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Banking efficiency in
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transition economies
The role of foreign ownership*
Laurent Weill
LARGE, Université Robert Schuman, Institut d’Etudes Politiques, 47 avenue de la Forêt-Noire,
67082 Strasbourg Cedex, France. E-mail: laurent.weill@urs.u-strasbg.fr
Abstract
An increasing share of the banking sector is controlled by foreign capital in the
majority of transition countries. To analyse the effects of this trend on the performance
of the banking sector in these countries, this study conducts a comparative analysis
of the performance of foreign-owned and domestic-owned banks operating in the
Czech Republic and Poland. We use the stochastic frontier approach to compute
cost efficiency scores. Following Mester (1996), financial capital is included in the
cost frontier model to control for risk preferences. Our finding is that on average
foreign-owned banks are more efficient than domestic-owned banks. We conclude,
however, that this advantage does not result from differences in the scale of
operations or the structure of activities.
* I would like to thank Erik Berglöf for his helpful comments which considerably improved the paper. I also
thank two anonymous referees. Finally special thanks are due to the seminar participants of the First
Meeting of the Czech Economic Society in Prague (November 2000).
1. Introduction
With the forthcoming privatization of the remaining large state-owned banks, the
banking sector will soon be almost completely owned by foreign investors in the Czech
Republic and Poland, with the exception of minor banks. At the end of 2001, foreign
investors owned 70 percent of the equity of the Czech banking sector (CNB, 2001).
This evolution which occurred in the most developed countries in transition, may
spread to the others in the near future. Whether this growing market share of foreign-
owned banks will improve the performance of the banking sector is therefore a major
issue for these countries. To understand the consequences of this process it is helpful
to analyse whether foreign-owned banks outperform domestic-owned banks. Despite
the importance of this question, no detailed study of it has yet been made. The general
opinion is in favour of foreign-owned banks for two reasons. First, since there is a strong
connection between foreign and private ownership in transition countries, foreign-
owned banks may benefit from better control from private shareholders, resulting
in better incentives for managers. Second, foreign shareholders, generally being
foreign banks, may contribute their know-how to organization and risk analysis.
However, two strands of empirical literature have produced arguments that
domestic-owned banks perform better. First, the literature devoted to the comparison
of performance between domestic-owned and foreign-owned banks generally con-
cludes that domestic banks have a performance advantage (Berger et al., 2000). This may
occur as a result of either organizational diseconomies in operating and monitoring
a bank from a distance or of cultural barriers that favour domestic-owned banks.
Second, the effect of foreign ownership on performance can be linked to the
analysis of the influence of private ownership, since all foreign-owned banks are
privately-owned. Several studies have compared the performance of public and
private companies in transition countries using various methodologies (e.g., Konings,
1997; Estrin and Rosevear, 1999). However, they do not provide conclusive evidence
that privately-owned companies in transition economies perform better. In summary,
empirical literature provides evidence against the general opinion that foreign-owned
banks perform better than domestic-owned banks in transition countries.
This paper aims to fill the gap in the literature about the comparative perform-
ance of domestic and foreign-owned banks in transition economies. In discussing
this issue, we use frontier efficiency techniques to estimate performance measures
for banks in the Czech Republic and Poland. These methods provide efficiency
scores which are synthetic and relative measures of performance. Unlike basic
productivity measures, these techniques have the advantage of including several
input and output dimensions in the evaluation of performance. Nevertheless they
have some limits, illustrated by doubts about the robustness of these approaches
(Bauer et al., 1998) and the debatable definition of banking outputs.
Our aim is to analyse the differences in cost efficiency between domestic and foreign-
owned banks in the Czech Republic and Poland in order to provide information
on comparative managerial performance. However, a simple comparison of the
Banking Efficiency in Transition Economies 571
mean efficiency scores would be misleading if we do not take into account bank
characteristics which are not endogenous to bank managers’ behaviour. Differ-
ences in risk preferences might explain discrepancies in efficiency (Mester, 1996).
This issue is of considerable interest in transition countries, as there may exist
differences in risk preferences between managers of domestic-owned banks and
those of foreign-owned banks. Differences in efficiency between domestic-owned
and foreign-owned banks may also come from discrepancies in size or in structure
of activities. If, for instance, foreign-owned banks are smaller than domestic-owned
banks, a higher cost efficiency for foreign-owned banks may be the result of dis-
economies of scale rather than superior managerial performance. It can be argued
that size and structure of activities are the result of management choices, as bank
managers are responsible for production decisions. Nonetheless, to adjust the size
and the structure of activities takes some time, because of the existence of significant
adjustment costs which influence the pace of capital investment. This is particularly
true for the banks in our study as the data come from 1997, by which time Czech
and Polish banks had had relatively little time to adjust to their new environment.
