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Ownership Structure and Bank Performance: Evidence from the Middle East and North Africa Region

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Abstract

This paper examines the impact of ownership structure and other relevant factors on the variability of bank performance in the Middle East and North Africa (MENA) region. It highlights a sector of the MENA economy rarely investigated in such details in the past despite its tremendous importance for future growth and stability in the region. Among its results, the paper found majority foreign-owned private banks, especially MENA foreign-owned banks, performed significantly better than other types of banks. It also found stock or publicly traded banks, as well as the extent of overall foreign bank presence in a respective banking industry, to be associated with relatively better performance.

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Notes

  1. For further insight on the development and banking challenges in the MENA region, see Yousef (2004), Abed and Davoodi (2003), http://www.marketresearch.com/product/display.asp?productid=1532336andg=1.

  2. The revised sample is an unbalanced panel data, as we did not have consistent information for some of the banks throughout the sample period. We were unable to find enough information about missing data in certain years. In some cases it was due to merger or acquisitions. In other instances the bank information were not reported in BankScope but were collected by contacting the bank or taking information from their websites which did not report complete information during our sample period. We created a dummy variable for these missing banks in our data set, and as a robustness test we brought this dummy variable as an additional independent variable in our regression estimations. It did not turn out to be a significant variable and importantly, it did not change the coefficients and the statistical significance levels of our key-focused variables in any significant way. We also traced banks with no missing information across sample years and created a panel data sample and the new estimations were still consistent with the reported results on key variables.

  3. If the ownership percentages in the data did not add to 100%, we relied on the available ownership characteristics – private, foreign, government – and made judgments on the residual percentage for which information was missing. We attributed that to the largest category of ownership reported and are available.

  4. The data available in BankScope reveal that the actual number of Islamic banks in our sample countries is very limited. Except for Iran, these banks constitute a very small component of the banking assets in each respective country. In 2002, the data for Islamic banks reported in BankScope were limited to 14 institutions (see Hassan and Bashir, 2005). A number of additional Islamic banks reported to BankScope in 2005 and 2006, however these additional numbers were negligible.

  5. It is sometime argued that government banks are not always motivated by profit with regard certain goals (such as employment or funding for social project), therefore it would be misleading to use the same indicators to evaluate the performance of state versus private profit maximizing banks if one does not take into consideration the supposed positive externalities of state-owned banks (Smith and Trebilcock, 2001). While such arguments have some validity, however, in the last two decades more and more of public sector enterprises in the region as well as everywhere in the emerging markets are being reorganized along the principles of private businesses. In many cases, such transformations have been prompted by the ineffectiveness of many SOEs to foster their intended social benefits (Smith and Trebilcock, 2001).

  6. Additional estimations, not reported in the text, reveal that the relative importance of the foreign ownership dummy (FOREIGN) variable is even more significant affecting performance of banks when the overall extent of foreign ownership share (FSHARE) in the country is high. Such evidence is operationalized by considering an interactive variable, FOREIGN*FSHARE.

  7. If we consider the per capita GDP (before taking logarithm), the range is between $993 and $18,896.

  8. Our reported results on efficiency in the text are based on a common frontier controlled for country and time differences. As mentioned, we have also estimated additional efficiency scores following different types of estimation adjustments, for example the rank-based estimations by Berger et al. (2004) in the multi-country context and the scores reported by the methods used by Miller and Parkhe (2002) which adjust for country differences. We have also estimated X-efficiency scores where the frontiers were based on each country rather than a common frontier as reported in the text. In some cases, it was not possible to estimate using country-level frontiers due to lack of sample size needed for estimating a translog function model with several parameters for each country. We could successfully estimate X-efficiency scores for 10 of the 17 sample countries: Bahrain, Egypt, Israel, Jordan, Lebanon, Morocco, Saudi Arabia, Tunisia, Turkey, and United Arab Emirates. Given that the results of these different estimation techniques were not qualitatively different than the efficiency scores reported in the text, we have kept our focus on the clarity of the ownership–performance relationship rather than providing excess empirical details of different estimation techniques associated with alternative efficiency scores. All estimations that were not explicitly reported in this paper are available upon request. See Appendix for further details on the procedures used in estimating efficiency scores.

