The Impact of Privatization on the Micro-behaviour and Performance of Chinese...

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CITY UNIVERSITY OF HONG KONG

香港城市大學

The Impact of Privatization on the

Micro-behaviour and Performance

of Chinese Banks

私營化對中國的銀行微行為和業績的影響

Submitted to College of Business

商學院 In Partial Fulfillment of the Requirements

for the Degree of Doctor of Business Administration 工商管理學博士學位

by

Tang Chin Tong Aaron 鄧展堂

August 2011 二零一一年八月

BANK PRIVATIZATION AND PERFORMANCE i

CONTENTS

ABSTRACT iii ACKNOWLEDGMENTS v LIST OF TABLES vi LIST OF FIGURES viii LIST OF APPENDICES ix ABBREVIATIONS AND ACRONYMS x1. INTRODUCTION 12. LITERATURE REVIEW 5 Definition and Motives of Privatization 5 Privatization 6 Bank Privatization 8 Case Studies in Bank Privatization 17 Summary of Prior Studies in Bank Privatization 22 Changes in Micro-behaviour 37 Corporate Governance 41 Risk-taking Behaviour 45 Endogenous Factors 46 Exogenous Factors 473. DEVELOPMENTS IN CHINESE BANKING SECTOR 50 Background 50 Regulatory Reforms in Domestic Banking Sector 55 Reforms in International Banking Sector 69 Market Studies of Domestic Banking Sector 734. EMPIRICAL ANALYSIS 77 Research Design 77 Sample and Observations 77 Empirical Model 82 Dependent and Explanatory Variables 86 Data Cleansing 94 Selection of Explanatory Variables 102 Empirical Results 1075. CASE STUDIES OF BANK PRIVATIZATION 117 Selection of Case Studies 117 Study Framework and Interview Questions 118 Case 1: Industrial and Commercial Bank of China 123 Case 2: Bank of China 132 Case 3: China Construction Bank 145

BANK PRIVATIZATION AND PERFORMANCE ii

Case 4: Bank of Communications 152 Case 5: Shanghai Pudong Development Bank 160 Case 6: Bank of Shanghai 167 Case 7: Bank of Beijing 173 Case 8: Bank of Hangzhou 178 Case 9: Qilu Bank 184 Case 10: Anonymous Bank 189 Observations and Discussions 192 Chapter Summary 2046. OTHER CASES OF BANK PRIVATIZATION 206 Other Cases 206 Recent Development 211 Discussions 2147. CONCLUSIONS AND RECOMMENDATIONS 221 Conclusions 221 Recommendations 226 BIBLIOGRAPHY 229 APPENDICES 243

BANK PRIVATIZATION AND PERFORMANCE iii

ABSTRACTS

This paper examines the relationship between changes in performance and the

process of privatization of state-owned commercial banks, joint-stock commercial banks

and city commercial banks in Mainland China. Changes in performances are

measured in terms of financial performance, corporate governance and risk-taking

behaviour. Panel data collected between 2000 and 2007 from 104 banks with a total of

445 observations are analyzed. The empirical results indicate that city commercial

banks out-performed state-owned commercial banks and joint-stock commercial banks,

listed banks out-performed non-listed banks, and banks with foreign-ownership are

generally more profitable. Foreign ownership and listing on stock exchanges added

value to the Chinese banks. Ten cases provide insights into bank-specific behaviour

and performance that cannot be captured in cross-sectional quantitative analysis. They

further indicate that foreign-ownership brought about a positive impact on corporate

governance by enhancing management through exposure to international market

practices while it did not necessarily create the anticipated business opportunities. The

objectives of introducing foreign strategic investors are examined; the outcomes and

problems encountered are assessed. I conclude it is doubtful the original objectives of

introducing foreign investors to resolve problems facing the Chinese banks and to open

up new business opportunities to them have been achieved. The foreign strategic

investors brought about improvements in corporate governance and risk-taking

capability but the transfer of expert knowledge and state-of-art technical skills was

limited. The domestic collaborations between foreign strategic investors and Chinese

banks produced limited achievements. The major conclusions drawn are that

privatization itself is insufficient to bring about performance improvements and needs

other changes such as corporate governance and risk-taking behaviour, and with

genuine changes in corporate culture. While foreign participation is better than no

BANK PRIVATIZATION AND PERFORMANCE iv

foreign participation, the importance of choosing an appropriate foreign investor is

equally important and a genuine change in corporate culture is a must, including the

independent directors acting to provide a system of checks and balances with the

external auditor as the third line of defence.

BANK PRIVATIZATION AND PERFORMANCE v

ACKNOWLEDGMENTS

I owe a great deal of gratitude to many people who have helped me throughout my

academic curriculum. First and foremost I would thank my supervisor Prof. Ho Yan

Ki Richard. He has given me much time and devotion. His constructive feedback

and insightful comments have helped shape my thesis. I would also thank Prof.

Kumar Kuldeep for his guidance and inspiring ideas throughout the coursework

component of the curriculum.

I would like to express appreciation to Prof. Lee Kwok On Matthew and Dr. Wong

Chak Sham Michael for their attendance at the thesis proposal committee with many

helpful comments and advice; Prof. Tang Y. N. Gordon, Dr. Wong Chak Sham Michael

and Dr. Fang Zhenmin for their participation in the thesis examination; and the

anonymous participants who granted me an interview and shared with me their

invaluable experience with the respective Chinese banks and foreign strategic investors.

I would also like to express my gratitude to the staff at the College of Business

who provided me with much support and administrative guidance.

Last but not least, I would like to thank my wife Shirley for her love and support

throughout this endeavour. Completion of the research and the writing of this thesis

would not have been possible without her.

BANK PRIVATIZATION AND PERFORMANCE vi

LIST OF TABLES

Table 1 Summary of prior studies in bank privatization 23Table 2 Chronology of major regulatory reforms in the Chinese banking

sector by The People’s Bank of China, up to and including 2003 60

Table 3 Chronology of major regulatory reforms in the Chinese banking sector by China Banking Regulatory Commission, since 2003

62

Table 4 Distribution of sample observations 82Table 5 Description of dependent and explanatory variables 91Table 6 Summarized descriptive statistics of dependent and explanatory

variables 95

Table 7 t-test for equality of means between types of banks 97Table 8 t-test for equality of means between privatized and

non-privatized banks 100

Table 9 t-test for equality of means between listed and non-listed banks 101Table 10 Correlation of explanatory variables with return on total assets

and return on equity 103

Table 11 Sub-groups of tied explanatory variables 105Table 12 Results of final model equation and stepwise regression 109Table 13 Questions in semi-structured interview 119Table 14

Summarized key operating indicators of Industrial and Commercial Bank of China

126

Table 15 Summarized key operating indicators of Bank of China 135Table 16 Summarized key operating indicators of China Construction

Bank 147

Table 17 Summarized key operating indicators of Bank of Communications

154

Table 18 Summarized key operating indicators of Shanghai Pudong Development Bank

162

Table 19 Operating revenues by region of Shanghai Pudong Development Bank

165

Table 20 Summarized key operating indicators of Bank of Shanghai 169Table 21 Summarized key operating indicators of Bank of Beijing 175Table 22 Summarized key operating indicators of Bank of Hangzhou 179Table 23 Summarized key operating indicators of Qilu Bank 186Table 24 Summary of privatization case studies: changes in corporate

governance, micro-behaviour and performance 196

Table 25

Foreign ownership of Chinese banks, as at year-end 2007 207

BANK PRIVATIZATION AND PERFORMANCE vii

Table 26 Proposed foreign ownership of Chinese city commercial banks, as at year-end 2008