It would consequently not be correct to study the performance of banks without
including the size and the structure of activities in the analysis.
To take these elements into account, we employ a two-step approach to exam-
ine the relative cost efficiency of domestic-owned and foreign-owned banks, using
a sample of 47 banks in Poland and the Czech Republic in 1997. In the first step,
we compute the cost efficiency scores using the stochastic frontier approach. Fol-
lowing Mester (1996), we include the level of equity in the estimation of the cost
function model to control for risk preferences. In the second step, the efficiency
scores are then put into a Tobit regression model in order to analyze the explanatory
variables of the efficiency gap between both types of banks. We include variables
for the size and the structure of activities with a view to separating these influences
from the impact of the nature of the ownership.
The paper is organized as follows. The recent evolution of Polish and Czech
banking sectors, and major issues on foreign ownership presence are briefly out-
lined in Section 2. Section 3 presents a short survey of the literature devoted to
banking efficiency in transition economies. The methodology is described in Sec-
tion 4, followed by the data and variables in Section 5. Section 6 presents the results
of the estimation of efficiency scores, and displays the regression of the efficiency
scores. We provide some concluding remarks in Section 7.
2. Background
directed the distribution of funds throughout the economy without taking their
productive use into account. In 1989, Poland decided to separate this dominant bank
into one central bank and nine state-owned regional commercial banks, with each
bank inheriting part of the portfolio of major state-owned firms. However, this reform
did not resolve the structural problems, since bank managers of state-owned com-
mercial banks continued to grant new loans to state-owned companies without
considering realistic perspectives of repayment. The recession in Poland in 1991,
following the shock therapy implemented in 1990, clearly highlighted this problem.
Main state-owned companies were strongly affected by the fall in demand and
restructuring efforts. Consequently, their solvency fell to the point that the amount
of non-performing loans increased to 31 percent of total loans in 1993 (OECD, 1996).
In that year, the Polish government decided to undertake the Enterprise and
Bank Restructuring Program (EBRP) to stop the deterioration of the financial
situation of the main state-owned banks and companies. The aim of this change in
effect until 1996, was recapitalization and the resolution of the problem of non-
performing loans prior to the privatization of state-owned banks. The Polish State
decided to proceed with a one-time recapitalization of the banks, based on the
value of the portfolio of bad debts at the end of 1991. However, this injection of
capital was provided on condition that banks undertook actions to resolve all their
non-performing loans at the end of 1994. Banks were then empowered to negotiate
workout agreements with problem debtors and force them on dissenting creditors.
These agreements should have been based upon restructuring programs, involving
the control of banks. Nine state-owned banks were affected by this reform. The
outcome of the restructuring program is generally considered as positive: the share
of non-performing loans in loan portfolios of the eleven major banks was reduced
from 27 percent in 1992 to 9 percent in 1996 (Palinski, 1999).
In parallel with the implementation of the EBRP, the Polish government also
launched the privatization of banks. The privatization of the nine regional state-
owned commercial banks was originally scheduled to be completed by the end of
1996, but it was delayed and only four regional banks were privatized by the end
of 1997. This privatization process was also the opportunity for the entry of foreign
banks into the Polish banking market, as the Polish authorities asked foreign banks
to get involved in the capital of the newly privatized banks. The result of this
process was the progressive dominance of foreign-owned banks in the banking
market with a share of 60 percent of the banking assets already owned by foreign
capital at the end of 1999. Since we used data from 1997 in our analysis, we have
a mixed sample for Poland consisting of a majority of domestic-owned banks,
along with both de novo and former state-owned foreign banks.
As in Poland, the Czech authorities decided quickly after the collapse of the old
regime to separate the activities of the former monobank combining the functions
of a central bank and commercial banks. The commercial activities were trans-
ferred to two banks. As with the Polish evolution, the number of banks greatly
increased in the first years of transition, from 9 in 1989 to 52 in 1993, mainly
Banking Efficiency in Transition Economies 573
on the host country. What determines the entry of foreign banks in a transition
country? The answer is two-fold as foreign bank presence results not only from the
will of local authorities, but also from the desire of the foreign banks to enter into
a new market that is connected to other location-specific factors.
