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5 th Annual Banking Research Conference - FDIC

5 th Annual Banking Research Conference - FDIC. Competition , efficiency and agency cost s in European banking An analysis of charter values Olivier De Jonghe Rudi Vander Vennet Ghent University. Motivation. Deregulation Second banking directive Mergers & acquisitions

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5 th Annual Banking Research Conference - FDIC

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  1. 5th Annual Banking Research Conference- FDIC Competition, efficiency and agency costs in European banking An analysis of charter values Olivier De Jonghe Rudi Vander Vennet Ghent University

  2. Motivation • Deregulation • Second banking directive • Mergers & acquisitions • Banks versus financial markets • Economic and monetary integration • Capital adequacy rules • Market structure • Competition • Efficiency • Capital • Profitability • Risk

  3. Motivation

  4. Motivation • Market structure • Competition • Efficiency • Capital • Profitability / Risk Effect on bank charter value  charter value =  the present value of the stream of profits that a firm is expected to earn as a going concern   franchise or charter value: return and risk in the long run  construction of a market-based performance measure: Tobin’s Q, noise adjusted

  5. Performance measure: QNA • Concept: QNA(based on Market Value Efficiency) • Definition:Market value inefficiency measures the shortfall of a bank’s market value from its highest potential market value as a proportion of the bank’s book-value investment in its assets • Parametric (Stochastic Frontier Analysis), translog (Hughes, Lang, Mester, Moon and Pagano, 2003 and 2004)

  6. Some summary statistics

  7. Hypotheses: Competition and Efficiency • Structure-Conduct-Performance: concentration • Relative Market Power: market share • X-Efficiency: management skills or production technologies • Scale-Efficiency: scale-related cost/revenue advantages • Implications for merger and antitrust policy • Hypotheses are interrelated Solution: reduced form (Berger,1995) Stigler (1964), Demsetz (1973), Berger (1995), Vander Vennet (2002)

  8. Hypotheses: Competition and Efficiency Bank profitabilityAccounting profits (ROA, ROE) • Subject to noise (tax distortions, accounting practices,earnings management) • Short-run performance (versus long-run equilibrium) • Backward looking >< sustainable rents Solution: use market value of a listed bank QNA Test Structure-Conduct-Performance, Relative Market Power, Efficiency paradigms simultaneously in a coherent forward-looking framework based on stock market values

  9. The role of capital Bank capital serves different purposes • Capital structure is regulated to reduce risk-taking • Capital may reduce funding costs (depositor discipline) • Capital as a signal of private information about future cash flows =>Capital affects bank charter value positively • Capital is inversely related to Leverage • Separation of ownership and control (principal-agent problem) • Value maximization  Utility maximization • Choice of capital structure may mitigate agency costs, due to alignment of interests (Berger and Bonaccorsi di Patti, 2003) =>Leverage affects bank charter value positively

  10. The Dataset • 255 listed banks • Large and medium-sized • All types: retail banks, commercial banks, savings banks, financial conglomerates • EU15 + Norway+ Switzerland • 1995-2003 (unbalanced) • Balance Sheet and Income StatementBankscope • Stock market data Datastream

  11. Market share is a long-term generator of superior future profits • Concentration plays no significant role • Leverage plays an important role in mitigating agency costs • Operational efficiency is strongly valued by stock market investors • Diseconomies of scale Baseline equation: results

  12. Robustness • Competition • Interaction between Market Share and HHI • negative and significant • Contestability: Foreign presence and importance • negative and insignificant • Concentration Ratio 5 in stead of HHI • Size classes • Leverage • Tier 1 Capital ratio • Charter value and capital ratio: endogeneity issue • Capital ratio classes  All conclusions remain valid: RMP X-Efficiency Leverage

  13. Robustness: Control variables • Diversification • Diversification benefit • Profitability • Accounting -and market-based variables • Positive effect • Risk • Accounting -and market-based variables • Negative effect • Regulation and supervision • Worldbank, KKZ, Heritage data • Low variation in sample • Not significant • Macro-environment • GDP, Inflation, LT-Interest rate, Stock Market index • Significant (if no time dummies) Bank-level Country-level All conclusions from baseline remain valid

  14. Conclusions • Using a market-based forward looking measure of bank performance, we find that: • Market share is a long-term generator of superior future profits • Concentration has no significant effect  Relative market power dominates structure! • Operational efficiency in banking is strongly valued by stock market investors • Market value diseconomies of scale  X-Efficiency is far more important than Scale-Efficiency • Capital plays a role in mitigating agency costs  Leverage/Creditworthiness trade-off • Basel 2, Pillar 3: use market mechanisms for prudential supervision • QNA (market values) are a useful indicator • Insight into building blocks of charter value  financial stability • Lack of bank market integration in EU even among the largest (listed) banks

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