210

Table 27 Ownership of Chinese banks by other domestic banks, as at year-end 2008

219

Table 28 Nominal GDP and nominal GDP growth rate, 2000-2007 256Table 29 Results of revised model equation and stepwise regression 257Table 30 Results of revised model equation and stepwise regression 260Table 31 Results of revised model equation and stepwise regression of

sub-sample 262

BANK PRIVATIZATION AND PERFORMANCE viii

LIST OF FIGURES

Figure 1 Quarter-end balance of total assets of the Chinese banking institutions, 2003 to mid-2010

52

Figure 2 Quarter-end balance of total liabilities of the Chinese banking institutions, 2003 to mid-2010

53

Figure 3 Quarter-end balance of non-performing loans by five-category loan classification of the Chinese commercial banks, 2004 to mid-2010

54

Figure 4 Major regulations and guidelines of Bank for International Settlements, The People’s Bank of China and China Banking Regulatory Commission, 2000 to mid-2010

72

Figure 5 Causal relationship of ownership structure, micro-behaviour, endogenous factors, exogenous factors and performance

83

Figure 6 Return on total assets of the Chinese banks, 2000-2009 193Figure 7 Regional average figures of return on total assets, 2000-2009 194

BANK PRIVATIZATION AND PERFORMANCE ix

LIST OF APPENDICES

Appendix 1 List of the Chinese banks in the empirical analysis, as at year-end 2007

243

Appendix 2 Pearson correlation coefficients of dependent and explanatory variables

250

Appendix 3 Use of macroeconomic variable instead of year dummy variables

256

Appendix 4 Use of dummy variable privatized instead of state-owned percent

259

Appendix 5 Analysis of sub-sample 261

BANK PRIVATIZATION AND PERFORMANCE x

ABBREVIATIONS AND ACRONYMS

ABC Agricultural Bank of China ADB Asian Development Bank BIS Bank for International Settlements BOC Bank of China BOCom Bank of Communications CAD Canadian dollar CAR capital adequacy ratio CBA Commonwealth Bank of Australia CBRC China Banking Regulatory Commission CCB China Construction Bank CMBC China Minsheng Banking Corporation CNY Chinese yuan or renminbi COAMC China Orient Asset Management Corporation CRCBank Chongqing Rural Commercial Bank EUR euro GBP pound sterling GDP gross domestic products HKD Hong Kong dollar HSBC The Hongkong and Shanghai Banking Corporation Huijin China SAFE Investments Limited (formerly known as “Central

Huijin Investment Limited”) HzBank Bank of Hangzhou ICBC Industrial and Commercial Bank of China IFC International Finance Corporation IMF International Monetary Fund LCFR la Compagnie Financière Edmond de Rothschild Banque MOF Ministry of Finance MOP Macanese pataca NPL non-performing loan PBOC The People’s Bank of China RBS Group Royal Bank of Scotland Group ROA return on total assets ROE return on equity ShacomBank Shanghai Commercial Bank SPDB Shanghai Pudong Development Bank THB Thai baht USD United States dollar

BANK PRIVATIZATION AND PERFORMANCE xi

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BANK PRIVATIZATION AND PERFORMANCE 1

CHAPTER 1

INTRODUCTION

The theoretical advantages and disadvantages of state-ownership have been

vigorously debated with most empirical studies concluding that privately-owned

companies perform better than state-owned firms (Caves, 1990; Megginson and Netter,

2001; Shirley and Walsh, 2000). Empirical research focused on privatized banks and

state-owned banks have reached similar conclusions (Beck et al., 2005a, 2005b; Berger

et al., 2005; Bonin et al., 2005b; Boubakri et al., 2005; Caves, 1990; Clarke et al., 2005a;

Cull and Clarke, 1998; D’Souza et al., 2006; Fries and Taci, 2005; Fu and Heffernan,

2008 ; la Porta et al., 2002a; Megginson, 2005; Megginson and Netter, 2001; Mohieldin

and Nasr, 2007; Nakane and Weintraub, 2005; Omran, 2007; Shirley and Walsh, 2000;

Otchere, 2007; Verbrugge et al., 1999). Profitability, efficiency and productivity are

higher in privatized banks than state-owned banks, and are inversely related to the

percentage stake of government.

This paper examines the relationship between changes in performance and the

process of privatization of state-owned commercial banks, joint-stock commercial banks

and city commercial banks in China between 2000 and 2007. The focus is on whether

the elements of best practices also apply in a fast growing, fast developing banking

sector in China. Changes in performances are measured from the three perspectives of

financial performance, corporate governance and risk-taking behaviour. The empirical

results demonstrate the effects on bank performance of bank privatization in the

contexts of state ownership, foreign ownership and foreign directors. The case studies

presented further indicated that foreign ownership brought about positive impact on

corporate governance by enhancing management through exposures to international

market practices but it did not necessarily create the anticipated business opportunities.

A study of bank privatization in China is important for several reasons. Firstly, an


important distinguishing characteristic of the Chinese experience is the extensive

influence of state and local government over privatized commercial banks. Notably,

the process of privatization usually involves majority equity shareholdings being

allocated to state-owned enterprises or state-owned investment funds. Although the

state or local government maintains a relatively small percentage of equity holdings in

the privatized commercial bank, they are still able to exert dominant but

disproportionate political influence. As a result, such commercial banks are essentially

privatized in terms of their legal form but are not in substance. A second

distinguishing characteristic is that the level of foreign ownership is relatively small and

the single largest foreign ownership is capped at 20% by domestic regulations. Thus,

foreign investors cannot effectively hold a controlling stake in a commercial bank in

Mainland China. This study contributes to the literature because its covers the effects

of foreign ownership in privatization in the context of substantial state intervention.

Thirdly, the literature documents the effect of privatization on performance for

state-owned commercial banks and joint-stock commercial banks in Mainland China.

Empirical evidence is mixed and the majority of studies make their observations in the

period prior to 2003, when China Banking Regulatory Commission (“CBRC”) took

over bank supervision from The People’s Bank of China (“PBOC”) and relaxed foreign

equity investment in Chinese financial institutions. This study enhances the literature

because it covers city commercial banks as well as evidence from the periods following

these regulatory changes.

To understand the role and significance of foreign ownership in bank privatization,

this study examines the associations between foreign ownership on corporate

governance and risk-taking behaviour on one hand and bank performance on the other.

The investigation is based on an empirical analysis into the relationships between

corporate governance, risk-taking activities and bank performance. The objectives of


this study are four-fold: firstly, to describe the approach to bank privatization in

Mainland China with special reference to extensive state-ownership; secondly, to

address the role and influence of foreign ownership on the Chinese banks; thirdly, to

provide empirical and descriptive evidence about changes in the performance of the

Chinese banks prior to and subsequent to privatization; and lastly, to draw conclusions

and formulate recommendations for other Chinese banks that are in the process of

selecting or planning to invite foreign ownership. These objectives aim to establish

quantitatively whether changes in micro-behaviour of the Chinese commercial banks

have indeed facilitated improvements in bank performance. The study compares bank

performance before changes in micro-behaviour with subsequent performance, which is

quantified in terms of corporate governance and risk-taking behaviour components.

There are several types of corporate governance and risk-taking behaviour indicators

specified in the study: changes in corporate governance due to bank privatization,

changes in equity shareholding by government, investment by foreign investors, foreign

board members, foreign management and listing in a stock exchange. Changes in

risk-taking behaviour are assessed through changes of capital adequacy ratio, loan

concentration ratios, non-performing loans ratio, and loan-deposit ratio. The results

shed light on several important questions. Does bank privatization lead to better bank

performance? Does listing in a recognized stock exchange lead to better bank

performance? Do foreign strategic investors cherry-pick their investments? In order

to address these issues, this study focuses on the empirical relationship between bank

corporate governance, bank risk-taking behaviour and bank performance. The major

conclusions drawn are that privatization itself is insufficient to bring about

post-privatization performance improvements and needs other changes such as

corporate governance and risk-taking behaviour, and with genuine changes in corporate

culture.


