Ownership Structure, Supervisory Regulation and the Diversification Effects on Bank Performance

Ownership Structure, Supervisory Regulation and the Diversification Effects on Bank Performance

Hsiangping TsaiHsiangping TsaiDepartment of Finance, Yuan Ze University

Yuanchen ChangYuanchen ChangDepartment of Finance, National Chengchi University

Kuanyu LaiKuanyu LaiDepartment of Finance, National Chengchi University

2

Effects of diversification on bank performance

• Possible benefits¤ Risk reduction, information sharing, internal

capital market Ross(1989); Saunders and Walter(1994); Houston et al.

(1997)

• Recent empirical evidence¤ Lower market valuation, poorer risk-adjusted

performance, higher level of risk taking Laeven and Levine(2007a), Stiroh(2004a, 2004b); Stiroh

and Rumble(2006); Demsetz and Strahan(1997); Acharya et al.(2006)

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Agency cost explanation

• Managers engage in diversification¤ To reduce their own risk (Amihud and lev,

1981; May, 1995)

¤ To obtain better compensation packages or to protect their own positions (Jensen, 1989, Shelifer and Vishny, 1989)

¤ To be able to pursue riskier activities (Demsetz and Strahan, 1997)

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Objective

• To document diversification effects on the performance of banks around the world

• What might help limit agency costs and thus constrain poor performance of diversification?¤ dominant shareholder monitor

¤ the ability of bank supervisors to identify and restrict high risk activities

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The role of dominant owner

• Ownership structure of banks: Government, foreign and domestic private owners.¤ State-owned banks may suffer from political

pressures La Porta et al. (2002), Sapienza (2004),Dinc ( 2005),

Micco et al. (2007)¤ Foreign and domestic private owners: Global

advantage vs. Home country advantage Berger et al. (2001), Bonin et al. (2005), Lensink and

Naaborg (2007)

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Supervisory restrictions on bank activities

• Debatable policy issue: restricted or diverse activities?

• We address this issue by asking ¤ whether restrictions on bank activities are

able to constrain the negative performance from diversification?

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Diversification measures

• Income diversity

• Asset diversity

incomeoperatingTotal

incomeoperatingOtherincomerestinteNet diversityIncome

- 1

assetsearningTotal

assetsearningOtherloanstotalNetdiversityAsset

- 1

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Diversification performance

• Activity adjusted performance

¤ αi and 1-αi: the share of each activity ¤ P: the average performance for specialized banks

in each activity

• Excess performance from diversification

21 )1( _ PPPadjAct iii

iii PadjActPPExcess _

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Sample selection and data sources

• Annual bank accounting data from 1995~2006¤ Bankscope (July 2007 DVD-ROM edition)¤ Banks excluded

total assets less than US$100 million Islamic banks, central banks & multi-lateral

government banks obs. with missing data or with extreme outliers those in countries with less than 100 obs.

¤ The remaining sample: 67,108 bank-year obs. from 70 countries.

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Sample selection and data sources

• Ownership¤ Source: Bankscope (July 2007 DVD-ROM edition)¤ Dominant owner: the largest owner who has more

than 25.01% voting shares¤ Ownership classification

Banks that are widely-owned Banks that are owned by a dominant owner: local

government, foreign or domestic private shareholder.

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Sample selection and data sources

• Supervisory restrictions on bank activities¤ Source: bank regulation and supervision

database provided by the World Bank¤ Activity restrictions

(1) Securities activities (SEC) (2) Insurance activities (INS) (3) Real estate activities (RES)

¤ Four level of restrictions (1) Unrestricted (2) Permitted (3) Restricted (4)

Prohibited

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Sample bank characteristics

#

OBS TA (M)

Equity Ratio

Listed Bank

INC DVSF

AST DVSF

ROA (%)

All Banks 67,108 4,166 0.09 0.16 0.46 0.58 0.78 LS LS_G LS_F LS_D SEC INS RES

All Banks 0.21 0.02 0.10 0.09 0.58 1.42 1.73

#

OBS TA (M)

Equity Ratio

Listed Bank

ROA (%) DVSF

DVSF_INC 56,771 4,220 0.09 0.16 0.78 0.52 SPEC_INC 10,337 3,867 0.11 0.11 0.79 0.10 DVSF_AST 59,563 4,213 0.09 0.16 0.75 0.63 SPEC_AST 7,545 3,790 0.12 0.10 1.05 0.10

