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Bank Performance in Transition Economies

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This paper examines the performance of 515 banks in 16 transition economies for the years 1994 - 99 based on their public financial accounts. We first examine lending behaviour and probability distribution of bank profitability to determine whether these banks exhibit behaviour and performance associated with excessive risk-taking. While we do not find evidence of excessive risk taking on average where there is significant progress in banking and related enterprise reforms, there may be a minority of poorly capitalised banks that do take excessive risks, particularly where progress in reform is less advanced. The paper then estimates cost and revenue functions based on a model of banks as multi-product firms. The results indicate that banks' performance differs significantly depending on the reform environment, as well as the competitive conditions, in which they operate. Banks with high market shares have higher costs and achieve lower margins on their loan and deposit activities. Where there has been significant progress in banking and related enterprise reforms, banks are making comfortable margins on loans and appear to be offering competitive margins on deposits, though they are still achieving overall negative returns on equity. By contrast, when substantial reforms have not been undertaken, banks have been sustaining high negative returns on loans, largely at the expense of depositors; in effect they have been able to appropriate much of the tax that inflation levies on nominal deposits, and have been using this revenue to prop up their weak loan portfolios. Overall interest margins are declining over time but are substantially higher in low reform environments. The results indicate that an appropriate policy and regulatory framework may be a necessary condition for significant progress to be made

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Paper provided by Economics Section, The Graduate Institute of International Studies in its series IHEID Working Papers with number 07-2002.

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Length: 31
Date of creation: Sep 2002
Date of revision:
Handle: RePEc:gii:giihei:heiwp07-2002

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Keywords: banking; cost functions; revenue functions; transition;

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  1. Reinhart, Carmen & Kaminsky, Graciela, 1999. "The twin crises: The causes of banking and balance of payments problems," MPRA Paper 14081, University Library of Munich, Germany.
  2. Boozer, Michael A., 1997. "Econometric Analysis of Panel Data Badi H. Baltagi Wiley, 1995," Econometric Theory, Cambridge University Press, vol. 13(05), pages 747-754, October.
  3. Wendy Carlin & Steven Fries & Mark Schaffer & Paul Seabright, 2001. "Competition and enterprise performance in transition economies: evidence from a cross-country survey," Working Papers 63, European Bank for Reconstruction and Development, Office of the Chief Economist.
  4. Neven, Damien & Roller, Lars-Hendrik, 1999. "An aggregate structural model of competition in the European banking industry," International Journal of Industrial Organization, Elsevier, Elsevier, vol. 17(7), pages 1059-1074, October.
  5. S. Baranzoni & P. Bianchi & L. Lambertini, 2000. "Market Structure," Working Papers 368, Dipartimento Scienze Economiche, Universita' di Bologna.
  6. Erik Berglof & Patrick Bolton, 2002. "The Great Divide and Beyond: Financial Architecture in Transition," Journal of Economic Perspectives, American Economic Association, vol. 16(1), pages 77-100, Winter.
  7. Ng, Charles K & Seabright, Paul, 2001. "Competition, Privatisation and Productive Efficiency: Evidence from the Airline Industry," Economic Journal, Royal Economic Society, Royal Economic Society, vol. 111(473), pages 591-619, July.
  8. De Bandt, Olivier & Davis, E. Philip, 2000. "Competition, contestability and market structure in European banking sectors on the eve of EMU," Journal of Banking & Finance, Elsevier, vol. 24(6), pages 1045-1066, June.
  9. Bresnahan, Timothy F., 1989. "Empirical studies of industries with market power," Handbook of Industrial Organization, Elsevier, in: R. Schmalensee & R. Willig (ed.), Handbook of Industrial Organization, edition 1, volume 2, chapter 17, pages 1011-1057 Elsevier.
  10. Baltagi, Badi H., 1981. "Simultaneous equations with error components," Journal of Econometrics, Elsevier, Elsevier, vol. 17(2), pages 189-200, November.
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