The role of the foreign banks in the 5 EU member states/Uzsienio banku vaidmens 5 Europos sajungos valstybese tyrimas.
Festic, Mejra
1. Introduction
Most banks in the EU's New Member States (NMS) have been
privatised with foreign strategic investors. In most New EU Member
States (NMS), majority foreign ownership of banks was allowed after
major banking and economic crises in the 90.ties. Banking systems had
become unstable due to the lack of hard budget constrains and ordinary
risk intermediation. Some recent empirical evidence found that foreign
ownership of the banking sector improved restructuring in the NMS
(regarding the benefits like improving efficiency in intermediation,
introducing hard budget constraints, improving risk management,
corporate governance etc.).
On the one hand, globalization provides banks with more
opportunities for the diversification of their business strategies (thus
reducing the exposure of banks to particular markets) and also with a
larger risk diversification, which is arguably an advantage of
globalization. On the other hand, the low cost of entry to foreign
markets intensifies competition among banks (and other financial agents)
and consequently increases their exposure to the risks of international
financial shocks.
The relationship between the market share of foreign banks in host
economies and the impact of ownership on loan supply has been analyzed
during the period of the financial crisis. In our estimates for the
Baltic States, Romania and Bulgaria (these economies have been chosen
due to a high share of foreign banks and their relative quick entrance
in these eastern markets), an evidence for the foreign banks
pro-cyclical reaction to changes in the host country's
macroeconomic environment has been tried to find. When economic growth
in host countries decelerates, the foreign banks in the host country
might attempt to stabilize credit supply and may also be encouraged to
decelerate the credit supply growth due to increased bad loan
performance.
The structure of the paper is as follows: The characteristics of
the banking sector and macro environment in the Baltic States, Romania
and Bulgaria are summarized in the second chapter. In the third chapter,
an overview of empirical literature--regarding the stability of credit
supply and the role of foreign banks in host economies--is presented. In
the fourth chapter, theoretical background, data explanation,
methodology of empirical analysis and results are explained. The
implications of the empirical analysis are revisited in the conclusion.
2. The banking sector and the macro environment of the Baltic
States, Romania and Bulgaria
The banking sectors in the analysed economies--having undergone
similar structural changes over a relatively short period of time--share
some common structural characteristics. Two of the defining
characteristics in banking sectors are a (considerable) foreign presence
with a relatively high concentration. These economies have been chosen
due to a high share of foreign banks and their relative quick entrance
in these eastern European markets (see Table 1). Foreign banks have
significantly contributed to the transformation of the banking sector in
these economies, owing partly to the increasing integration of EU
banking sectors.
The economies used different strategies for privatization in the
90.ties. While some economies went for the quick sale of their banks to
foreign investors, others combined public offerings with management
buyouts and some placements with foreign strategic investors (see also:
Festic et al. 2010).
While the Estonian and Lithuanian banking sector became truly
consolidated, Latvia has remained the exception, with a number of
smaller niche banks oriented towards the Russian market. Estonia
privatized its last remaining large state-owned banks into foreign
hands. The Lithuanian banking sector is considerably smaller and its
effectiveness has been lower than in Estonia or Latvia due to state
ownership, which lasted longer in Lithuania, and due to the fact that
the banks are too risk-averse (Adahl 2006). In Bulgaria and Romania,
sustained economic recovery and foreign ownership of the banking sector
have increased competition and boosted confidence. Banks have also
enjoyed adequate profitability (profits were also supported by continued
cost-containment) and banks have benefited from the enhancing of asset
quality, which has allowed for reduced provisioning at the end of the
90.ties and after 2000 till the financial crisis in 2007.
Already in the aftermath of the Russian crisis at the end of the
90s, Estonia and Latvia experienced very rapid loan growth between
2000-2002, while Lithuania lagged somewhat behind. The acceleration in
domestic lending--in particular to households--was fuelled by strongly
increasing foreign liabilities, while the corporate sector gained better
access to alternative financing sources in the Baltics. Many Baltic
corporations are likely to find financing elsewhere: either from foreign
investors or in European financial markets. Credit growth to the
corporate sector lagged behind loans to households, which can be partly
explained by the fact that an important share of investment by the
non-financial corporate sector was financed by retained earnings,
inter-company loans and foreign capital, including credits from banks in
other countries and FDI in the period from 2002 to 2006. From 1999-2002
more than half of all loans were granted in foreign currencies and the
majority in Euros (Adahl 2006) (1).
In the Baltics, signals of economic overheating with a medium-term
risk of a hard landing were already evident in 2007. The deceleration of
economic growth in the second half of 2008 was mostly due to a supply
side shock and the unwinding of the boom in the EU economies in 2008.