We investigate first the reasons why the authorities might favour the entry of
foreign banks. As mentioned above, the banking sector was wholly-owned by
the State at the start of the period of transition. Therefore, the entry of foreign
banks was directly connected to the privatization process. Following the desire to
abandon the monobank system, privatization aimed to cut the links between the
State and the banking sector in order to favour the optimal allocation of financial
resources, to improve corporate governance in banks, and to increase bank compe-
tition. In summary, it was important to privatize banks to create an efficient banking
system. Why then sell banks to foreigners? A first reason was the public wish
to receive a satisfactory selling price: as more capital was available abroad, selling
to foreigners was the most profitable way. Another motive related to the corporate
governance of banks was the argument that selling to foreigners would create a
market for corporate control, as a measure of disciplining bank managers. Further-
more, the entry of foreign shareholders, which were often foreign banks, allowed
the introduction of operational expertise within banks.
Next to the privatization process, several location-specific factors have been sug-
gested in the literature as influences on the decisions of foreign banks to expand into
a transition country. The first refers to the historical pattern of foreign direct investment
(FDI), according to which banks follow their clients abroad. FDI in banking should
then be directly connected to the extent of the integration between home and host
countries. Empirical literature indeed confirms the positive link between economic
integration and foreign bank entry in developed countries (Goldberg and Johnson,
1990, for the US; Moshirian, 2001, for the US, the UK and Germany). Furthermore,
Focarelli and Pozzolo (2001) observe for OECD countries that FDI in banking is pos-
itively correlated with the ratio of exports to GDP, which also supports the hypothesis
that banks follow their clients. Nonetheless, additional research is needed in devel-
oping and transition countries on this issue to allow more conclusive comments.
Another determinant of banks’ location decisions is the existence of profitable
opportunities in the host country. The impact of this factor is confirmed by empirical
evidence in both developed and developing countries, which supports a positive
relationship between the share of foreign banks and host GDP growth (e.g.,
Moshirian, 2001). Moreover, when investigating the determinants of global FDI in
transition countries, Bevan and Estrin (2000) observe that global FDI is positively
linked to the host country GDP. Some other factors have been tested in the literature
to explain the pattern of foreign bank entry, such as host country regulation, a tighter
regulation on banking activity tending to reduce foreign bank entry (Focarelli and
Pozzolo, 2001). Cultural connections may also be relevant: Bevan and Estrin (2000)
consider that the close cultural ties of Germany with Eastern European countries may
explain FDI from Germany in these countries. Furthermore, these authors support
Banking Efficiency in Transition Economies 575
1
It is also of utmost interest to mention the results of the survey of 3,000 enterprises by Clarke, Cull and
Martinez-Peria (2002) in developing and transition countries. They support the assertion that the access to
credit for small and medium-sized enterprises was not reduced but improved by the foreign bank entry.
576 Weill
A second danger of foreign bank entry could be its impact on financial stability,
considering the lack of ‘loyalty’ of foreign banks in cases of economic difficulties
or systemic problems in the banking sector. According to this argument, while
domestic banks are committed to the domestic economy, foreign banks would
neglect the host country in the event of economic problems by reducing credit
more than domestic banks. Evidence from Latin America, however, suggests a
different view on this issue; indeed, Peek and Rosengren (2000b) and Dages et al.
(2000) find that domestic and foreign banks adopt the same lending behaviour
during crisis periods.
An alternative source of financial instability may be the fact that economic
fluctuations in the home country of the foreign-owned bank influence its lending
behaviour. As a consequence, there would be a risk that the host country is affected
by cyclical influences from other countries. Evidence suggests the existence of such
channels of transmission (Peek and Rosengren, 2000a). However, Eastern European
countries can hedge against this risk by diversifying the home countries of
entrants, a strategy that has been observed in practice. In any case, the opposite
effect may occur: as foreign banks have more internationally diversified portfolios,
their presence stabilizes the financial system, because they would suffer less during
economic crises; Demirgüc-Kunt, Levine and Min (1998) conclude that foreign
bank presence reduces the likelihood of banking crises. These remarks about the
positive influence of foreign bank presence are in fact connected to the more
general debate regarding the role of foreign banks in the financial development of
a country.
Does foreign bank presence influence the financial development of Eastern
European countries? The answers to this are mixed, depending on which dimen-
sion of the financial development is analyzed. There appears to be no impact of
foreign bank presence on the development of stock markets. When focusing on the
amount of credit to households and enterprises, empirical literature suggests a
positive influence of foreign bank presence (e.g., Fries and Taci, 2002). The entry of
foreign banks also favours bank competition, as observed by Claessens, Demirgüc-
Kunt and Huizinga (2001) for a large sample of countries, including transition
countries. Thus, foreign bank presence can be seen as a positive factor for financial
development, since it favours the expansion of credit and bank competition.
