Bank Ownership and Efficiency

Article excerpt

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.

OVER THE YEARS, a considerable literature has developed on the relationship between industrial ownership and performance. Two clear messages from that literature are (i) that ownership can be important; and (ii) that it is helpful to view the issue in the context of the principal-agent framework and public choice theory. However, while that literature has provided considerable understanding of the effects of ownership, its primary focus is on nonfinancial firms. This paper shifts the focus to banks and to the question of whether the ownership structure of banks influences their economic behavior. In particular, the paper attempts to evaluate whether cost and profit inefficiencies and technical change are related to bank ownership structures. The empirical work is carried out in the context of the German banking market which has a broad mix of ownership forms--private, public, and mutual.

Reasons for different ownership forms leading to different efficiency levels have been extensively explored in the literature; and the dominant model to consider the effect of ownership utilizes the principal agent framework and public choice theory to highlight the importance of management being constrained by capital market discipline. The theoretical argument is straightforward: a lack of capital market discipline weakens owners' control over management, making management freer to pursue its own agenda, and giving it fewer incentives to be efficient. However, whilst extensive empirical evidence provides some support for the hypothesis that public enterprises perform less efficiently than private enterprises, it should be noted that this theoretical argument is not without its critics.(1) Also, it should be stressed that the empirical work has largely concentrated on the simple dichotomy of privately owned and publicly owned firms, particularly nonfinancial firms, and particularly in noncompetitive environments.(2)

In turning to the banking industry, it is clear that not only is the industry highly competitive, but also that in many countries mutual ownership must be considered alongside that of public and private ownership forms. In addition, there is relatively little guidance from the literature about the relative efficiency of these three ownership forms of financial firms. One way forward is to ask the more general question of why management may not be minimizing their costs of production (in each of the ownership forms). This question is, of course, central to the well-established literature on X-inefficiency (Leibenstein 1966) and technical inefficiency (Farrell 1957)--a literature that emphasizes the role of environmental pressure in weakening management's incentive to be efficient. High levels of competition in a firm's market is a classic example of a high-intensity environmental pressure that should strengthen management's incentive to be efficient.(3)

In the specific case of the banking industry, the separation of ownership from control is common to all three ownership forms. However, the lack of capital market discipline, common to mutual and public ownership, may indicate that management in these banks experience a lower intensity of environmental pressure and therefore may operate less efficiently than privately owned banks. …