Looking at the structure of output growth, increasing domestic demand
also played a prominent role, since net exports were negatively affected
by sluggish economic activity in Europe. Structural dependence on
external financing--which is in part a by-product of the effect of low
levels of internal savings--have led to large current account deficits
and financial instability in the Baltics.
In Romania, the cautious approach of banks to lending after the
banking crisis in the late 90s and their preference for doing low-risk
business led to a crowding-out of the private sector and to a low share
of private sector loans to GDP. In Romania, domestic credits have
primarily been financed by domestic deposits and external sources. The
banks' ability to fund loan expansion was boosted by strong capital
inflows through the banking system, amid high global liquidity and low
interest rates (Naraidoo et al. 2008). In Bulgaria, banks are
predominantly deposit financed and banking sector's assets have
been increasingly dominated by claims on the domestic sector, while
securities and repurchasing agreements continue to play a subordinate
role. In light of the credit boom Bulgarian National Banks introduced
measures in order to decrease credit growth rate in the period from
2004-2006 (Ess et al. 2006).
Progress in the implementation of reforms has been an important
driver for Bulgaria in achieving macroeconomic stability and
productivity improvements. Despite the sustainable strengthening of
export growth, the gap between the positive contributions of domestic
demand and the negative contributions of net exports has called for
strengthening the supply side and improving competitiveness in the
period between 2000 and 2006. Romania's economy grew strongly on
the back of strong household spending, accelerating investment growth
and FDI. The credit-led domestic demand growth was accompanied by
macroeconomic imbalances like overleveraged households and external
imbalances. Buoyant growth in Romania rode on the back of robust
consumption spending together with accelerating investments (as a result
of reconstruction activities and a large number of programmes
co-financed by the EU) in the period between 2000 and 2006.
Structural dependence on external financing in the analysed
economies (see Table 1)--which is in part a by-product of the effect of
the low levels of internal saving--have led to large current account
deficits and financial instability in recent years (between 2000 and
2007). The huge current account deficits have been financed by a steady
increase in the net-inflow of FDI, net portfolio investment and foreign
currency loans. Credit growth had been largely foreign-funded and loans
to the private sector grew at a rapid pace in the period from 2002-2007
(2).
Despite good foreign direct investment coverage and the recovery of
export growth, the sustainability of the external imbalance has been an
issue of concern in 2008 and 2009 (Thangavelu et al. 2009). Broad-based
contraction in economic activity, accompanied by a strong fall-off in
exports as well as imports, could already be seen at the end of 2007,
and continued through 2008. This trend remained in 2009 and 2010.
Given the dependency of the local economies on external funding
(mainly in the form of international private debt and foreign direct
investment) and the drying-up of capital inflows meant a constraint on
growth after 2007. The international liquidity crisis has been reflected
in a drying up of international interbank and debt markets and
consequently in the higher cost of external funding. As part of the
global effort to support the banking system through the crisis, most
European governments have been offering support schemes for their local
banks, to help increase capital ratios and to restore confidence in the
interbank market in the period from 2007 to 2010.
The rising concerns about credit quality are behind such a credit
crunch, rather than liquidity concerns. Uncertainty over income and
employment prospects, coupled with the tightening of credit standards,
has been responsible for a visible adjustment in household sector
behaviour, resulting in a weakening dynamic of consumption expenditure
and borrowing in the period from 2008 till 2011. Lending activity in the
corporate sector has also remained subdued in the period from 2008 till
2010 and lending growth is expected to remain tied to deposit generation
capacity in Romania and Bulgaria, except in the Baltics.
The deterioration in the economic outlook after 2007 resulted in a
substantial increase in the share of distressed banking assets
throughout the region, for both the retail and corporate sector. The
ongoing economic, financial and banking crises are modifying the shape,
structure and functioning of the global banking sector (higher capital
ratios, deleveraging, de-risking, efficiency and cost cutting etc.).
In the aftermath of the global crisis, the economic environment is
now slowly showing signs of recovery. The driver of the current recovery
is corporate business, as the engine of future growth. Within the
context of high unemployment and low consumption, the retail sector can
only slowly develop its potential. The countries boast attractiveness
and a low risk profile in 2010, while the strongest impact of the crisis
affected the Baltic States, prompting a need to rebalance their growth
model. Thus, the whole CEE region remains a bastion for foreign banks to
exploit future growth opportunities (Shrieves et al. 2010).
3. The overview of empirical literature about the role of foreign
banks
This chapter provides an overview of findings from papers with
regard to questions about how foreign banks affect the operations of
banks in host economies, as well as the influence of foreign banks on
the stability of loan supply in host countries.
Barth et al. (2004) pointed out that banks with oversized direct
state control do not necessarily provide greater stability for loan
volume. The privatization of banks through domestic ownership structures
positively affects the increased efficiency of banking operations while
the effects of potential foreign ownership reflect only over a longer
period of time (Williams, Nguyen 2005). Megginson (2005) stated that the
state as owner exhibits a tendency for lending to preferential
industrial branches and finances projects that provide more social
rather than financial gains; and also stated that foreign co-ownership
reduces the political involvement of banks and increases efficiency.
