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

Ownership Structure, Supervisory Regulation and the Diversification Effects on Bank Performance. Hsiangping Tsai Department of Finance, Yuan Ze University Yuanchen Chang Department of Finance, National Chengchi University Kuanyu Lai Department of Finance, National Chengchi University.

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

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  1. Ownership Structure, Supervisory Regulation and the Diversification Effects on Bank Performance Hsiangping Tsai Department of Finance, Yuan Ze University Yuanchen Chang Department of Finance, National Chengchi University Kuanyu Lai Department 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)

  3. 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)

  4. 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

  5. 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)

  6. 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?

  7. Diversification measures • Income diversity • Asset diversity

  8. 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

  9. 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.

  10. 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.

  11. 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

  12. Sample bank characteristics

  13. Sample bank characteristics

  14. Baseline results: bank diversification performance

  15. Baseline results: bank diversification performance

  16. Effects of dominant owner on diversification performance

  17. Effects of dominant owner on diversification performance

  18. Effects of dominant owner and activity restrictions on diversification performance

  19. Effects of dominant owner and activity restrictions on diversification performance

  20. 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

  21. Conclusion • Supervisory restrictions • Restrictions on securities work to limit negative diversification performance • Restrictions on insurance and real estate activities further strengthen negative diversification performance.

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