Kraft and Tirtiroglu (1998) estimate levels of cost efficiency and scale efficiency
in the Croatian banking sector in 1994 and 1995. They employ the stochastic
frontier approach on a sample of 43 banks. The authors focus on the comparison
both between old and new, and between state and private banks. When analyzed
in terms of these bank groupings, the results suggest that newer banks are less
cost-efficient and scale-efficient than either older privatized banks or older state
banks. Taci and Zampieri (1998) use another parametric technique, the distribution-
free approach, to investigate the cost efficiency of Czech banks. Efficiency is
analyzed in conjunction with size and ownership structure (private or public). The
conclusion is that private banks have a higher mean efficiency score, supporting
rapid privatization.
Opiela (2000) employs the stochastic frontier approach to estimate cost and
profit efficiency for a sample of 56 Polish banks. He aims to provide empirical
evidence on several issues relating to the Polish banking sector. He tentatively
concludes that there are two tendencies. First, there are more 100 percent efficient
banks among foreign-owned banks than among Polish-owned banks, suggesting
higher efficiency for foreign-owned banks. Second, there are fewer 100 percent
efficient banks among small banks than among large banks, suggesting the exist-
ence of economies of scale in the Polish banking sector. This can also be connected
to Konopielko (1995), who observes increasing returns to scale in the Polish bank-
ing sector. Furthermore, Konopielko (1997) estimates a cost function for 65 Polish
banks to compare the possible results of creating consolidated banking groups in
Poland. This study concludes in favour of consolidation in Polish banking, providing
evidence on increasing returns-to-scale in the banking industry.
Weill (2001) also uses the stochastic frontier approach to measure the evolution
of cost efficiency between 1994 and 1997 for 22 Polish banks and 12 Czech banks.
The aim of the study is more specifically the analysis of the outcome of the Enter-
prise and Bank Restructuring Program on bank performance in Poland. The study
separates Polish banks in to two groups, according to whether or not the bank
implemented the Enterprise and Bank Restructuring Program. This work then
compares the evolution between both groups of Polish banks, and also between
Polish and Czech banks. The result is mixed evidence in favour of the Polish model
of banking reform. On the one hand, the improvement of cost efficiency was
greater for Polish banks than for Czech banks. This indicates that the entire bank-
ing system may have benefited from the restructuring program. On the other hand,
the Polish banks which benefited from the program showed less improvement in
cost efficiency than the other Polish banks.
This brief survey on banking efficiency literature in transition economies can be
summarized in three points. First, evidence is ambiguous on the relative efficiency
of private and public banks. While Kraft and Tirtiroglu (1997) find superior effi-
ciency for public banks in Croatia, Taci and Zampieri (2000) find greater efficiency
for private banks in the Czech Republic. In connection to the debate about the
relative efficiency of domestic-owned and foreign-owned banks, this result shows
578 Weill
4. Methodology
as using labour and capital to produce deposits and loans. The choice of approach
might therefore influence the computation of the measures of banking perform-
ance. Two studies have analyzed the influence of the choice of the treatment of
deposits on efficiency results (Wheelock and Wilson, 1995; Berger, Leusner and
Mingo, 1997). Both concluded that the chosen approach has an impact on the levels
of efficiency scores, but does not imply strong modifications in their rankings.
owned banks. Finally, parametric approaches allow easier control of the influence
of variables on the structure of the cost frontier than non-parametric techniques.
Indeed, the inclusion of some environmental variables or the risk differences is
easily done by adding terms in the estimated cost frontier, as shown by Mester (1996).
In summary, the advantages and weaknesses of the stochastic frontier approach
are as follows. On the positive side, it allows the separation of random error from
the inefficiency term, avoiding the consideration of exogenous events as inefficiency,
and a simple control of the role of variables on the structure of the cost frontier. On
the negative side, it imposes some assumptions on the distributions of random error
and the inefficiency term, and specifies the functional form of the cost function.
We decide to use the stochastic frontier approach because we consider it the most
appropriate one for our purpose. Other parametric approaches are not suitable as
mentioned above. And, in addition DEA has the major drawback of increasing
the number of efficient observations by default for our rather small sample of 47
observations. Furthermore, DEA does not allow for taking into account risk and
environmental differences between both countries in a simple way.
derived using Shepard’s lemma. Estimation of this system adds degrees of freedom
and results in more efficient estimates than just the single-equation cost function.