Consequently, the stability of credit supply is enabled by good credit
portfolio and lower share of non-performing loans (NPL). Mixed ownership
with a foreign partner enables the increase in economic efficiency and
the greater stability of the banking sector, better risk management,
stable supply of loans etc.
Galindo, Micco and Powell (2003) noted that foreign banks can
stabilize loan supply when domestic deposits are in crisis. Similarly,
Martinez Peria, Powell and VladkovaHollar (2005) confirmed that the
demand responsiveness of foreign banks to the specificities of the
host-country environment decreases, by increasing aggregate exposure to
the host country. According to some studies, foreign banks act
stabilizing to the environment of the host country if there are no
shocks in their home country and if they do not draw their liquidity
from the host country's environment. Cabballero and Krishnamurthy
(2003), Galindo et al. (2010) stated that in the case of shocks, foreign
banks can promptly leave the host country, thus reducing their
operations in the local market more than domestic banks, which have a
smaller possibility of portfolio diversification. Weller (2000)
confirmed that the arrival of foreign banks is connected with a lower
loan supply of domestic banks while their lending portfolio quality
improves. De Haas and Lelyveld (2006) stated that the reaction of
domestic and foreign banks to the crisis and economic cycle in Central
and Eastern European countries differed, with the reaction of foreign
banks depending on the health of the parent bank. They confirmed that
domestic banks in Central and Eastern European countries reduced the
volume of their loans more than foreign banks (with the exception of
foreign bank affiliates). It can be argued that a stable loan supply in
times of crisis, when the loan supply of foreign banks acted
counter-cyclically or at least less pro-cyclically than the loan supply
of domestic banks. Arena et al. (2006) analyzed the differences in the
attitude of domestic and foreign banks in a time of crisis and in
relatively calmer periods. Considering the differences in the ownership
structure of banks, weak evidence about the reduced vulnerability of
foreign bank loans to economic terms has been proven. However, these
differences have only been confirmed with banks that have a lower
liquidity of assets and worse capital adequacy. Kamil and Rai (2009)
argued that the liquidity restrictions (in the US monetary market)
reduce cross-border lending and the number of foreign bank affiliates in
host economies.
Cull and Martinez-Peria (2007) claimed that countries with a major
share of foreign banks were confronted with a bigger crisis in
comparison with countries that had a smaller presence of foreign banks.
Even Stiglitz (2002) claimed that financial stability in the time of
globalization and the arrival of foreign banks is questionable. Studies
that confirm better financial and loan supply stability in host
countries--at the time of the arrival of foreign banks in CEE
countries--are incomplete.
4. Empirical analysis: theoretical background, data specification,
methodology, empirical results
4.1. Theoretical background
The influence of domestic and foreign banks on the stability of
loan volume to the private sector can be measured by the share of bad
loans to total assets, the ratio between bank investments and total
assets, crisis and the ownership structure of banks, and the ratio
between the loss of the fair value of derivative financial instruments
and cash flow under the heading of insurance against the loss in
relation to the volume of lending (see Table 2).
Loans and investments represent two competing sources of income;
and a bank manager must decide how to allocate this capital. The sign of
the derivatives variable with respect to loans is positively related to
the market share of the foreign bank. It indicates that a loss on a bank
hedge will cause a retrenchment, whereas an increase prompts the bank to
increase its market share. The investment variable is also consistent
with this reasoning. The negative sign suggests that an increase in a
bank's investments reduces its market share of credit as an
institution shifts funds away from loans into other sources of revenues
and reserves (Galindo et al. 2003). Low bank capitalization can often
lead to the adoption of imprudent lending strategies with direct
implications for banks' loan portfolios, which tend to be heavily
skewed towards high risk projects and non-performing loans (NPL) could
increase; consequently the market share of an individual bank should
decrease (Babihuga 2007). The loan-assets ratio is positively correlated
with banking problems, increasing the NPL ratio and (in)solvency is a
result of a bank's long-term mismanagement (Mannasoo, Mayes 2009).
As well, heterogeneity across economies might prove a different
relationship between asset qualities, market share and the business
cycle (see Table 2).
4.2. Data specification
The relationship between the market share of the foreign banks in
host economies and banking sector variables as a source of determinants
influencing the share of (individual) bank credits relative to the total
loans in the country was analyzed, in order to assess the banking
sector's vulnerability to a financial crisis regarding the
ownership structure, using the panel regression method (4).
The choice of explanatory variables in the model reflects the
evidence provided by the large amount of empirical literature mentioned
above (see Table 2).