This paper is organized as follows. Chapter 2 reviews the literature on

privatization, corporate governance, risk-taking behaviour and performance. Chapter 3

provides background on the historical evolution of the Chinese banking sector, the

supervision of CBRC, and market concerns. Chapter 4 uses bank-level data to analyze

casual relationships, if any, between profitability, corporate governance and level of

risk-taking activities. Chapter 5 summarizes the findings of ten case studies,

discussing particularly variation in outcomes and interprets interviews with foreign

strategic investors, directors and management. Chapter 6 discusses the observations in

other cases of Chinese bank privatization and further developments. Finally, Chapter 7

reviews and concludes with attempts to draw lessons and propose recommendations for

other Chinese banks.


CHAPTER 2

LITERATURE REVIEW

Definition and Motives of Privatization

Privatization can be interpreted in different ways. In the broad sense,

privatization refers to the divestiture of a state-owned enterprise through various

techniques. In the narrow sense, privatization implies permanent transfer of control,

whether as a consequence of a transfer of ownership right, from a public agency to one

or more private parties (Guislain, 1997). Boycko et al. (1996) describe privatization as

a strategy to reduce inefficiency of public enterprises and a combination of reallocation

of control rights over employment from politicians to managers and the increase in cash

flow ownership of managers and private investors. Shirley (1999) defines

privatization as the sale of state-owned assets, and thus an enterprise is no longer

state-owned when management control is passed to private shareholders. Management

control is defined as the right to appoint the managers and board of directors.

Megginson and Netter (2001) view privatization as the deliberate sale by a government

of state-owned enterprises or assets to private economic agents. In this study, I adopt

the definition proposed by Megginson and Netter (2001) and the narrow sense by

Guislain (1997).

A critical factor behind a government’s motive in privatization is the

widely-documented poor performance of state-owned enterprises or public enterprises.

Boycko et al. (1996) see privatization as a strategy available to the reformers to reduce

inefficiency of public enterprises. Megginson (2005) explains the inefficiency of

state-owned enterprises as a consequence of managers lacking adequate incentives to

maximize revenues or minimize costs. State-owned enterprises are also subject to less

intense monitoring by the politicians who oversee them; there is commonly a

commitment to avoid bankruptcy of poorly performing state-owned enterprises. Lastly,


state-owned enterprises are exploited by politicians to benefit their own. Liu et al.

(2006) argue that the willingness of government to privatize does not necessarily assure

the success of privatization which will be a product of the particular economic and

socio-political constraints at play in the particular context. Liu et al. (2006) analyze

the political economy of Chinese-style privatization from the perspective of local

government. Following the fiscal and monetary centralization and budget constraints

on local governments, local government officials have to assume primary responsibility

for local economies. Intensive cross-regional competition drives local governments to

privatize their state-owned enterprises, hoping thus to create greater incentive for

managers to improve the enterprises’ competitiveness, which in turn fuels increases in

the fiscal revenue of local governments.

Privatization

The early works of Caves (1990) explore the use of privatization and liberalization

to achieve allocative efficiency and productive efficiency. The fundamental question

of the relative performance of the privatized enterprises under public and private

ownership cannot be immediately answered as the benefits derived from privatization

will require to be revealed. In addition, the process of privatization has led to changes

in the behaviour of state-owned enterprises especially in terms of corporate governance.

It is arguable that privatization can enhance productive efficiency in ideal circumstances

where there is a perfectly functioning market for corporate control in the private sector

and efficient executive compensation contracts that align with incentives of managers

with the shareholders’ interest in maximizing profits. Privatization can also enhance

allocative efficiency as a result of the shift in objectives towards maximizing its profits.

Shirley (1999) highlights the principal criticism of state-owned enterprises, namely that

motivation to hold management accountable for performance is lacking since no one

stands to gain from a state-owned enterprise’s efficient operation and market incentives


fail to discipline managers who are not maximizing profits since no one has a clear

claim over the residual assets of the state-owned enterprise. Managers, bureaucrats

and politicians instead use their control of state-owned enterprises to further their

personal interests rather than the enterprises’ efficiency. The prolonged debates over

public and private ownership (Boycko et al., 1996; Caves, 1990; Guislain, 1997;

Havrylyshyn and McGettigan, 1999; Nellis, 1999; Shirley, 1999; Xu and Wang, 1997)

are reviewed by Shirley and Walsh (2000) who assess the arguments, identifying three

key questions: (i) does competition matter more than ownership? (ii) are state

enterprises more subject to welfare reducing interventions by government than private

firms are? and (iii) do state enterprises suffer more from governance problems than

private firms do? The review found greatest ambiguity surrounding the merits of

privatization and private ownership. In the debate over competition, theory suggested

that ownership may matter and if so, then private firms will outperform state-owned

enterprises. The subsequent review of Kikeri and Kolo (2005) also shows that

privatization is neither a panacea nor a universal solution that could be easily applied to

all countries and sectors. Policies and approaches have to be varied with the particular

circumstances of the country and sector. Although many studies examining

post-privatization changes record significant increases in output, efficiency, profitability

and capital investment spending and significant declines in leverage, Megginson and

Sutter (2006) were unable to find any one consistent or universal effect of privatization.

Differences in impacts are variable across countries and industries and there appears to

be no standard outcome.

Megginson and Netter (2001) also survey theoretical and empirical research on

relative economic performance of state-owned and private-owned enterprises aiming to

establish the extent to which privatization programs have actually improved the

economic and financial performance of privatized enterprises. Contrary to the findings


of Shirley and Walsh (2000), Megginson and Netter (2001) found consistent evidence of

significant relationship. Their findings suggest that private ownership can lead to

better firm-level performance than continued state-ownership; foreign ownership, when

allowed, is associated with greater post-privatization performance improvement than

purely domestic ownership; firm-level restructuring is associated with significant

post-privatization performance improvements; performance improves more when new

managers are brought in to run a firm after it is privatized than when the original

managers are retained; and for smaller firms, improvements in performance decline over

time. D’Souza et al. (2007) looked at how restructuring and corporate governance

changes affect the firm’s post-privatization performance. They argue that there is

ample evidence of the economic benefits of privatization, and the issue is no longer

whether privatization leads to performance improvements but rather why those

post-privatization performance improvements occur. The results suggest that both

restructuring and corporate governance changes are important determinants of

post-privatization performance, and the relative shares of post-privatization ownership

by the state, foreign investors and employees are an important indicator of the firm’s

success following privatization.

Bank Privatization

Moving to the empirical literature analyzing the banking sector, the current study

reviews previous research on bank privatization focused on ownership structure, process,

listing and performance. Dittus (1994) investigates whether bank behaviour has

changed as a reaction to banking reform and changes in the market environment in the

former Czechoslovakia, Hungary and Poland. The results indicate that banks have

become more prudent in their lending behaviour and it is argued that this change is

linked to the changes in the economic and legal environment that banks are facing.

Clarke and Cull (1999) analyze the performance of Argentina’s banks before and after


privatization and estimate fiscal savings associated with Argentina’s bank privatization

as opposed to keeping them public and later recapitalizing them. The results suggest

that improved regulation and supervision alone do not deliver the same results as when

such measures are combined with privatization as the state-owned banks remaining in

the public sector did not demonstrate the same performance levels as the privatized

banks.

Verbrugge et al. (1999) consider 65 bank privatizations that use public security

offerings as the divestment mechanism. Their results document limited improvements

in bank profitability, operating efficiency, leverage and non-interest revenue after

privatization. Substantial government ownership of banks continued even after

privatization which may raise serious problems establishing market-oriented governance

and decision-making systems in the newly-privatized banks. The governments are

reluctant to surrender control over commercial banks since credit and direct grants are

important components in the engine of political control in economies where state-owned

enterprises are dominant. These observations bear a close resemblance to the context

of Mainland China.