  9. Note that multi-collinearities among the independent variables were not a problem – as reported earlier, the Variance Inflation Factor (VIF) (the reciprocal of tolerance, which is defined as 1−R 2 for a variable with respect to all other independent variables in the model) values associated with the variables were well below the acceptable threshold value of 10. We estimated several different combinations of control variables and in one of the models we only added the size variable (LASSET) as the control variable. In addition, we have discarded variables that were highly correlated with other independent variables in estimating alternative regression models. The economic and statistical significance of our key-focused variables, that is the ownership and organizational variables, did not change to an extent that required separate reporting. Therefore, we simply report the estimations that used all control variables in the regressions.

  10. Given the similarity of results with dependent variables ROA and ROE and in order to maintain brevity, we do not report the ROE-based estimations in the paper separately. Results are available upon request.

  11. FSHARE is strongly significant without controlling for any other ownership variable in the estimation. For brevity, we report this hypotheses while controlling for CFOREIGN, FOREIGN, and GOVERNMENT variables.

  12. If we considered a continuous variable for foreign ownership and retained all banks’ observations in our estimations (including zero foreign-owned banks), we still found positive relationship between ownership and performance, but the parameters were not statistically significant, or were only marginally significant, in the case of ROA. That significance level did not exist when we added the country dummy variables in the estimation. But if we took the subsample of banks with majority foreign ownership only (n=686), we found that higher the foreign ownership, higher was the performance in two of the three performance equations. However, the statistical significance of the continuous variable (foreign ownership percentage) was still very weak and it was significant only at 10% level in some of the equations. These additional tests reveal that majority foreign ownership did matter. But having an ownership more than 50% (eg, 75% foreign ownership) does not necessarily provide any significantly difference in bank performance in our sample.

  13. We have also estimated additional regressions where the sample was limited only to private foreign and domestic banks. In these estimations based on a sample of 1,247 observations, the STOCK_BANK variable showed a positive and statistically significant impact at least at the 10% level in all estimations. Later, we restricted the sample to private domestic banks only and found the STOCK_BANK to be significant at the 5% significance level based on 561bank observations.

  14. Given that some of the control variables were explicitly or implicitly associated with calculating the dependent variable PEFF, it was better to consider them as correlates and investigate their potential association with efficiency rather than considering them as factors determining the variability of efficiency scores (Mester, 2003). Also, see Kumbhakar and Lovell (2000, Chapter 7) on the advantages and disadvantages associated with the incorporation of exogenous influences on efficiency scores.

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Acknowledgements

This work has benefited from a financial grant from the Economic Research Forum. The contents and recommendations do not necessarily reflect the views of the Economic Research Forum. Usual caveat applies.

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  1. Long Island University – C.W.Post, 720 Northern Blvd. Brookville, New York, 11548-1300, USA

    Nada Kobeissi

  2. Johns Hopkins University, 10 N. Charles St., Baltimore, 21201, MD, USA

    Xian Sun

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APPENDIX

APPENDIX

Profit X-efficiency

There are several methodologies used to measure bank efficiency. None of them have clear advantage over the other. The key differences among the various approaches are associated with the assumptions of the efficient frontier. There are three prominent parametric approaches in the literature: Stochastic frontier approach (SFA) (Berger and Mester, 1997; Miller and Parkhe, 2002), Thick frontier approach (Berger and Humphrey, 1994), and distribution free approach (DeYoung, 1998). All these approaches use a cost, profit, or production functional form which depicts the productivity or efficiency with respect to profit or cost associated with a given combinations of outputs and inputs and allow for random error.