The market share of foreign banks in the Baltic States, Romania and
Bulgaria is expressed as bank credits (in billions (bn) of domestic
currency and deflated by the consumer price index) relative to the total
loans of the banking sector in the country (in bn of domestic currency
and deflated by the consumer price index) and utilized for the dependent
variables in our analysis. The five largest foreign banks in individual
economies have been included in our observations.
Originally, the following time series for explanatory variables
were considered: the non-performing loans (NPL) variable (in bn of
domestic currency and deflated by the consumer price index) is expressed
as the share of total assets (in bn of domestic currency and deflated by
the consumer price index). The banks' investment (i.e. in bn of
domestic currency deflated by the consumer price index) is expressed as
a share of the total banking assets (in bn of domestic currency deflated
by the consumer price index). A time dummy that identifies the timing of
the financial crisis and foreign ownership structure were included as
additional explanatory variables. The ratio between cash flow hedges (in
bn of domestic currency, real terms) and the banks' total loans (in
bn of domestic currency, real terms) is used to measure any losses on
derivative positions. The index of the rule of law is used as a rough
measure of creditor protection and as an institutional explanatory
variable. The interaction effect between income level (expressed as
average income per employee) and the business cycle (divided into
categories low, middle and high) was included as an indicator of
pro-cyclicality between the purchasing power and economic cycle.
In order to control for a potential endogeneity problem (as
explained later in the methodology section), several instrumental
variables were employed: a market concentration measure (proxied by the
assets of five foreign banks relative to total banking sector assets,
expressed in bn of domestic currency, in real terms), capital adequacy
(as the share of regulatory capital to risk-weighted assets of the
parent bank, as a rough measure of the quality of regulation and
supervision); the net interest margin (as the ratio between the
accounting value of net interest revenues relative to interest
bearing--total earning--assets, expressed in bn of domestic currency, in
real terms) and the government effectiveness index as an institutional
variable (see also: Kaufmann et al. 2009; Rosenberg, Tirpak 2008).
All the nominal variables expressed in national currencies are
corrected by an individual country's appropriate deflator(s) (using
the second quarter of 2010 as the base) and converted into EUR by using
the exchange rate of the second quarter of 2010.
The internal databases of the BACA (2010), EIPF (2010), quarterly
financial statements of banks, central banks' databases and
Bankscope were used. The quarterly time series were used for the period
from the first quarter of 1999 to the second quarter of 2010, in order
to explain the banks' market share dynamics in the Baltics, Romania
and Bulgaria.
4.3. Methodology
According to the relatively short time series and similarities
between the analyzed economies, a panel regression was decided to use in
order to obtain more information on the analyzed parameters. This method
allows one to control for omitted variables that are persistent over
time and, by including the lags of regressors, potentially alleviate
measurement errors and endogeneity bias. The advantage of the applied
method is that it lowers co-linearity between explanatory variables as
well as dismisses heterogeneous effects.
A contribution to the existing empirical evidence on the impact of
the banks' ownership on credit supply stability was made by
analyzing the model with fixed effects (which controls the impact of
neglected and changing variables among observed countries that are
constant within a time period) and the model with random effects, both
as instrumental variable regressions.
Lutkepohl and Xu (2009) have demonstrated that logarithmic
approximation is only accurate in certain, special cases. Since the
dynamics of some variables (the NPL, investment to asset ratio and
derivatives) are sometimes considerable, this approximation would
produce a significant downward bias in the estimation. Therefore, the
original time series are transformed into differences and expressed as
percentage changes. By using the differences of the variables expressed
as percentage changes, the problem of spurious regression is avoided
(5). Variables are seasonally adjusted by the X-12 ARIMA seasonal
adjustment method on the basis of quarter-on-quarter data. The lag
length selection in the specified model is based on information criteria
(Schwarz, Akaike and Hannan-Quinn). A parsimonious model with four lags
proposed by the Schwarz criterion was used. The time dummy variable with
the value of 1 during the financial crisis from the middle of 2007 was
included.
The following variables may suffer from endogeneity: the
non-performing loans to assets ratio, derivative cash flow relative to
loans and investments relative to assets. In this case, a bias in the
estimation could arise from the correlation between the vector of
explanatory variables and the error term. To control for this problem,
the simultaneous causality bias by choosing suitable instrumental
variables and employing two stage least squares (TSLS) estimation was
eliminated (See also: Roodman 2007; Murray 2006).
The following set of instrumental variables, which should be
correlated with the offending regressors, according to economic theory
was employed (See: the text below): capital adequacy, market
concentration, net interest margins and the government effectiveness
index. In the following paragraphs, the economic reasoning behind the
correlations between the proposed instrumental variables and the
variables suffering from endogeneity are discussed.
The higher the banking sector concentration, the higher the
ownership of foreign banks, the more foreign direct investment in the
financial sector comes from abroad, the more possibilities the banks
have for offering more credit, increasing their market share and
creating lower capital adequacy (Podpiera 2006). Increased concentration
has a negative impact on financial soundness (Uhde, Heimeshoff 2009).