La Porta et al. (2002a) examined the government ownership of banks making use

of data on state-owned banks from 92 countries, addressing four related questions: (i)

how significant is government ownership of banks in different countries? (ii) what types

of countries have more government ownership of banks? (iii) does government

ownership of banks promote subsequent financial development? and (iv) does

government ownership of banks promote subsequent economic growth and, in

consequence, how does it effect factor accumulation, savings, and growth of

productivity? The findings confirm that government ownership remains substantial

and prevalent around the world and is larger in countries with low per capita income,

undeveloped financial systems, interventionist and inefficient governments.


Government ownership in the past has been associated with slower subsequent financial

development and per capita income.

Megginson (2005) surveys the empirical literature examining bank privatization by

documenting the extent of, theoretical rationale for, and measured performance of

stated-owned banks around the world, and assesses why many governments have

chosen to privatize their very large state-owned banks. The findings showed that while

state-owned banks are less efficient than privately owned banks there was little evidence

to suggest that privatization alone can transform the efficiency of divested banks,

especially when they are only partially privatized. A number of important issues and

questions are proposed to ensure successful bank privatization. Minimum conditions

include the government acting as a passive investor if it retains partial ownership;

effective methods of dealing with bad loans during the privatization process; ending the

propensity and culture to lend to state-owned enterprises after privatization;

development of a bank regulatory system; avoiding the establishment of full deposit

insurance schemes; and an emphasis on sales to foreign owners.

Clarke et al. (2005a) explored whether and under what circumstances privatization

will improve bank performance asking five questions: (i) how does privatization affect

bank performance on average? (ii) are benefits smaller when the government retains

some ownership of the privatized bank? (iii) does the method of privatization affect

outcomes? (iv) are outcomes better when foreign owned banks are allowed to purchase

privatized banks? and (v) what is the interaction between privatization and competition?

The case studies and cross-country analysis support the conclusion that privatization

improves performance and raises competition. However, various policies undermined

the improvements: continued state ownership; concentrated strategic investors in weak

institutional environments; prohibiting foreign participation in the privatization process;

oligopolistic banking and foreign banks tendency to be more prudent which may result


in lending in weak regulatory environment. Although bank privatization usually

improves bank efficiency, Clarke et al. (2005a) argue that the gains are greater when

government fully relinquishes control, banks are privatized to strategic investors,

foreign banks are allowed to participate in the privatization process and the government

does not restrict competition.

Berger et al. (2005) analyze the static, selection and dynamic effects of domestic,

foreign and state ownership on bank performance. Their studies of U.S. corporations

regard “governance” as the methods shareholders use to reduce managerial agency cost,

such as board composition, voting rules, and stakes held by managers; whereas studies

outside U.S., especially in developing countries, focus on the role of ownership in

reducing the agency problems. Berger et al. (2005) argue that it is important to

account for the static, selection and dynamic effects of all the major types of governance

and tested the effects of governance on bank performance in Argentina. The research

concludes that state-owned banks tend to have poorer long-term performance on

average than domestically or foreign-owned banks.

Boubakri et al. (2005) examine the post-privatization performance of 81 banks

from 22 developing countries. The results suggest that on average, banks chosen for

privatization have a lower economic efficiency and a lower solvency than banks kept

under government ownership; in the post-privatization period, profitability increases but,

depending on the type of ownership, levels of efficiency, risk exposure and

capitalization may worsen or improve; over time, privatization yields significant

improvements in economic efficiency and credit risk exposure and newly privatized

banks that are controlled by local industrial groups become more exposed to credit risk

and interest rate risk after privatization.

Another cross-country study by Fries and Taci (2005) compare the cost efficiency

of banks in East European countries using a two-step procedure. The estimated bank


inefficiency measures were obtained from the estimation of the stochastic cost

efficiency frontier, and then regressed on a set of variables that are associated with

management at the bank level. The results reveal that at the country-level, banking

systems with a higher share of majority foreign owned banks in total assets have a

larger ratio of capital to total assets and tend to have lower costs. At the bank level,

privatized banks are significantly more efficient than state-owned banks.

The impact of bank privatization in six transition countries (Bulgaria, the Czech

Republic, Croatia, Hungary, Poland and Romania) is investigated by Bonin et al.

(2005b). The empirical results provide evidence of the influence of ownership on the

performance of individual banks and support the hypothesis that foreign-owned banks

are more efficient, confirming the importance of attracting foreign strategic investors.

Bonin et al. (2005b) conclude that both the method and timing of privatization are

significant factors impacting on performance.

Nakane and Weintraub (2005) studied the impact of the privatization of

state-owned banks on productivity in Brazilian banking industry, following the

methodology of Berger et al. (2005) with variables controlled for static, selection and

dynamic effects. The results demonstrate that state-owned banks were less productive

than private-owned banks and suggest that privatization is a preferable strategy to

restructuring and keeping the banks under state control.

Beck et al. (2005a) analyze the different options − liquidation, federation,

privatization and restructuring − that the Brazilian governments faced for the

transformation of their state-owned banks. The evaluation considers how the

government chose between the different options and the effects of privatization,

federalization, and restructuring on the subsequent performance of the state-owned

banks. The results help to assess the effect of bank privatization on performance in

comparison with the effect of restructuring and remaining under government ownership.


It evaluates different approaches to privatization offering insight into the factors behind

the political process of bank privatization and the determinants of continued

government ownership of banks around the world. It also assesses the effect of

privatization on performance on Nigerian banks. The evidence here indicates

performance improvements in banks that were privatized and negative effects of the

continuing minority government ownership on the performance of many Nigerian

banks.

Changes in the financial and operational performance of Egyptian banks, as a

result of control being transferred from the state to the private sector are analyzed by

Omran (2007). By comparing pre-privatization and post-privatization performance

according to ownership structure, Omran (2007) finds that private-owned banks and

banks having a majority private ownership, including privatized banks, are more

profitable and efficient than state-owned and majority state-owned banks. Delfino

(2007) examines the effect of control changes on efficiency and productivity in

Argentina with similar conclusions that state-owned banks were less efficient than

domestic private competitors. Nevertheless, the results also show that bank

privatization provided positive short-term efficiency gains which were gradually lost

over time. The evidence here did not provide strong justification for widening foreign

access.

Mohieldin and Nasr (2007) also look at the privatization of the banking sector in

Egypt and assess the relative performance of the state-owned and private banks over the

period 1995-2005 based on indicators such as capital adequacy, asset quality, earnings

and profitability. Their results indicate that state-owned banks in Egypt lag behind in

terms of efficiency and performance, suggesting that retaining government ownership

can adversely affect performance.

From 2005, there was a sudden rush by foreign banks to purchase minority stakes


in Chinese banks in order to help those banks improve their performance and, through

the process, gained access to the extensive branch networks of those banks in Mainland

China with the aim of marketing their own products.1 A number of studies focus on

the privatization and performance of Chinese banks. Berger et al. (2009), Dobson and

