data to estimate the response of bank lending to changes in monetary policy stance between 1991 and 1999. In particular, we classify banks according to asset size and capital strength to see if these factors have a significant impact on the lending channel. Using a panel data approach we find that across the EMU systems, undercapitalised banks (of any size) tend to respond more to change in policy.

Market structure and performance in Spanish banking

Abstract Two competing hypotheses with regard to market structure and performance are the traditional structure-conduct-performance (SCP) paradigm and the efficiency hypothesis. In this paper, results are presented for tests of both hypotheses with respect to the Spanish banking industry using pooled and annual data for the period 1986–1988. The results generally support the traditional SCP paradigm as an explanation for the market behaviour of Spanish banks and this suggests that further concentration in the Spanish banking market, currently being encouraged by the government and the Bank of Spain, is likely to unambiguously decrease the level of competition in the system and cannot be justified on efficiency grounds.

Competition and market contestability in Japanese commercial banking

Abstract In this paper we present an empirical assessment of competitiveness in the Japanese banking market using the Panzar-Rosse methodology to test for evidence of contestability. We cannot reject the hypothesis that bank revenues behaved as if earned under monopoly or conjectural variations short-run oligopoly in 1986 but as if under monopolistic competition in 1988. The results are consistent with the lack of entry by domestic institutions into commercial banking being a result of incumbent firms acting in a contestable manner.