The higher the banking sector concentration, the more possibilities the
banks have for offering more loans and creating lower capital adequacy
(Babihuga 2007). Excessive credit lending is usually associated with a
decreasing capital ratio, according to Dell'Ariccia and Marquez
(2006).
According to Podpiera (2006), Kaufmann, Kraay and Mastruzzi (2009)
a higher degree of compliance with Basel core principles is associated
with a narrower interest rate margin. And even more, a market
concentration is positively and significantly associated with interest
rate margins. On the other hand, less capitalized and high-risk banks
offer relatively higher deposit rates to attract deposits, leading to a
narrow interest spread (Berger et al. 2004). According to Uhde and
Heimeshoff (2009), the passing through of increased short-term interest
rates to deposit rates contribute to an increase in banks' funding
costs and leads to higher loan interest rates--consequently resulting in
more non-performing loans.
Further, the positive and significant effect of the cycle-on-asset
quality and the market share of individual bank--in economies with a
relatively lower level of financial development - would be expected. The
positive effect dampened in low-income economies, implying that the
negative relationship between the business cycle and capital adequacy
ratio is smaller in economies with a higher quality of supervision and
rule of law (Uhde, Heimeshoff 2009). The compliance with the Basel Core
Principles index is highly correlated with an index of government
effectiveness and an index of measuring the rule of law (Kaufmann et al.
2009). The higher share of derivatives and investment in the asset
structure are expected in more developed banking sector and economic
environment.
Instrumental variable methods rely on two assumptions (Staiger,
Stock 1997): (i) the excluded instruments are distributed independently
of the error process (i.e. instruments are valid), (ii) the instruments
are sufficiently correlated with the included endogenous regressors
(i.e. the instruments are not weak). The Hansen-Sargan test of
overidentifying restrictions addresses the first assumption, whereas the
weak identification tests address the second assumption. The Stock and
Yogo (2005) test for weak instruments is based on the largest acceptable
bias of the TSLS estimation relative to the OLS estimation. The
statistic was originally proposed by Cragg and Donald (1993) to test for
underidentification. When disturbances are heteroskedastic or
autocorrelated, these test statistics are no longer valid (Stock, Yogo
2005). Research by Kleibergen and Paap (2006) led to the development of
a robust version of the weak instrument test statistic that solves the
previously mentioned problems and, additionally, does not require i.i.d.
errors (Kleibergen, Schaffer 2007).
In our case, the Hansen-Sargan statistic of over-identifying
restrictions does not reject the null hypothesis that the instrumental
variables are uncorrelated with the error term. The rejection of the
null hypothesis of the Kleibergen-Paap test, on the other hand, suggests
that the chosen instruments are not weak (see Table 3).
The estimation results for the fixed and random effects model
estimated by TSLS are presented in Table 3 (6). Given the high p-values
of the Hausman test (Hausman 1978), both fixed effects and random
effects produce consistent estimators, but fixed effects are less
efficient.
4.4. Results
As the income level increases relative to the business cycle over
time and as the rule of law index increases, the bank gains more market
share, according to our empirical analysis. The sign of the derivatives
variable indicates that an increase on a bank hedge prompts the bank to
increase its market share. A positive cash flow under the heading of
derivative financial instruments adds to the growth of loan volume (see
Table 3).
Loans and investments represent two competing sources of income. An
increase in a bank's investments reduces its market share of credit
(with the coefficient of -0.04), as banks shift funds away from loans
into other sources of revenues. Additional gains from innovative
financial instruments enable additional credit supply (with the
coefficient of 1.3). Non-performing loans (to assets) indicate that
banks retrench their lending operations when its non-performing loans
increase (with the coefficient of -0.7). It can be stated that the
vulnerability of foreign banks to economic terms in host economies has
probably been confirmed with foreign banks that have a lower liquidity
of assets and worse capital adequacy of the parent bank. Irrespective of
ownership, banks will reduce their lending activity by means of a
necessary balance sheet and capital adequacy amendments in this case
(7). The correlation between lending operations in the host country and
the cycles of the local economy is positive (with the coefficient of
0.11). And additionally, the higher market share of foreign banks is
usually associated with a higher degree of compliance with Basel core
principles, an institutional creditor protection and a rule of law (with
the coefficient of 0.37).
The ownership structure does not affect the market share of the
loans in host economies. In fact, the positive sign suggests that
foreign banks have not actually decreased their market share of loans in
the period of crisis (with the coefficient of 0.02). Foreign banks did
not reduce their credit supply during adverse economic times in the host
countries regarding the ownership structure in the Baltic States,
Bulgaria and Romania. Indeed, they viewed such economic problems as
opportunities to expand, by acquisition or by growth of existing
subsidiaries. Even more can be said, that there is evidence that foreign
banks (probably with sufficient international portfolio diversification)
played a stabilizing role during the crisis in these host economies (8).
