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Optimal level of state ownership in banks: prevention measure versus emergency action—evidence from the new millennia

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Abstract

Previous literature is rather inconclusive concerning the impact of state ownership on banks. We report that its overall impact is not monotonic as it has so far been implicitly assumed, and that it depends on a contemporaneous conflicting impact on risk and financial performance. This suggests the existence of an optimal level, which we investigate by comparing the relative “overall performance” and efficiency of the institutions. We show that a minimal presence, as opposed to no state ownership can improve performance and efficiency, reduce the likelihood of a bailout, while it is less costly compared to capital injections.

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Notes

  1. State-owned firms are run by bureaucrats who have power to make capital allocation decisions, but, since potential profits go to the national accounts, have no incentive to increase/power over cash flows. In addition, state-owned firms might prioritize social welfare over firm value (Beuselinck et al., 2015).

  2. As a response to the 2008 financial crisis, the Bank for International Settlements (BIS) developed some metrics that define Globally (G-SIB in 2011) and Domestically (D-SIFI in 2012) Systemically Important Financial Institutions, primarily aiming at addressing global interconnectedness risk. The criteria employed can be classified into five categories: (i) Cross-jurisdictional activity (G-SIFIs), (ii) Size, (iii) Interconnectedness, (iv) Sustainability and (v) Complexity. For further information please refer to BIS at https://www.bis.org/publ/bcbs255.pdf We select size as our selection criterion for the following reason. G-SIFI and D-SIFI classification was not available in the pre-crisis period and therefore, it could not have been an instrument for domestic government policy. We want to investigate whether government participation in the equity capital before a crisis yields different results in a post-crisis period due to different balance sheet structures or risk-return profiles and therefore, we prioritize criteria that were available before 2008. Larger banks are more likely to be considered systemic (in domestic terms) by their respective governments during a pre G- and D-SIFI classification era because they interact with a larger proportion of the domestic economy. Consequently, our focus is primarily on domestically systemic banks because they are more likely to have domestic governments participating in their ownership capital. With size as a selection criterion of domestically systemic banks, our sample is wide enough to cover all institutions included in the first G-SIFI list in 2011 and almost 100% of the institutions in the first D-SIFI list in 2012.

  3. In order to address the endogeneity concerns expressed in the literature, where state ownership might be endogenous to either or both risk and financial performance (e.g., Demsetz & Villalonga, 2001; Pindado & De La Torre, 2004; Micco et al., 2007), we also test the robustness of our findings by re-estimating an extended version of our model that investigates a potential tri-fold endogeneity (3 equations). The estimates of the parameters of interest remain qualitatively the same without exhibiting significant endogeneity with state ownership. All tables are available upon request. For comparability reasons with previous literature (e.g., Iannotta et al., 2013) we focus on the exogenous impact of SO after filtering out endogenous effects (orthogonalizing all independent variables and adding bank fixed effects). This is also consistent with the second part of our study that does not consider SO as an ex ante monotonic criterion.

  4. Following Hryckiewicz (2014), we consider three credit events. First, we consider a state bail-out either in the form of equity or capital injection. Second, we consider implicit or explicit announced guarantees (e.g., Iannotta et al., 2013; Laeven & Valencia, 2012). Finally, we consider a major restructuring/split, a takeover and/or a bankruptcy as a market discipline measure. The data has been collected manually for each institution. The dummy variables constructed get a value of one when a bank experiences one of the events, while no data about the magnitude of the support is collected. A bank might experience all or none of the events and therefore, the dummy variables are not mutually exclusive.

  5. This is consistent with Iannotta et al. (2013), who argue that in the case of a high state ownership concentration, the owners and the bailing out entity might coincide and therefore, state aid in the form of implicit guarantees is more likely than capital injection.

  6. The impact of state ownership should be better reflected in the market value of equity, because it would also include implicit valuation of off-balance sheet items and of implicit guarantees. However, due to a large number of fully state-owned banks and a significant number of nationalizations, the number of observations with market valuations drops significantly. Therefore, we also consider the book value of equity. This might not reflect investors’ expectations, but it should take into consideration the liquidation value of the assets, which should also include write-offs during crisis periods.

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Authors and Affiliations

  1. Audencia Business School, Institute of Finance, Special Interest Group in Regulation, Market Structure and Asset Pricing, 8 Route de la Joneliere, 44312, Cedex 3, Nantes, France

    Emilios Galariotis, Iordanis Kalaitzoglou & Constantin Zopounidis

  2. School of Economics, Finance and Accounting, Coventry University, Coventry, UK

    Jacek Niklewski

  3. School of Production Engineering and Management, Technical University of Crete, Chania, Greece

    Constantin Zopounidis

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  1. Emilios Galariotis
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Galariotis, E., Kalaitzoglou, I., Niklewski, J. et al. Optimal level of state ownership in banks: prevention measure versus emergency action—evidence from the new millennia. Ann Oper Res 304, 165–197 (2021). https://doi.org/10.1007/s10479-021-04085-1

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