Since the share equations sum to unity, we solve the problem of singularity of
the disturbance covariance matrix of the share equations by omitting one input cost
share equation from the estimated system of equations. Standard symmetry con-
straints are imposed. Homogeneity conditions are imposed by normalizing total
costs and the price of labour by the price of borrowed funds. Thus, the complete
model is the following:
TC w 1
ln = β 0 + ∑ α m ln ym + ∑ β n ln n + ∑∑ α mj ln ym ln y j +
w3 m n w3 2 m j
1 w w w
∑ ∑ β nk ln n ln k + ∑∑ γ nm ln n ln ym + ln EQUITY + COUNTRY + ε
2 n k w3 w3 n m w3
TC w
Sn = ∂ ln ∂ ln w n = β n + ∑ β nk ln w k + ∑ γ nm ln y m + η n
w3 k 3 m
where TC is total costs, ym m bank output (m = 1, 2), wn nth input price (n = 1, 2),
th
2
Sn is equal to the expenses for the input n divided by total costs.
3
This item includes the ‘other earning assets’ in the IBCA terminology, which are all the earning assets
other than loans.
582 Weill
Following Mester (1996) and Altunbas et al. (2000), we include the level of equity
in the estimated cost function to control for differences in risk preferences. If managers
from one bank are more risk-averse than the managers from other banks, they can
hold a higher level of equity than the cost-minimizing level. Consequently, by omitting
the level of equity, we may consider a bank as inefficient even if it behaves optimally,
given the risk preferences of its managers. If, for instance, bank managers of foreign-
owned banks are more risk-averse than the managers of domestic-owned banks,
their performance would be underestimated if equity is not controlled in the cost
efficiency model. We therefore include the level of equity to take the differences in
risk preferences into account. This variable is not introduced as an interactive
variable in the model, because it would significantly reduce the degrees of freedom,
due to the expansion of terms and the limited number of observations.
Berger and Mester (1997) provide two additional reasons to include the level of
equity in the estimation of the cost efficiency model. The first one is that the bank
insolvency risk depends on the equity available to absorb losses. Consequently, the
insolvency risk affects the bank’s costs through the risk premium that the bank has
to pay in order to borrow funds. This issue has a particular importance in transi-
tion economies where the insolvency risk of banks can be particularly great, due
to the high proportion of non-performing loans in loan portfolios. The second
reason is based upon the fact that equity constitutes an alternative funding source
for loans for banks. Even if deposits imply financial costs while equity does not,
raising equity involves higher costs than raising deposits. As a result, omitting
equity may favour the banks that rely more on equity for the funding of loans if
equity is more costly than deposits.
Despite these arguments, the introduction of the equity variable in the cost
function model is rare in the studies on banking efficiency. Only a few papers have
included this improvement in cost efficiency estimations (Mester, 1996; Berger and
Mester, 1997; Altunbas et al., 2000). However, the specific issues of banks in transition
economies, with possible differences of risk preferences between bank managers
and the reality of bank insolvency risk, require this inclusion, in order to avoid a
bias in efficiency scores. Since some banks from the sample have a negative level
of equity, we proceed to a transformation of the equity variable to get a positive
value of the logarithmic expression of equity in the model. The transformed equity
variable used in the model for each bank is then the sum of equity for the bank,
the minimum of the equity variable computed on the sample, and one, so that each
transformed value of equity is above one, meaning that the logarithmic expression
of equity is positive for each bank.
4
The banks of the sample represent 67.4 percent of total loans from Poland, 68.8 percent from the Czech
Republic.
584 Weill
6. Results
This section compares the efficiency of domestic-owned and foreign-owned banks.
We first present the efficiency results of the ITSUR estimation of the cost function
estimated jointly with both share equations. The main descriptive statistics for the
cost efficiency scores are presented in Table 2. We observe that foreign-owned
banks are more cost-efficient on average than domestic-owned banks. The mean
cost efficiency score is 70.4 percent for foreign-owned banks, while it is 62 percent
for domestic-owned banks.5 The analysis of the dispersion of efficiency scores
shows no significant difference between the two types of banks: the standard devi-
ation of efficiency scores is 11.22 percent for domestic-owned and 11.1 percent for
foreign-owned banks.