It can be concluded that foreign banks can stabilize loan supply in
host economies when domestic deposits are in crisis and they act
stabilizing in the environment of the host countries, especially if
there are no shocks in their home country and if they do not draw their
liquidity from the host country's environment (crisis--per
se--contributed to lowering of market share of the foreign banks only
with the coefficient of -0.09). The foreign banks in Central and Eastern
European host countries usually took over better clients and left the
remaining ones to domestic banks.
It can be said that in less-developed environments, the tendency
for bank takeovers was greater, since in this way foreign banks
increased their profits (on account of economies of scale), their market
share and took over clients from domestic banks. The purchase of a
domestic bank could signify a long-term orientation of the bank and
stability of credit supply, while an affiliate could be more short-term
oriented. The link between the parent bank and the domestic bank (that
was taken over) is weaker than the link between the parent bank and its
affiliate in the host country. The results have proven that majority of
domestic banks--that have been taken over by foreign banks--remained
in-dependant foreign banks in the analysed host economies--that enabled
the stability of credit supply during the crisis.
5. Conclusion
Economic growth is more likely to have a positive effect on loan
portfolio quality, and this is primarily due to the cyclical pattern of
revenues. The financial crisis did not lead to a retrenchment of credits
by foreign banks in the Baltics, Romania and Bulgaria.
The ownership structure does not affect the market share of the
loans in host economies. Foreign banks may run a more stable lending
policy because of their integration into the global environment. Because
of better knowledge of risk estimation, they enable the greater
stability of the banking sector; and with sufficient international
diversification, they have played a stabilizing role during the crisis
in the Baltic States, Bulgaria and Romania.
doi: 10.3846/16111699.2011.620156
Received 17 March 2011; accepted 07 June 2011
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(1) Despite the fact that lending grew rapidly in the period from
2002 to 2007, banks in the Baltics have maintained adequate solvency
buffers. They also identified consolidation, the adaptation of
organizational structures and regulatory incentives, as significant
drivers of change.
(2) The predominance of foreign exchange lending has been
particularly relevant in Romania and in countries with a fixed or
'stable' exchange rate, like in the Baltics.
(3) After the EU accession, fixed capital formation as the major
driving force of GDP growth in Baltics, a higher capacity to absorb EU
investment grants and strong external demand have caused relatively high
GDP growth rates. Significant amounts of FDI have been related to the
banking sector and nontradable sector (like real estate business) that
are closely tied to the availability of bank finance, which
differentiates the Baltics from the central Europe, where most of
capital inflows have taken the form of FDI into the tradable sector.
After the EU accession, Romania and Bulgaria faced the recovery of EU
economies and the positive externalities of accession to the EU have
contributed to economic growth. Romania and Bulgaria have become one of
the main beneficiaries of FDI in tradable sector in the Central and
Eastern European Region due to their EU accession, the relatively low
wages of the highly educated labour force, the rapidly growing domestic
market and the strategic geographical positioning of their countries.
(4) The sources of our panel data are the quarterly financial
statements of banks, internal data provided by EIPF (2010) and BACA
(2010); and central banks databases, Bankscope.
(5) Namely, the original variables are integrated in different
orders. Some of the variables are already stationary in the level form,
whereas the majority is integrated in order 1. The cointegration
analysis for all of the variables could not be performed due to
different levels of integration, but we find five cointegrating
equations among the set of variables. A long-term relationship for all
of the variables could not be established, perhaps due to the
transformational changes that occurred in the Baltics, Romania and
Bulgaria or with specific events on the credit market and banking sector
during the transition period.
Q-statistics were employed to check for autocorrelation in the
residuals. We accept the hypothesis of no autocorrelation, with high
probabilities and low Q-statistics.
(6) All the calculations were performed by Eviews 6.0 and Stata 10.
(7) Dages, Goldberg, and Kinney (2000) proved that foreign banks
exhibited stronger and less volatile loans growth than domestic banks,
but differences in asset quality, rather than ownership, appeared to be
decisive in explaining the behaviour of bank credit.
(8) Domestic banks reduced the volume of their loans more than
foreign banks (De Haas, Lelyveld 2006).
Mejra Festic
Bank of Slovenia, Ljubljana, Slovenia
E-mail: mejra.festic@bsi.si
Mejra FESTIC * is Full Professor of Economic Theory and Policy,
Banking and Finance. She was employed at the University of Maribor on
Faculty of Business and Economics from 1995 till March 2011. She was a
Vice-rector for the field of academic affairs at the University of
Maribor and the principal of the institute EIPF Economic Institute,
established in 1963 (http://www.eipf.si/predstavitev.html) till March
2011, specialized for economic dynamics forecasts in world economies,
Euro area and Europe. Her research field regards to financial stability,
monetary systems, banking, finance, bank risks management and
coordination of economic policies. From the 1st March 2011 she is
employed as a vice-governor at the Bank of Slovenia.
