# Presentation: 295016

## 5th 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 **
**Banks versus financial markets **
**Economic and monetary integration**
**Capital adequacy rules**

**Market structure**
**Competition**
**Efficiency**
**Capital**
**Profitability**
**Risk**

## Motivation

## 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

## 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)

## Some summary statistics

## 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)

## 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 ********Q****NA**
**	**
**	****Test Structure-Conduct-Performance, Relative Market Power, Efficiency paradigms simultaneously in a coherent forward-looking framework based on stock market values**

## 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**

## 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

## Baseline equation: results

## Robustness

- Competition
- Interaction between Market Share and HHI
- negative and significant
- Contestability: Foreign presence and importance
- negative and _in_significant
- 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

## 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)

- All conclusions from baseline remain valid

- Bank-level

- Country-level

## 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