Bank Control, Capital Allocation, and Economic Performance Randall Morck University of Alberta M. De

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Bank Control, Capital Allocation, and Economic
PerformanceRandall MorckUniversity of
AlbertaM. Deniz YavuzArizona State
UniversityBernard YeungNUS
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Financial System Efficiency

• Is the control structure of the banking system
  related to capital allocation efficiency and
  economic outcomes?
• family, state, and independent control of banks
• Result
• Fraction of banks control by business families is
  correlated with
• less efficient allocation of capital,
• more non-performing loans,
• more bank crisis,
• more macro volatility, and
• slower growth
• Opposite is true for independent bank control
• State control is correlated only with less
  efficient allocation of capital and more NPL

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Motivation Type of wealth and growth
The Cross-Country Relationship Between Growth in
Real Per Capita GDP and Capital Ownership,
Controlling for Current per Capita Income,
Capital Investment Rate, and Level of Education
(from Morck, Stangeland, and Yeung, 2000)
H1 includes only the wealth of billionaires known
positively to be heirs, politicians or
politicians relations. H2 also includes the
wealth of billionaires who are probably heirs.
H3 includes H1 plus fortunes jointly controlled
by a founder and his heirs. H4 includes all the
above. H5 through H8 are analogous to H, H2, H3
and H4 but do not include politician billionaires
and their relations.
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Why such results?

• Around the world firms have controlling owners,
  LLSV 1999
• a large fraction of these dominant owners are
  wealthy families.
• Via pyramids, etc., these wealthy families gain
  control of a large fraction of corporations and
  corporate assets
• more micro efficiency among family controlled
  set of firms
• Overcome inefficiency in using the market due
  to information asymmetry and regulatory/bureaucrat
  ic burdens
• what is good for a set of firms can be bad for
  the economy
• Intrinsic results due to biased resources
  allocations
• Economic entrench rent seeking
• Lobby for entry barriers (Fogel 2006)
• Capture the capital market

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Why capture the financial market?

• Developed financial markets encourage creative
  destruction and promote competition.
  (Schumpeter, 1942)
• Not always in the best interest of
  elite/powerful-families to promote efficient
  financial systems.
• Capture the institutional development save
  capitalism from capitalist
• Morck, Stangeland, Yeung, 2000, 2002, 2005 Rajan
  and Zingales 2003, 2004.Perotti and Vorage 2008
  etc
• Morck et al 2002, Rajan and Zingales 2003
• An economy may have no stock markets, but, cannot
  do without banks
• Capturing the banking system
• Family bank ownership was first looked at Caprio
  et al JEI 2007

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Create more curiosity

• The positive and negative consequences of family
  control of banks
• Efficiency view (mostly applies at the micro
  level)
• Interest alignment and mitigating information
  asymmetry (Diamond 1984 Hoshi et al. 1991
  Khanna et al. 2000 Fisman Khanna 2004 Almeida
  Wolfenzon 2006 etc)
• Entrenchment view (has macro level implications)
• Family banks may favor related firms (see, e.g.,
  La Porta et al. 2003), limit capital to potential
  competitors,
• ATM Engage in risk shifting, government bails
  out (see, e.g., La Porta et al. 2003).
• Add state ownership
• LLSV, Government Ownership of Banks, JFE, 2002

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Empirical investigation of .

• Relationship between bank ownership structure and
• Efficiency in capital allocation
• NPL, Bank Crisis
• Macro Volatility
• Growth
• Efficiency vs. economic entrenchment?

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Dataset and Ownership Variables

• Starting sample is the 10 largest banks in 44
  countries (Banker 2001).
• Caprio et al. (2007) provide control structure of
  244 public banks.
• We add the ownership structure of private banks
  (total 318 banks).
• Most of the data come from Bankscope 2001.
• Controlling shareholder largest ultimate
  shareholder with stake 10.
• Controlling classifications State, family,
  independent.
• Bank Control variables Fraction of the banking
  system controlled by state, family and
  independent banks weighted by total loans.
• Same if weighted by assets

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Measures of Capital Allocation Efficiency

• Elasticity of capital spending with respect to
  the value added, by industry.
• Version 1 UNIDO (UN General Industrial
  Statistics) Data for 1993 through 2003.
• Version 2 UNIDO (UN General Industrial
  Statistics) Data for 1963 through 2003.

as in Wurgler (2000)
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Data and econometric problems

• Hold your questions on
• Data timing (contemporary data on ownership
  (2001-2003) and target dependent variables (1993
  2003)
• Causality?
• Endogeneity?
• Mis-classification of ownership due to timing?
• Etc.
• Will deal with them after providing a snap shot
  of the results

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Other Critical variables

• Nonperforming loans /Total loans outstanding.
• WDI site World Development Indicators (World
  Bank)
• Average between 1993 and 2003.