* The statements of the author do not present the statements of the
institution where the author is employed.
Table 1. Macro and banking sector indicators for the NMS-53
Macro and banking sector indicators
Share of banking Gross external GDP growth
system assets debt to GDP in (20092010
under foreign % (2010 (f)) (f)2011 (f))
ownership (2008)
Estonia 97.0 122.2 -15.31.23.2
Latvia 61.0 162.3 -16.3-1.33.9
Lithuania 88.0 93.2 -17.0-0.93.3
Bulgaria 84.0 105.9 -6.3-1.01.8
Romania 88.0 64.7 -7.5-2.51.7
Macro and banking sector indicators
Denominated Loans to NPL as % of
loans in FX deposits ratio gross loans
in % of total (200820092010 (20080910
loans (2008) (f)) (f))
Estonia 85.2 199195189 1.96.58.0
Latvia 88.4 247250230 3.616.219.8
Lithuania 64.0 196187185 4.616.118.4
Bulgaria 56.7 123121122 3.25.710.0
Romania 56.0 126119116 6.316.017.5
Macro and banking sector indicators
Rating EBRD index
Moody'sS&P of banking
2010 sector
reform *
Estonia A1 stable 3.7
A stable
Latvia Baa3 stable 3.7
BBstable
Lithuania Baa1 stable 3.0
BBB stable
Bulgaria Baa3 positive 3.7
BBB stable
Romania Baa3 stable 3.0
BB+ stable
Notes:
Portfolio quality and loan classification categories:
Estonia--standard, watch, doubtful, uncertain, loss; Latvia and
Lithuania--standard, watch, substandard, doubtful, loss. Substandard
loans are 91 to 180 days past due (and require provisioning between 15
and 40), doubtful loans are 181 to 365 days past due (and require
provisioning between 40 and 99) and losses are not repaid (requiring
100% provisioning). In Estonia, loans overdue for 150 plus days have
to be written off. In Latvia, the substandard classification covers
loans 31-90 days overdue and provisioning levels are 103060100 ===
percent, respectively. In Romania and Bulgaria: the NPL as
substandard, watch, doubtful loans--defined as loans that are more
than 90 days past due
(f) : forecast, FX: foreign exchange
* The ERBD indicators of banking sector reform are measured on a scale
of 1 to 4+ (for 1997 and 2005): score 2: established internal currency
convertibility, significant liberalised interest rates and credit
allocation; score 3: achieved substantial progress in establishing
prudential regulation and supervision framework; score 4: level of
reform approximates the BIS institutional standards.
Source: BACA (2010), EIPF (2010)
Table 2. Overview of the literature on explanatory variables of the
stability of loan supply
Explanatory Reference Explanation of theoretical
variable(s) background
Ownership Morgan and Strahan If economic growth in the host
and cycles (2003), Goldberg country slows down, lending will be
(2005) redirected in favour of other
regions, where the economic
dynamics are more favourable.
Domestic banks in the CEE are short
of these possibilities and are
therefore less vulnerable to local
cyclical fluctuations. The
correlation between lending
operations in the host country and
the cycles of the local economy is
positive. On the other hand, there
is a possibility for the foreign
bank to excessively increase its
cross-border operations when the
possibilities for economic growth
in the home country are weak.
Crisis Cull and Martinez- Also, foreign banks can stabilize
Peria (2007), the supply of loans during the
Herrero and crisis. On the other hand,
Martinez-Peria countries with a higher share of
(2007) foreign banks faced a harder
financial crisis than countries
with a lower share of foreign
banks. The reaction of foreign
banks abroad depends on the capital
adequacy of the parent bank and the
business opportunities in the host
economies.
Income Clarke et al. Foreign banks most frequently enter
level to (2003), Haddad and countries with a large share of
cycle Hakim (2009) direct foreign investment, since
they usually follow their clients
ignoring the development rate of
the host country. Entering
countries with strategic raw
materials--as a significant
component of GDP structure--is a
long-term orientation of foreign
banks in these host economic
environments. It can also be
assumed that in these countries
there is no substantial outflow of
capital during times of crisis.
Economies with lower income level
per capita and lower income level
relative to cycle generally enable
better growth and development
prospects; and these markets are
therefore attractive for foreign
strategic investors and banks
accompanying them ensuring a stable
loan supply.
Rule of law Kaufmann, Kraay The higher market share of foreign
and Mastruzzi banks is usually associated with a
(2009), Bennacceur higher degree of compliance with
and Omran (2008) Basel core principles, a rule of
law and institutional creditor
protection.