Kashyap (2006), Hu et al. (2008), Kumbhakar and Wang (2007), Lin and Zhang (2009),

and Yao et al. (2008) assess the effect of ownership reform on performance and

efficiency. It is generally agreed that the state-owned commercial banks are less

profitable, less efficient and have worse asset quality than other types of banks, and that

privatization would lead to improved performance. Fu and Heffernan (2008) compare

state-owned and joint-stock commercial banks to explore the extent to which ownership

types affect economies of scale and scope, considering the influence of market structure

on bank performance through a comparison of city commercial banks and state-owned

commercial banks. Ferri (2009) accounts for the effect of geographical location and

local policy on bank performance, again finding worse performance from those banks

controlled by the state. Jia (2009) studies the relationship between ownership and

prudential (i.e. risk-taking) behaviour of Chinese banks, and suggest that accountability

to shareholders and depositors give joint-stock banks a better incentive than state-owned

banks to engage in prudent lending. Chen et al. (2009b) adopt a different perspective

by examining the identity of shareholders of China’s listed companies, grouping them

into those controlled by state asset management bureaus, state-owned enterprises

affiliated to the central government, and state-owned enterprises affiliated to local

government and private investors. They argue that these distinct types of shareholders

have different objectives and motivations which directly affect how they exercise 1 Examples of foreign banks investing in the Chinese banks included Allianz, American Express, Bank of America, Citigroup, Commonwealth Bank of Australia, Deutsche Bank, Goldman Sachs, Hongkong and Shanghai Banking Corporation, ING, Royal Bank of Scotland, Shanghai Commercial Bank, and UBS which are described in Chapter 5. Other examples included ANZ Bank, BNP Paribas, CIMB Group, Fubon Bank, Habib Bank, Hang Seng Bank, Intesa Sanpolo, Oversea-Chinese Banking Corporation, Rabobank, Rothschild Bank, Scotiabank and Wing Hang Bank which are described in Chapter 6.


control over the companies they invest in. The results of this study indicate that the

operational efficiency of the listed companies under investigation varied across the type

of controlling shareholders.

More recently, Lin and Zhang (2009) assess the effect of bank ownership on

performance by regressing Chinese banks’ performance measures (including return on

equity, return on assets, impaired assets to total loans, and costs to operating income) on

corporate ownership changes, following the methodology proposed by Berger et al.

(2005). The results indicated that the “Big Four”2 state-owned commercial banks are

less profitable, less efficient and have worse asset quality than city-level commercial

banks, domestic joint-equity banks and newly established Chinese-foreign joint-equity

banks and banks capitalized by foreign funds. The study finds that banks undergoing a

foreign acquisition or public listing record better pre-event performance than those that

do not. These results suggest that foreign investors may choose to acquire the banks

with stronger performance, or alternatively the government sells the equity of these

banks first in an effort to attract foreign and private investors. However no evidence

was found of a significant performance change following a foreign acquisition or public

listing, a result that is inconsistent with similar studies of other countries. While their

methodology and conclusions on the under-performance of the “Big Four” state-owned

commercial banks are plausible, Lin and Zhang (2009) may have erred in their

conclusions on post-event performance due to sampling bias. The observation period

of their study was 1997-2004 whereas all of the “Big Four” state-owned commercial

banks and most of the city commercial banks did not have foreign acquisition or

significant non-performing loans carve-out on during this period. The positive

post-event performance effect, if any, would not have materialized during their

2 The so-called “Big Four” state-owned commercial banks are Agricultural Bank of China, Industrial and Commercial Bank of China, Bank of China and China Construction Bank.


observation period. The study consisted of an unbalanced sample of only 3-26 city

commercial banks and during the relevant period, a handful of city commercial banks

were merged, absorbed and/or restructured. Their sample was restricted to

comparisons between the surviving city commercial banks and the “Big Four”

state-owned commercial banks.

Instead of studying the effect of ownership structure on post-privatization

performance, Hawes and Chiu (2007) discusses the differences in corporate cultures

between the Chinese banks and Western banks in terms of how these differences may

obstruct their ability to work together for mutual benefit, arguing that Western banks

need to modify their basic assumptions about doing business in China if they wish to

maintain harmonious relationships with their Chinese strategic partners and succeed in

China over the long term. Nolan (2010) investigates the variety of institutional forces

which influences the adoption of Western corporate governance mechanisms in the

Chinese banks. Internal governance mechanisms, such as the board of directors and

diversified ownership structures have been widely adopted. The perception appears

that the majority shareholder in most banks remains the state and the inclusion of

foreign shareholders and non-executive directors does not resolve the principal-agent

problem. Baradwaj et al. (2008) compare the Chinese banks with U.S. banks in terms

of bank size, growth rate, liquidity risk, profitability, efficiency and capital adequacy

and suggest that the Chinese banking reforms have achieved moderate success.

McGuinness and Keasey (2010) also studied six Chinese state-owned commercial banks

to examine how these banks were reorganized for initial public offering, in terms of the

removal of non-performing loans and the massive recapitalization of the banks’ balance

sheets, and whether the banks were able to retain market share, further commercialize

and enhance overall financial positions post-listing. The results show that post-initial

public offering the banks have significantly improved profitability, book loan size, book


loan quality and capital reserve protection. The key issue addressed is the extent to

which the banks’ desire to reform and commercialize have been implemented

post-listing. Foreign investors have retained sizable holdings and exert influence on

the bank’s day-to-day activities through board participation and the creation and

expansion of joint ventures. McGuinness and Keasey (2010) conclude that the success

of China’s leading state-owned commercial banks reflects their growing commercial

orientation and a clearly defined strategy to consolidate market share.

Foreign investment in Chinese banks led to the introduction of new management

perspective and practice. Consequently, bank strategies have shifted to focus more on

cost reduction, exploring new business opportunities and technology implementation.

For privatization to be successful, Megginson (2005) suggests a set of preconditions,

inter alia: (i) full privatization is preferable; (ii) effective methods of dealing with bad

loans are needed prior to and/or during the privatization process; (iii) an end to the

propensity and culture of banks to lend to state-owned enterprises; (iv) a regulatory

system that is sufficiently independent from political influence; (v) avoiding the

establishment of 100% deposit insurance; and (vi) sales to foreign owners, particularly

foreign commercial banks, in order to attract the required capital, expertise, technology

and financial legitimacy.

Case Studies in Bank Privatization

In addition to studying the effect of privatization on bank performance through

quantitative approaches, a number of qualitative case studies have been conducted on

privatization of commercial banks in particular countries and privatization of individual

banks which merit consideration. Snyder and Kormendi (1997) study the

transformation of the Czech Republic’s largest commercial bank, Komerční Banka, into

smaller organization units. Their objective is to determine how elements of the

transactional structure influence the bank’s market position, business strategy, and


performance with focus on the bank’s franchise value, corporate governance and the

government’s influence on allocation of credit. The study finds no incidence of

privatization where no capital is raised, no strategic foreign investors are enlisted, and

the government failed to yield control to new equity holders. Abarbanell and

Meyendorff (1997) examine the disbanding of one of Russia’s five specialized banks,

Zhilsotsbank, and the subsequent creation and performance of its successor,

Mosbusinessbank. The primary objective is to differentiate the Russian approach from

the approaches followed in Central Europe in order to gain insights into how methods of

privatization can influence subsequent bank organization, corporate governance,

competitive position and performance. Although the disbandment achieved a speedy

transfer of property rights to private owners, it failed to transfer effective control rights

to them. The case of Mosbusinessbank serves as an example of agency problems that

occur in the absence of effective corporate governance, monitoring, and voting rights

mechanisms. Abarbanell and Bonin (1997) look at the privatization of Bank Ślaski,

one of nine regional commercial banks in Poland aiming to describe the policies

relevant to the privatization process and assess the roles and influence of sector-wide

conditions on the bank’s subsequent organization, competitive position, corporate

governance and financial performance. Their secondary objective is to link bank

privatization strategies in Poland to overall banking reform. A critical lesson learnt

from the privatization of Bank Ślaski is the importance of a foreign investor assuming

an active role in the development strategy to bring about the fundamental changes

necessary. For bank privatization to succeed, a complete disengagement is required

from the government, enabling governance, the operation and ultimate control of the

bank to be fully transferred to new, preferably private, owners.