The SFA X-efficiency model – PEFF in this paper – is based on a methodology originally developed by Aigner et al., (1977). It allows one to calculate a measure of cost (or profit) efficiency for each sample institution (see Kumbhakar and Lovell (2000) for more extensive details on this methodology). The stochastic frontier function to be estimated, for example a maximum profit or a minimum cost frontier, incorporates a two-component error structure. One component is a controllable factor and the other is a random uncontrollable component. Below is a brief description of the SFA methodology.

For the ith producer in the tth time period, we observe

with i=1, …, N and t=1, …, S, where TP it (TC it ) represents the firm's total profit (total cost), Y it represents the various bank outputs or products and services, P it represents the prices of inputs and ɛ it represents a random disturbance term which allows the cost (profit) function to vary stochastically, that is it captures the fact that there is uncertainty regarding the level of total profit or cost that will be incurred for given levels of production. Decomposing the error term yields,

with i=1, …, N and t=1, …, S, where v it 's represent random uncontrollable factors by the management that affect total profit or costs. The u it 's, represent the controllable components. The efficiency score is produced using the Jondrow et al. (1982) method.

A commonly used translog functional form is used to estimate the profit or cost measures of the banks.

The general form of the translog function is defined as

which in this paper assumes that banks earn profit (or incur cost) by producing various bank outputs or products and services – loan, investment, deposits, and other assets. P it represents the prices of inputs used by the bank in the production of these products. The inputs are price of labor (employee expenses to number of employees), price of capital (office expenses to fixed assets), and cost of funds (interest expenses to total deposits). In estimating the profit frontier, we use a non-standard specification that has been applied to banking data following Berger et al. (1996). In a ‘standard’ approach to estimate a profit function, markets are assumed perfectly competitive where profit is a function of output prices and input quantities. The ‘non-standard’ function assumes that banks have market power, and profits are specified as a function of input prices and output quantities. This approach is popular, as it avoids the use of output price data which is difficult to obtain. Furthermore, following other papers in the literature, we add a constant sum to profit for all banks in the sample to avoid having negative net profits in any observation. This makes all profit numbers positive and allows us to take logarithms of all profit function variables. With respect to PEFF, a best-practice efficient bank will have a maximum score of one. Therefore, the more efficient a bank is, the closer to one would be its PEFF score.

The level of PEFF of a bank is determined by comparing its actual costs to the best-practice maximum profit to produce the same output under the same conditions using estimates of the efficiency factor ln u, which is disentangled from the estimated non-standard profit function residual using some distributional assumptions (Berger and Mester, 1997).

Alternative estimations using rank (as outlined in footnote 8), we employ the efficiency rank, for which only the ordering of the residuals are used assuming they are in the same order as the ln u. We consider that the bank with the lowest profit function residual is the least efficient and the one with the highest residual is the most efficient. We create a rank ordering of the banks in each year within a nation based on the residuals. The ranks are then converted to a uniform scale over [0, 1] using the formula (order it −1)/(n t −1), where order it is the place in descending order of the ith bank in the tth year in terms of its residual and n t is the number of banks in the nation in year t. In addition, once the simple efficiency scores we also create country adjusted normalized scores, following Miller and Parkhe (2002). We normalize the X-efficiency scores – based on individual country-based frontier estimation – in order to accommodate inter-country differences in accounting standards, efficient frontiers, tax rates, and interest rates. This creates an index or rank, which takes into account the relative differences of X-efficiency scores across firms which is comparable across nations. The formula used is

where N−EFFij is the normalized X-efficiency score of bank i in country j, EFFij is the X-efficiency score of bank i in country j, EFF* j is the mean X-efficiency in country j, and σj is the standard deviation of X-efficiency scores in country j. The best-practicing banks have the highest normalized X-efficiency scores in their respective host countries. Moreover, a normalized X-efficiency score, which is less (greater) than zero means that the bank group has below (above) average X-efficiency in a particular environment.

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Kobeissi, N., Sun, X. Ownership Structure and Bank Performance: Evidence from the Middle East and North Africa Region. Comp Econ Stud 52, 287–323 (2010). https://doi.org/10.1057/ces.2010.10

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