LS LS_G LS_F LS_D SEC INS RES DVSF_INC 0.22 0.02 0.10 0.09 0.55 1.45 1.66 SPEC_INC 0.18 0.02 0.08 0.08 0.72 1.29 2.11 DVSF_AST 0.19 0.02 0.09 0.08 0.58 1.44 1.75 SPEC_AST 0.33 0.02 0.16 0.16 0.55 1.30 1.57

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Sample bank characteristics

#

OBS TA (M)

Equity Ratio

Listed Bank

ROA (%)

INC DVSF

AST DVSF

All Banks 67,108 4,166 0.09 0.16 0.78 0.46 0.57 Non-LS 53,054 3,522 0.09 0.16 0.72 0.44 0.59 LS 14,054 6,596 0.10 0.16 1.01 0.51 0.52 LS_G 1,305 11,530 0.11 0.42 0.99 0.52 0.60 LS_F 6,635 5,243 0.11 0.19 1.02 0.54 0.54 LS_D 6,114 7,012 0.09 0.08 1.00 0.48 0.49 SEC=0 (Unrestricted) 29,284 3,456 0.08 0.06 0.62 0.47 0.58 SEC=1 (Permitted) 35,302 4,788 0.10 0.23 0.88 0.44 0.57 SEC=2 (Restricted) 1,349 5,659 0.10 0.38 1.26 0.53 0.64 INS=0 (Unrestricted) 1,472 4,324 0.09 0.07 0.81 0.59 0.43 INS=1 (Permitted) 36,419 4,729 0.10 0.19 0.88 0.44 0.55 INS=2 (Restricted) 26,872 3,436 0.08 0.10 0.62 0.47 0.61 INS=3 (Prohibited) 1,172 5,911 0.12 0.32 0.98 0.48 0.54 RES=0 (Unrestricted) 24,553 3,576 0.08 0.04 0.55 0.47 0.56 RES=1 (Permitted) 2,763 2,470 0.12 0.26 1.46 0.53 0.60 RES=2 (Restricted) 4,683 5,369 0.11 0.30 1.03 0.56 0.59 RES=3 (Prohibited) 33,936 4,659 0.10 0.21 0.85 0.43 0.58

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Baseline results: bank diversification performance

Panel 1: ExROA (ROA adjusted for income diversity) Model 1 Model 2 Model 3

Coeff S.E. Coeff S.E. Coeff S.E. Intercept 1.718a 0.081 1.897a 0.082 -0.750 a 0.094 Income diversity -0.529a 0.020 -1.415a 0.071 -0.554 a 0.067 Income diversity 2 0.902a 0.069 0.334 a 0.064 Total Equity to Total Asset 5.375 a 0.051 Net Interest Revenue to Total Operating Income 0.663 a 0.026 Ln (Asset) 0.048 a 0.003 Listed bank 0.108 a 0.015 Adj R-sq 0.122 0.125 0.249 # obs 67,108 67,108 67,108

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Baseline results: bank diversification performance

Panel 2: ExROA (ROA adjusted for asset diversity) Model 1 Model 2 Model 3

Coeff S.E. Coeff S.E. Coeff S.E. Intercept 1.528a 0.082 1.671a 0.084 -0.733 a 0.092 Asset diversity -0.256a 0.018 -0.840a 0.071 -0.372 a 0.066 Asset diversity 2 0.549a 0.064 0.281 a 0.060 Total Equity to Total Asset 5.641 a 0.051 Total Customer Loans to Total Earnings Assets 0.360 a 0.021 Ln (Asset) 0.053 a 0.003 Listed bank 0.095 a 0.015 Adj R-sq 0.133 0.134 0.268 # obs 67,108 67,108 67,108

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Effects of dominant owner on diversification performance

Panel 1: ExROA (ROA adjusted for income diversity) Model 1 Model 2 Model 3

Coeff S.E. Coeff S.E. Coeff S.E. Intercept -0.729 a 0.094 -0.655 a 0.094 -0.522 c 0.273 Income diversity -0.562 a 0.067 -0.569 a 0.067 -0.746 a 0.167 Income diversity 2 0.319 a 0.064 0.326 a 0.064 0.457 a 0.154 LS * Income diversity 0.093 a 0.020 LS_G * Income diversity -0.196 a 0.057 LS_F * Income diversity 0.014 0.026 LS_D * Income diversity 0.243 a 0.028 0.271 a 0.045 Total Equity to Total Asset 5.372 a 0.051 5.381 a 0.051 5.036 a 0.121 Net Interest Revenue to Total Operating Income 0.664 a 0.026 0.666 a 0.026 0.765 a 0.053 Ln (Asset) 0.045 a 0.003 0.045 a 0.003 0.040 a 0.008 Listed bank 0.112 a 0.015 0.119 a 0.015 0.032 0.040 Adj R-Sq 0.249 0.250 0.246 # obs 67,108 67,108 12,749