Meyendorff and Snyder (1997) generalize the findings from the three case studies

above, observing evidence of the effects of the transactional structure of bank


privatization on bank micro-behaviour and performance. The conclusions drawn from

their analysis include the fact that creating only one large commercial bank impedes

privatization; recapitalization and privatization should be closely linked to maximize the

value of the privatized bank and decrease the expectation of a future bailout; there are

benefits to rapid privatization; effective mechanisms for corporate governance need to

be in place; foreign strategic investors contribute to the efficiency and health of

privatized banks and product market competition is an important complement to the

privatization of state-owned banks. Bonin and Wachtel (1999) examine the interaction

between bank restructuring and bank privatization in Poland, Hungary and the Czech

Republic. These three countries initiated financial sector reform at about the same

time but took different approaches to the sequencing of bank restructuring and

privatization. Three stages are identified in the development of the banking sector in

transitional economies, namely: (i) establishment of commercial banks as joint-stock

companies; (ii) restructuring of bank portfolios and recapitalization of the banks; and

(iii) transfer of ownership from the government. The lessons drawn suggest that

proper sequencing is important, credible transfer of control from the state is crucial and

foreign ownership and participation is essential and inevitable. The proper corporate

culture is established by attracting strategic investor.

The differing corporate cultures between Chinese and foreign banks are explored

by Hawes and Chiu (2007). Neale and Bozsik (2001) describe a set of mini-case

studies in Hungarian bank privatization. The study described each of the main

privatizations to highlight the variety of methods applied, as dictated by differences in

bank circumstances and prevailing financial conditions. The Hungarian experience

offers useful lessons to other transitional economies facing similar issues. Otchere and

Chan (2003) analyze the effect of the privatization of the Commonwealth Bank of

Australia (“CBA”) on the bank’s performance and that of rival banks. CBA is one of


the few privatized banks where government ownership is eliminated after two

subsequent offerings following the initial partial privatization. This study notes that

the bank’s long term stock performance improved markedly as the proportion of

government ownership decreased. The implication is that full privatization is

necessary in order to achieve strong gains in efficiency, profitability, and stock market

performance. Kang (2003) describes the restructuring of Seoul Bank, which remained

a government-owned bank following the introduction of a new management team when

the bank was sold to Hana Bank in a merger transaction. The restructuring of Seoul

Bank raised a number of issues surrounding the roles of the government and board of

directors, and other governance issues. One major issue is the timing of the

privatization of a state-owned bank. Premature attempts to sell the bank may distract

management and employees from restructuring efforts. Other governance issues are to

prevent the bank from making arbitrary credit decisions so as to minimize future credit

losses, and the need to check and prevent moral hazard of the chief executive and the

management from abusing their power. Kang (2003) suggests the introduction of a

board structure in which outside directors are in a majority and the establishment of an

audit committee with a standing auditor.

Sun and Tobin (2005) considered the listing of Bank of China (Hong Kong),

suggesting that international listing can provide an effective mechanism to mitigate the

consequence of discretionary policies and managerial opportunism at home because the

bank is disciplined and regulated by a more developed capital market outside the home

jurisdiction. Chen et al. (2005) also looked at the partial privatization of Bank of

China (Hong Kong) and argue that there are a number of issues to be addressed when

China privatizes other major banks − namely, reform in corporate governance,

separation of ownership and control, greater access for foreign private investors and

foreign banks to participate in ownership and control. Mohieldin and Nasr (2007)


explore the factors hindering smooth implementation of bank privatization in Egypt,

identifying various pre-implementation constraints, such as the political sensitivity of

privatizing the banking sector in a country where the financial market is subject to a

significant degree of government intervention and state control; associated difficulties in

disclosure of genuine information on the quality of the state-owned banks’ portfolio;

and a lack of alternative investment opportunities. In the implementation of bank

privatization, impediments included pricing and valuation difficulties, financial

restructuring and resolution of the non-performing loans, and social concerns associated

with redundant employees and overstaffing. Post-privatization concerns include

retaining a majority or minority public sector ownership, trade-offs between stock

market offerings and anchor investors, and identification of effective sales strategies.

In summary, choosing a suitable approach and careful timing present critical policy

issues for the success of the privatization program.

Cull and Spreng (2008) studied the successful privatization of Tanzania’s National

Bank of Commerce, when the bank was split into the new National Bank of Commerce

and the National Microfinance Bank. As in other developing countries, sale to a

foreign strategic investor resulted in improved profitability and reductions in

non-performing loans. Keneley and McKenzie (2008) revisited the privatization

experience in the Australian banking and insurance sectors and with a focus on the

environment in which the banks were privatized. The study suggests that

technological changes and regulatory changes, the two most significant factors affecting

information costs in the banking sector, can create organizational change. Clarke et al.

(2009) looked at the privatization of the Uganda Commercial Bank which became part

of the South African bank Stanbic to test whether elements of best practices can apply in

a concentrated and under-developed banking sector. The study identified potential

pitfalls including the political difficulties and associated implications for performance


for the privatization of a domestic bank with extensive branch networks. It also noted

that shifts in strategy in post-privatization portfolio allocation are not without costs,

although these should decline over time.

Asian Development Bank (2009) studied the restructuring of state-owned Bank

Rakyat Indonesia. The lessons learnt are that effect methodologies of bank

restructuring differ, depending on the country context, but there are some fundamental

principles that should be applied in the restructuring of state-owned banks for successful

transformation. These are: (i) a banking sector as a whole must be conducive to

changes; (ii) an independent board of directors free of government interference and a

code of conduct are indispensable; (iii) restructuring banks need to expand their

outreach to other segments; and (iv) restructuring of a bank requires changes in the

corporate culture and mindset of both management and staff.

Summary of Prior Studies in Bank Privatization

A summary of the various approaches taken in earlier research on bank

privatization is depicted in Table 1. The vast majority of studies adopt a quantitative

approach to evaluate the collective effect of ownership structure, board composition and

board diversity on bank performance. Nevertheless, some studies use a qualitative

approach to describe in details the transactions and results of individual cases.


Table 1 Summary of prior studies in bank privatization (in chronological order)

Study

Sample, study period and methodology

Findings and conclusions

Dittus, 1994 studies changes in bank

behaviour in former

Czechoslovakia, Hungary and

Poland after banking reform

banks have become more

prudent in their lending

behaviour

Abarbanell and

Bonin, 1997

case study of Bank Ślaski in

Poland

illustrates the benefits of

attracting a strategic foreign

investor taking an active role in

the development of bank

strategy

Abarbanell and

Meyendorff, 1997

case study of Zhilsotsbank in

post-Communist Russia

agency problems in corporate

governance, monitoring and

voting rights mechanisms

Meyendorff and

Snyder, 1997

reviews case studies of Bank

Ślaski, Komerční Banka and

Zhilsotsbank

evidence about effects of

transactional structures of bank

privatizations on bank

microstructure and performance

Snyder and

Kormendi, 1997

case study on Komerční Banka

in the Czech Republic

lack of actual privatization

Bonin and

Wachtel, 1998

case studies of bank

privatization in Poland,

Hungary and the Czech

Republic

bank restructuring and

privatization have different

approaches and outcomes


Table 1 (Continued)