Derivatives Clarke et al. The less developed the banking
(2003) environment of the host country,
the larger the opportunity of
foreign banks to make bigger gains
by introducing the derivatives and
other innovative financial
instruments in the banking
environment of less developed host
economies. Additional gains from
innovative financial instruments
enable additional credit supply.
Investment Amess and At the time of entry into less
to assets Demetriades developed banking environments,
ratio (2010), Hermes and foreign banks increased their
Lensink (2003) reserves as they evaluated credit
risks more realistically than
domestic banks. The arrival of
foreign banks results in the
formation of a higher level of
reserves for domestic banks, as
they want to retain their market
share and extend loans under terms
that involve higher risks for
banks. Higher (secondary) reserves
could be also seen in higher
investment (money market
securities) to assets ratio of
banks and less disposable credit
supply.
Non- Clarke et al. The foreign banks have a stronger
performing (2002), Berger, tendency to lend to larger rather
loans Klapper and Udell than smaller or mid-sized companies
(2001), Tschoegl and they have problems providing
(2003), Corden credit to smaller companies in the
(2009), Uiboupin host country. The foreign banks in
(2006) Central and Eastern European
countries took over better clients
and left the remaining ones to
domestic banks. And even more, some
authors argue that lending volume
contracted after selling domestic
banks to foreign buyers because of
portfolio cleaning. Lending volume
reached a level prior to the sale
only after several years. These
statements are confirming the
negative relation between higher
share of foreign ownership of banks
in host economies and lower
non-performing loans (NPL). The
takeover of a domestic >>bank in
trouble<< by a foreign bank can add
to the efficiency of banking
operations in the future as lending
policy is directed neither to
extending loans to bad companies
nor to achieving political goals.
Table 3. Panel regression results for the Baltic States, Romania and
Bulgaria
Dependent Variable: d[(Market share of loans), Cross-sections included:
5 (the first quarter of 1999--the second quarter of 2010)
Variable TSLS fixed TSLS random
effects effects
C 0.1857 0.1850
(2.5452) (1.7176)
(0.0126) ** (0.0891) *
d[(Non-performing loans).sub.-2, -1)] -0.6860 -0.6682
(-12.2706) (-10.6418)
(0.0000) *** (0.0000) ***
d[(Derivatives).sub.(-1,-4)] 1.3161 1.2760
(7.5104) (7.1648)
(0.0000) *** (0.0000) ***
d[(Investment to assets).sub.(-1, -3)] -0.0459 -0.0392
(-2.3655) (-2.0547)
(0.0201) ** (0.0427) **
d[(Income level to cycle).sub.(-4, -3)] 0.1006 0.1139
(2.9143) (2.8639)
(0.0045) *** (0.0051) ***
d[(Ownership).sub.(-2, -2)] 0.0215 0.0227
(2.0501) (2.2511)
(0.0432) ** (0.0267) **
Crisis -0.0918 -0.0920
(-3.5845) (-3.3585)
(0.0005) *** (0.0011) ***
d[(Rule of law).sub.(0, 0)] 0.3678 0.3679
(2.9880) (2.9673)
(0.0036) ** (0.0038) **
Weighted Statistics
R-squared (Adjust.) 0.3581 0.3516
S.E. of regression 7.5804 7.5382
F-statistic 4.2502 5.4872
Prob(F-statistic) 0.0000 0.0000
Random and Fixed
Effects Tests (Prob.)
Hausman Random Effects Test -- (0.8743)
Redundant Fixed Effects Test (0.0276) --
Kleibergen-Paap Test (0.00370) (0.00000)
Hansen-Sargan Test (0.5978) (0.6738)
Variables:
Market share of loans: expressed as credits of foreign bank(s) to
total banking sector credits; Non-performing loans: expressed as loans
more than 90 days past due to bank assets; Derivatives: cash flow
hedges as returns or losses on derivative positions relative to bank
loans; Investment to bank assets: expressed as ratio; Income level to
cycle: the interaction effect between income level (as average income
per employee) and business cycle (expressed as low, middle and high);
Ownership: the actual percent of foreign ownership in an individual
bank; Crisis: the time dummy as the timing of the financial crisis;
Rule of law: expressed as index.
Instrumental variables: Market concentration (measured by the assets
of five foreign banks relative to total banking sector assets),
Capital adequacy (measured as capital to risk weighted assets of the
parent bank), Net interest margin (measured as a bank's net interest
revenues as a share of interest bearing--total earning--assets of the
analysed banks), Government effectiveness index
Notes:
d[(x) denotes the difference of the variable as a percentage change
(measured in percentage points). The time lag of the variable is given
in subscripts. In the first part of the table, the t-statistics are
given in brackets below the coefficients and the p-values are in
brackets below the t-statistics. Significance levels are denoted as:
*** significant at 1%; ** significant at 5%; * significant at 10%