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Other Critical variables

• Macro variables Beck et al 2003, Beck et al
  2000, Penn world Tables,
• Real per capita GDP growth
• 1993 through 2003 and 1963 to 2003
• Estimate as the time trend
• TFP Growth 1993-2003
• a 30
• using logarithms of first differences for Y, K,
  and L to estimate the rate of change of the
  parameter A TFP growth
• Capital accumulation Beck et al (2000), 1993 -
  2003
• d 7
• 1964 as the starting points
• Forward iteration to get capital stocks
• Calculate the rate of change
• Economic stability, 1993 - 2003

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Snap shot
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So

• Family ownership of banks is associated with
• Less allocation efficiency
• more NPL and bank crisis,
• more macro volatility
• slower growth
• Opposite result for independently owned banks
• State ownership is only associated with
• Less allocation efficiency
• Implications
• Economic entrenchment, not efficiency argument
• Previous results on the effect of state owned
  bank may need refinement

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Data Issues

• Contemporary data ownership and the target
  variables
• Should use lagged bank control variables
• Cannot get them
• May not be that important if control structure
  changes slowly.
• Only 14 banks (4.4 of the total 318) switch
  category between 2001-2007.
• Still, many bank privatizations between 1993-2001
  from Megginson (2004).
• 16 banks change control.
• Beware of the Chen factor
• incompetent and corrupt government passes the
  control of state owned banks to rich families
• Result corrupt and incompetent government
• Do the data both way
• Move all family owned back to state owned
• Or, like we did before, keep them as family owned
• Identical results
• So, the mis-classification not a factor

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Data Limitations and Endogeneity

• Bank control is endogenous
• Precisely because of expecting poor resource
  allocations and thus own banks?
• To address this concern we use time invariant
  instrumental variables
• legal origin (La Porta et al. 1998, 2008)
  financial development
• religion (Stulz and Williamson, 2003) credit
  rights
• latitude (Hall and Jones, 1999 Acemoglu et al.
  2001) Western influence
• Use them to predict ownership (Tobit)
• French legal origin family ownership most
  prevalent
• Protestant countries independently owned banks
  most prevalent
• Highest latitude independently owned banks most
  prevalent
• Instrumental variable result table 7
• Plead guilty legal origin and religion are
  exogenous, but, they may have a relationship with
  our target performance variables

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Other Robustness Tests

• Different Ways of Constructing Bank Control
  Variables
• Calculate bank control variables by using total
  assets as weights.
• Control assumed at 15 or 20 instead of 10.
• Ignoring countries with number of banks lt 3.
• Alternative Regressions
• Regression robust to outliers.
• Weighted least squares regressions.
• Correcting for arbitrary heteroscedasticity vs
  simple OLS.
• Alternative right hand side variables
• Bank crisis Dell Ariccia et al 2008
• Deposit runs, bank holidays or nationalization,
  fiscal cost of bank rescues gt 2 GDP, NPL gt 10
  bank assets
• 1993 - 2003

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Robustness in interpretation

• Is the claim that the results support economics
  entrenchment robust?
• Paris Hilton effect?
• Step one, improve the bank ownership data
• Get ownership data to identify families that do
  and do not own other business
• Orbis to identify other business owned
• Use also the internet
• Reclassify those with no known other business
  as independent
• Same result

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• Step two
• Dig up alternative stories
• Incompetent family?
• Find that family ownership is highly related to
  entry barriers
• Number of procedures,
• Time and costs to set up a firm
• Aside family bank ownership is related to more
  income inequality and a smaller middle class too

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Conclusion

• Control of the banking system is important for
  efficiency of capital allocation.
• Family and state control over banks have
  similarly economically significant and negative
  implications for capital allocation efficiency.
• However, family control is also correlated with
  lower economic growth, elevated macroeconomic
  instability, and more income inequality.

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• Implication
• Do not let families capture the banking system!
• Multiple governments (e.g., Singapore, Canada)
  actually stipulate against bank owning families
  from holding non-banking business
• "Measures to separate financial and non-financial
  activities of banking groups Speech by DPM Lee
  Hsien Loong At The Association Of Banks in
  Singapore (ABS) 21 June 2000
• with banking and non-banking activities
  inter-meshed within a conglomerate, there will be
  a strong tendency to stretch any safety net
  intended for the banking system also to cover
  non-bank operations in the group.

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• Why is family ownership of banks common?
• Political Economy Outcome.
• Rajan and Zingales (2004) Morck, Wolfenzon,
  Yeung(2005) Stulz (2005) Perotti and
  Volpin(2007) Haber and Perotti(2008) Acemoglu,
  Johnson and Robinson (2008).
• Families are the highest bidders because their
  efficiency gains are the highest.

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State Control and Capital Allocation Efficiency
Private

• State control of banks versus propensity of
  capital to flow to highest value-added industries

Capital allocation efficiency
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Independent Banks Capital Allocation Efficiency

• Unaffiliated banks versus propensity of capital
  to flow to highest value-added industries

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Family Banks Capital Allocation Efficiency

• Business family control of banks versus
  propensity of capital to flow to highest
  value-added industries