Study Sample, study period and

methodology


Cull and Clarke,

1998

comparison of bank

performance in Argentina

before and after privatization

bank privatization succeeds

only when accompanied by a

sound, incentive-compatible

system of prudent regulation

Clarke and Cull,

1999

comparison of provincial bank

performance in Argentina

before and after privatization

whether privatization helps

provincial banks is yet to be

examined, but initial indications

are promising

Verbrugge,

Megginson and

Owens, 1999

studies 65 bank privatizations

that use public security

offerings as the divestment

mechanism

limited improvement in bank

profitability, operating

efficiency, leverage and

non-interest revenue after

privatization

Neale and Bozsik,

2001

mini-case studies of Hungarian

bank privatizations

variety of methods applied

dictated by bank circumstances

and financial conditions

Dammert and

Lasagabaster, 2002

examines the factors leading to

the success or failure of the

bank privatizations

regulatory and supervisory

weakness are at the root of

privatization failures

Clarke, Cull and

Shirley, 2003

literature review of the effect of

privatization on bank

performance, privatization

literature grouped along three

continued government

ownership harms privatized

banks performance; prohibiting

foreign participation in


Table 1 (Continued)


methodology


themes: competition, political

intervention, and corporate

governance

privatization reduces gains from

direct sales and share issue

privatization

Gruben and

McComb, 2003

tests the competitiveness of the

Mexican banking commercial

banking system by estimating

an index of market power

in super-competition, banks

accept losses now because they

think the market share they get

would offer a positive present

value based on expected future

return

Kang, 2003 case study of restructuring of

Seoul Bank in South Korea

raises issues on the role of

government, the board and

governance

Levine, 2003 examines the corporate

governance of banks

it is important to strengthen the

ability of private investors with

incentives to exercise authority

over banks rather than relying

excessively on government

regulators

Otchere and Chan,

2003

case study of CBA in Australia full privatization is necessary in

order to achieve strong gains in

efficiency, profitability and

stock market performance

Ábel and Siklos, investigates the problems and a strategy of allowing foreign


Table 1 (Continued)


methodology


2004 choices in privatization of the

banking sector in Hungary

domination enabled dramatic

improvements in stability of the

banking sector

Haber, 2004 discussions on why Mexican

government privatization of

commercial banks failed in

1982 and allowed foreign firms

to purchase controlling interests

in restructured banks in 1997

producing disappointing results

institutions are necessary for

the creation of a stable

privatized banking system

Andrews, 2005 discusses the possible linkage

between state-owned banks,

privatization and banking sector

crises

policymakers in post crisis

countries have a greater

preference for private

ownership of banks

Beck, Crivelli and

Summerhill, 2005a

regression analysis of

performance (return on equity,

return on assets and overheads

costs/assets) based on size,

status, and time trend on 19

state banks in Brazil

privatized banks increased their

performance, but not

restructured banks

Beck, Cull and

Jerome, 2005b


performance based on different

regulatory systems, ownership

some positive performance

effects of privatization


Table 1 (Continued)


methodology


types, size, age, business

orientation, and loan portfolio

orientation of 69 banks in

Nigeria

Berger, Clarke,

Cull, Klapper and

Udell, 2005

regression analysis of bank

performance based on bank

portfolio allocations and

exogenous variables for 18

privatized banks in Argentina

privatized banks improved

dramatically after privatization

(dynamic effect)

Boehmer, Nash

and Netter, 2005

regression analysis of the

prospects for successful bank

privatization based on political,

institutional, and economic

factors for 101 countries

negative relationship between

probability of privatization and

bank quality is stronger in

developing countries

Bonin, Hasan and

Wachtel, 2005b


performance based on

ownership and privatization for

59 banks in Bulgaria, Czech

Republic, Croatia, Hungary,

Poland and Romania

government-owned banks are

less efficient with respect to

cost and profit

Boubakri, Cosset,

Fischer and

Guedhami, 2005

multivariate analysis of bank

performance (profitability,

efficiency, risk exposure and

long-term significant

improvement in efficiency and

credit risk exposure


Table 1 (Continued)


methodology


capital adequacy) based on

ownership, bank level and

country level variables for 81

banks in 22 countries

Chen, Li and

Moshirian, 2005

regression analysis of daily

returns based on market returns,

interest rates and privatization

event for 23 financial

institutions in Hong Kong and

China

rival financial institutions

reacted negatively to

privatization

Clarke and Cull,

2005

case study of Argentina’s

provincial bank privatization of

the 1990s

political constraints affect bank

privatization transactions

Clarke, Cull and

Shirley, 2005a

literature review on the effect of

privatization on firm

performance

continued state ownership

harms the performance of

privatized banks

Fries and Taci,

2005

cross-country comparisons of

cost efficiency

progress in banking reform has

a non-linear association with

cost efficiency; in the initial

stage of banking reform, cost

efficiency increases

significantly, but it then

declines as reforms advance


Table 1 (Continued)


methodology


further

Megginson, 2005 literature review on the extent

of and theoretical rationale for,

measured performance of

state-owned banks around the

world

privatization generally

improves performance; foreign

ownership in large-scale bank

privatization is positive in an

economic sense, but

problematic politically

Nakane and

Weintraub, 2005

regression analysis of bank

working assets based on labour,

other intermediaries,

communications, capital, and

time for 242 banks in Brazil

privatization increased

productivity

Otchere, 2005 t-test of daily market-adjusted

return across different event

periods of pre- and

post-privatized banks and their

rivals in middle- and

low-income countries

privatized banks

underperformed against market

and rival banks

Sun and Tobin,

2005

case study of Bank of China

(Hong Kong) in Hong Kong

international listing can provide

an effective mechanism to

mitigate the consequence of

discretionary policies and

managerial opportunism


Table 1 (Continued)


methodology


Williams and

Nguyen, 2005

examines the impact of changes

in governance on bank

performance in South East Asia

1990-2003

bank privatization and repeal of

state ownership on economic

grounds; the potential benefit of

foreign ownership may take

longer to be realized

Dobson and

Kashyap, 2006

appraisal of China’s gradualist

banking reforms

the five big banks (including

the “Big Four”) will not behave

like commercial banks if

Chinese government maintain

majority ownership

Fries, Neven,

Seabright and Taci,

2006

examines how market entry and

privatization affect the margins

and marginal costs of banks

privatized banks earn higher

margins

Jegasothy, Pham

and Tippet, 2006

estimated

ownership-performance model

using cross-sectional

time-series data and tests the

influence of ownership changes

on performance

results in improved

performance in regional banks,

but insignificant benefits in

major banks

Liu, Sun and Woo,

2006

identifies the motives of local

government leaders and the

constraints during privatization

of Chinese state-owned

the motivation of local

government to privatize

depends on expected economic

benefits and socio-political


Table 1 (Continued)


methodology


enterprises constraints

Delfino, 2007 examines effect of control

changes on efficiency and

productivity in the banking

industry of Argentina

control changes due to

privatization have positive

short-term effects on

productivity but gradually lost

over time

Hawes and Chiu,

2007

analyzes the phenomenon of

foreign banks purchasing

strategic stakes in Chinese

banks

Western banks need to modify

some of their basic assumptions

about how to do business in

China if they wish to maintain

harmonious relationships with

their Chinese strategic partners

Iannotta, Nocera

and Sironi, 2007

compares the performance and

risk of 181 large banks from 15

European countries 1999-2004

period and evaluate the impact

of alternative ownership models

a higher ownership

concentration is associated with

better loan quality, lower asset

risk and lower insolvency risk

Kumbhakar and

Wang, 2007

analyzes the impact of banking

reforms on efficiency and total

factor productivity in the

Chinese banking industry

joint-equity banks are more

efficient than wholly

state-owned banks

Mannsberger and

McBride, 2007

examines the two-step process

of bank privatization in Mexico

the bank privatization process

was characterized by


Table 1 (Continued)


methodology


in the 1990s inadequate regulatory and

financial controls which

permitted large-scale corruption

and fraud

Micco, Panizza

and Yañez, 2007

re-assesses the relationship

between bank ownership and

performance

state-owned banks in

developing countries are less

profitable than their private

counterparts

Mohieldin and

Nasr, 2007

comparison of performance

between state-owned and

private banks in Egypt

retaining government

ownership adversely affects

bank performance; choosing a

suitable approach and careful

timing is critical for success of

privatization

Omran, 2007 comparison of

post-privatization and

pre-privatization performance

of 12 Egyptian joint-venture

banks

better bank performance

depends on a lower degree of

state-ownership

Unal, Aktas and

Acikalin, 2007

comparative performance

analysis between state-owned

and privately-owned

commercial banks in Turkey

state-owned banks are as

efficient as private banks, and

more efficient in some aspects


Table 1 (Continued)


