Academic journal article IBAR

Examining the Profit-Efficiency Relationship in Irish Credit Institutions

Academic journal article IBAR

Examining the Profit-Efficiency Relationship in Irish Credit Institutions

Article excerpt

Brian M. Lucey*

Introduction

The aim of this paper is twofold, first to present evidence regarding the returns earned by depository credit institutions in Ireland and second, the bulk of the paper, to look at the possible theories that might be hypothesized to explain the profitability and profit levels of these bodies. A more complete explanation of the profit behaviour of Irish depository credit institutions than is provided here would require a great deal more information - information possessed by the regulatory authorities, and yet to be made available.

The Credit Institutions Sector in Ireland

The main institutions operating in the credit sector in Ireland are Licensed Banks, Building Societies (agencies which have historically operated as mortgage lenders) and a number of state sponsored specialist banks. All of these sectors are represented in this study, but not fully. Since 1987, with the creation of an International financial Services Centre in Dublin, there has been an increasing international banking presence in the Irish banking sector. While these banks are domiciled in Ireland, and are licensed by and appear in the data of, the Central Bank of Ireland, they are not active in the domestic market. Only non resident transactions are allowable for the extensive tax based incentives. consequently, the market of analysis here, the loan and deposit market, relates to the resident transactions of resident offices of Irish licensed banks and building societies. Within this sector, the main overlap between the banks ( including the state sponsored credit institutions) and the Building Societies has been the mortgage market. However, the 6 building societies analysed here account for an aggregate mortgage loan equivalent to twice that of the banking sector, as of 1993, the end of the period of analysis. It was only since 1990, over midway through the time period of analysis here, that the banks begun to make substantial inroads into the mortgage market.

The data availability varies according to the status of the banks. For those banks which have PLC status, there are of course audited and publicly available accounts. This is only a small number of banks. Those that operate on the basis of a private company or are branches of other EU banks are required merely to display their aggregate balance sheet data. None of these banks are included. However, the major banks are all either PLC or are voluntary publishers of substantial data. Accordingly, these are the banks included in the analysis, as they generally tend to be those that are operating in the resident market.

For building societies, there is a requirement to publish, through the regulatory agency, the annual profit/loss and balance sheet data. The profit histories of the sectors have also diverged. Figure 1, above, shows the average return on assets achieved by banks and by building societies over the period. This paper attempts to find explanations from the industrial economics literature for the return on assets performance of these institutions.

Four Theories in Search of an Explanation

This section of the paper looks at variations on the traditional Structure - Conduct Performance (SCP) and Relative Efficiency RE theories. The objective here is not to provide a comprehensive analysis of the area but instead to outline the theories and show the microeconomic underpinnings of the work to be carried out later. A good analysis of the SCP paradigm is to be found in Hannan ( 1991) Interested readers are referred to this for detail. Let us now look at the four main theories to be analysed.

The Relative Efficiency (RE) theory-This states that market power and profitability are functions of efficiency (and the realisation of economies) differences across firms. The more efficient the firm is the lower cost of production is for it and therefore the greater will be its market power and profitability. …

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