The comparison of these results with the literature on banking efficiency shows
that the level of cost inefficiencies for Czech and Polish banks is slightly higher
than in other studies which use this methodology. Indeed, in their survey of the
studies on banking efficiency, Berger and Humphrey (1997) observed a mean effi-
ciency score of 84 percent for the studies on US data with parametric approaches.
However, several studies using parametric approaches in other countries have
found similar inefficiencies: for instance, Resti (1997) obtains a mean efficiency
score of 69.4 percent in Italy.
5
A first version of the paper applied non-parametric DEA on the same sample of banks, coming to the same
conclusion about the relative efficiency of domestic-owned and foreign-owned banks. This alternative esti-
mation limits the sensitivity of our results to the adopted methodology for the estimation of the efficiency
scores. This work is available on request to the author.
Banking Efficiency in Transition Economies 585
The dependent variable is the percentage cost efficiency score (EFF). We include
in the regression a dummy variable for the nature of the ownership (FOREIGN): 0
if the bank is domestic-owned, 1 if it is foreign-owned. Discrepancies in efficiency
may result from differences in the nature of activities. Thus we take into account
the impact of the mix of inputs and outputs by introducing two variables in the
regressions: the ratio of loans to investment assets (LINV), and the share of deposits
in the total balance sheet (SHAREDEP). The scale of operations may also induce
586 Weill
Notes: *, **, *** denote an estimate significantly different from 0 at the 10%, 5% or 1% level, respectively.
Notes: Dependent variable is the cost efficiency score in percentage. t-value is in parentheses.
*, **, *** denote an estimate significantly different from 0 at the 10%, 5% or 1% level, respectively.
N: 47 banks.
domestic-owned banks does not influence the relationship between the variable
FOREIGN and the efficiency score. In other words, the positive link between
foreign ownership and cost efficiency is not the result of the smaller size of foreign-
owned banks.
As explained above, foreign-owned banks’ advantage may be the result of
better control by private shareholders as well as of their comparative advantage in
banking know-how provided by their mother companies. We suggested above that
foreign-owned banks’ managers might suffer from a poorer knowledge of the
economic and legal environment than domestic-owned banks’ managers. Foreign
managers who often manage foreign-owned banks have longer experience of
banking in a market economy than domestic-owned banks’ managers, but they may
suffer from poorer information on local companies. Because they have less infor-
mation on the quality of borrowers, foreign-owned banks may be faced with more
adverse selection problems than domestic-owned banks. Furthermore, they may be
less experienced in moral hazard problems in transition countries, where western
standards of contract rules are not respected: accounting information is uncertain,
leading to misvaluation of collateral and equity values. Nevertheless, our results
clearly prove that the comparative advantage of foreign-owned banks with better
shareholder control and banking know-how is not offset by weaker knowledge of
local customers.
The coefficients of both variables for the structure of activities are not signifi-
cant. This suggests that, in Poland and the Czech Republic, loans are not more or
less costly to produce than investment assets, but also that deposits do not imply
lower costs than other financing sources. The coefficient of the size variable is not
significant in both regressions, suggesting no linear relationship between size and
cost efficiency for Polish and Czech banks. This issue is connected with the debate
on the economies of scale in banking, on which there is no clear consensus. As
588 Weill
7. Concluding remarks
The research presented has analyzed the influence of the nature of ownership on
the cost efficiency of banks in the Czech Republic and Poland. This is an issue of
considerable interest, due to the increasing involvement of foreign capital in the
banking sectors of transition economies.
We found evidence in favour of the positive influence of foreign ownership
on cost efficiency in both transition countries. We first observed a higher mean
efficiency score for foreign-owned banks, which does not result from differences in
risk preferences between types of banks. Furthermore, the regression of cost effi-
ciency scores on control variables for size and the structure of activities as well as
the variable for the nature of ownership showed a positive and significant influ-
ence of foreign ownership. We explain this advantage in favour of foreign-owned
banks by the fact that they benefit from a transfer of banking know-how, since
many mother companies are banks, and by better corporate governance exercised
by foreign shareholders.
Thus, our main positive conclusion is that the degree of openness of the
banking sector to foreign capital has a positive impact on performance. It may also
have a positive influence on the macroeconomic performance of these countries,
because of the important role of the banking sector in the financing of these
economies. These results should, however, be interpreted with care. Indeed, as
mentioned above, the methodology adopted here, the efficiency frontiers, is subject
to some limits. Moreover, further research is needed on this topic not only to
confirm these results but also to investigate the origins of the advantages of
foreign-owned banks.
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Appendix