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Effects of dominant owner on diversification performance

Panel 2: ExROA (ROA adjusted for asset diversity) Model 1 Model 2 Model 3

Coeff S.E. Coeff S.E. Coeff S.E. Intercept -0.700 a 0.092 -0.656 a 0.093 -0.470 c 0.270 Asset diversity -0.398 a 0.066 -0.407 a 0.066 -0.423 a 0.148 Asset diversity 2 0.287 a 0.060 0.295 a 0.060 0.145 0.141 LS * Asset diversity 0.084 a 0.019 LS_G * Asset diversity -0.106 b 0.050 LS_F * Asset diversity 0.069 a 0.025 LS_D * Asset diversity 0.146 a 0.027 0.104 b 0.043 Total Equity to Total Asset 5.632 a 0.051 5.633 a 0.051 5.204 a 0.121 Total Customer Loans to Total Earnings Assets 0.358 a 0.021 0.356 a 0.021 0.520 a 0.046 Ln (Asset) 0.050 a 0.003 0.051 a 0.003 0.052 a 0.008 Listed bank 0.098 a 0.015 0.102 a 0.015 0.010 0.040 Adj R-Sq 0.269 0.268 0.235 # obs 67,108 67,108 12,749

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Effects of dominant owner and activity restrictions on diversification performance

Panel 1: ExROA (ROA adjusted for income diversity)

Model 1 Model 2 Coeff S.E. Coeff S.E.

Intercept -1.608a 0.058 -0.492a 0.097 Income diversity -0.588a 0.079 -0.574a 0.091 Income diversity 2 0.429a 0.065 0.346a 0.065 LS_G * Income diversity -0.170a 0.059 LS_F * Income diversity 0.028 0.027 LS_D * Income diversity 0.250a 0.028 SEC * Income diversity 0.531a 0.035 0.350a 0.049 INS * Income diversity -0.201a 0.023 -0.141a 0.035 RES * Income diversity -0.065a 0.017 -0.026 0.019 Total Equity to Total Asset 5.523a 0.052 5.365a 0.052 Net Interest Revenue to Total Operating Income 0.672a 0.026 0.673a 0.026 Ln (Asset) 0.038a 0.003 0.044a 0.003 Listed bank 0.177a 0.015 0.118a 0.015 Adj R-Sq 0.229 0.248 #obs 65,935 65,935

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Effects of dominant owner and activity restrictions on diversification performance

Panel 2: ExROA (ROA adjusted for asset diversity)

Model 1 Model 2 Coeff S.E. Coeff S.E.

Intercept -1.642a 0.055 -0.740a 0.094 Asset diversity -0.238a 0.076 -0.456a 0.084 Asset diversity 2 0.273a 0.061 0.268a 0.061 LS_G * Asset diversity -0.094c 0.051 LS_F * Asset diversity 0.065b 0.026 LS_D * Asset diversity 0.150a 0.027 SEC * Asset diversity 0.355a 0.033 0.036 0.048 INS * Asset diversity -0.096a 0.022 0.105a 0.033 RES * Asset diversity -0.107a 0.016 -0.050a 0.017 Total Equity to Total Asset 5.840a 0.052 5.626a 0.052 Total Customer Loans to Total Earnings Assets 0.391a 0.021 0.355a 0.021 Ln (Asset) 0.041a 0.003 0.050a 0.003 Listed bank 0.164a 0.015 0.100a 0.015 Adj R-Sq 0.246 0.267 #obs 65,935 65,935

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Conclusion

• Diversified banks perform worse than their specialized peers.

• Dominant owner functions as a monitor¤ Banks with a dominant owner suffer less¤ Who the dominant owner is matters

Home country advantage: domestic owner function better than foreign owner

Government owner tends to reinforce negative diversification performance

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Conclusion

• Supervisory restrictions¤ Restrictions on securities work to limit

negative diversification performance¤ Restrictions on insurance and real estate

activities further strengthen negative diversification performance.