methodology


1997-2006

Wu, Chen and

Shiu, 2007

examines the impact of

financial development and bank

characteristics on operational

performance in China

the longer a bank is in

existence, the worse the

return-on-equity; larger Chinese

banks in terms of assets have

return-on-equity performance

inferior to smaller banks

Cull and Spreng,

2008

case study of privatization of

Tanzania’s National Bank of

Commerce

profitability improvements after

the privatization at the expense

of reduced access to financial

services for some groups

Fu and Heffernan,

2008

assesses whether different

ownership types and banking

reforms affect economies of

scale and scope

presence of constant returns to

scale and significant economies

of scale for most joint-stock

banks

Hu, Su and Chen,

2008

studies the efficiency of 12

nation-wide banks in China

1996-2003

no significant effect of

ownership reform on cost

efficiency

Keneley and

KcKenzie, 2008

explains the experience of

privatized banks and insurers in

Australia

organizational changes

influence the outcomes of

privatization

Yao, Han and

Feng, 2008

measures the efficiency of

Chinese commercial banks to

Chinese commercial banks

reacted positively to ownership


Table 1 (Continued)


methodology


evaluate their reactions to new

reforms and challenges

reform and foreign competition

Asian

Development

Bank, 2009

studied restructuring of

state-owned Bank Rakyat

Indonesia

some fundamental principles

should be applied in the

restructuring of state-owned

banks

Berger, Hasan and

Zhou, 2009

studies bank ownership and

efficiency of Chinese banks

1994-2003

the “Big Four” state-owned

banks are least efficient,

minority foreign ownership is

associated with significantly

improved efficiency

Chen, Firth and

Xu, 2009b

traces the identity of large

shareholders and grouped

China’s listed companies into

those controlled by state asset

management bureaus,

state-owned enterprises and

private investors

operating efficiency of Chinese

listed companies varied across

the type of controlling

shareholder

Chen, Mai, Liu

and Mai, 2009a

explored how the Chinese

government determines the

percentage of shares of

state-owned commercial banks

to be released to foreign

release of shares to foreign

investors will reduce the

outputs of state-owned banks


Table 1 (Continued)


methodology


investors

Clarke, Cull and

Fuchs, 2009

case study of the privatization

of Uganda Commercial Bank

into South African bank

improved bank profitability and

performance

Ferri, 2009 survey of 20 city commercial

banks from three provinces in

China to study whether

out-performance is due to

superior corporate governance

or due to favourable

environment

geography and policy are

influential factors

Fu and Heffernan,

2009

studies the relationship between

market structure and bank

performance in China

1985-2002

the reforms are associated with

joint-stock banks becoming

relatively more efficient

Jia, 2009 studies the relationship between

ownership and the prudential

behaviour of Chinese banks

1985-2004

lending by state-owned banks is

less prudent than joint-equity

banks, but has improved over

time

Lin and Zhang,

2009

assesses effect of ownership on

bank performance 1997-2004 in

China

“Big Four” state-owned

commercial banks are less

profitable, less efficient and

have worse asset quality than


Table 1 (Continued)


methodology


other types of banks

Otchere, 2009 examines the pre- and

post-privatization operating

performance of privatized

banks 1981-1999

privatization has encouraged

excessive risk taking among

privatized banks in developing

countries

Burki and Ahmad,

2010

studies the performance effects

of bank governance reforms in

Pakistan 1991-2005

private banks demonstrated

higher levels of cost efficiency,

followed by foreign, and then

state-owned banks; privatized

and restructured banks suffer

from efficiency losses in the

years following

privatization/restructuring but

improve performance once they

adjust

McGuinness and

Keasey, 2010

case study of six Chinese

state-owned banks

shows that post-initial public

offerings have significantly

improved profitability, loan

book size and quality and

capital reserve protection

Nazir and Alam,

2010

evaluates the operating

efficiency of 28 Pakistani

commercial banks 2003-2007

strong evidence of the impact of

financial restructuring on

banking performance


Table 1 (Continued)


methodology


Nolan, 2010 in-depth qualitative interviews

to investigate the variety of

institutional forces which

influenced the adoption of

aspects of Western governance

mechanisms in Chinese banks

the majority shareholder in

most banks is still the same, the

inclusion of foreign

shareholders and non-executive

directors does not resolve the

principal-agent problem

Changes in Micro-behaviour

The studies on consequential changes in micro-behaviour after privatization can be

grouped into two main streams: corporate governance and risk-taking behaviour. Esty

(1997a, 1997b) added to the effect of organizational form but not much literature has

explored this area in any depth.

Corporate Governance

La Porta et al. (2002b) present a theoretical and empirical analysis of legal

protection and valuation. Equity shareholdings of large public traded firms are

generally not completely dispersed but have controlling shareholders. The problem of

agency costs in these firms is expropriation of minority shareholders and creditors by

controlling shareholders within the constraints imposed by laws. The study evaluates

the influence of investor protection and ownership by controlling shareholders on

corporate valuation and finds that, consistent with theory, better shareholder protection

is empirically associated with the higher valuation of corporate assets. Building on the

work of la Porta et al. (2002b), Maury and Pajuste (2005) study the effects of multiple

large shareholders on the valuation of firms arguing that multiple block-holders can

assume two different roles within firms. On one hand, a block-holder has the power


and incentive to monitor the largest shareholder and reduced ability to diverse profit.

On the other hand, a block-holder could form a coalition with other block-holders and

share the diverted profit. Maury and Pajuste (2005) proposed that the very existence

of multiple blocks could have a positive effect on firm value. Their study reveals that

this has not always been the case but nevertheless suggests that a more equal

distribution of voting rights will enhance firm value. Instead of focusing on ownership

structure, Oxelheim and Randøy (2003) concern themselves with the effect of foreign

board membership on corporate performance. Noting that the traditional way to break

away from domestic capital markets is through international listing, Oxelheim and

Randøy (2003) argue that an alternative approach to creating potential value is the

inclusion of representatives from Anglo-American corporate governance systems on the

boards of non-Anglo-American firms. The superior performance reflects the fact that

the firms have partially broken away from their domestic capital market by re-orienting

towards an Anglo-American corporate governance system. The action itself signals

the willingness of firms to expose themselves and adapt to new forms of corporate

governance with the implicit aim of developing and improving their own system of

governance. The study demonstrates that the effect of such moves appears to be

stronger in the cases of large firms while the long-term effect is also stronger in

comparison to listing in Anglo-American markets. In addition to ownership structure,

Caprio et al. (2004) assess the combined effects of ownership, shareholder protection

laws and supervisory/regulatory policies on bank valuation. The study concludes that

larger cash-flow rights for controlling shareholders enhance valuation; weak

shareholder protection laws reduce valuation; and greater cash-flow rights mitigate the

negative effect of weak shareholder protection laws. Thus, contrary to the findings of

la Porta et al. (2002b), this study did not support the view that increased supervision and

regulatory will increase valuation of banks.


Bank Risk-taking Behaviour

Another perspective analyzes the performance of banks within a moral hazard

framework. Moral hazard was a widely accepted explanation for the failures of banks

in the past. Stockholders of firms with limited liability could profit at the expense of

debt-holders by undertaking excessively risky activities. A number of studies have

examined the effects of bank supervision and regulations, a common reason cited to

explain banks taking excessive risks. As with corporate governance, ownership

structure also has a material influence on banks’ risk-taking behaviour. Anderson and

Fraser (2000), Chen et al. (1998), and Saunders et al. (1990) analyze the potential

conflicts of interest in banks which are both management-controlled and

stockholder-controlled. Saunders et al. (1990) argue that the risk-taking incentives of

managers depend on the degree to which their best interests or preferences are tied to

stockholders. Managers may act in a risk-averse rather than a value-maximizing

manner, in which case the optimal degree of risk-taking will be less than that desired by

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