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Journal of Banking & Finance 29 (2005) 2015–2041

www.elsevier.com/locate/jbf

Privatization and bank performancein developing countries

Narjess Boubakri a, Jean-Claude Cosset a,*, Klaus Fischer b,Omrane Guedhami c

a HEC Montreal, 3000, chemin de la Cote Sainte-Catherine, Montreal (Quebec), Canada H3T 2A7b Faculte des sciences de l’administration, Universite Laval, Quebec (Quebec), Canada G1K 7P4

c Faculty of Business Administration, Memorial University of Newfoundland,

St. John’s (Newfoundland), Canada A1B 3X5

Available online 11 April 2005

Abstract

We examine the postprivatization performance of 81 banks from 22 developing countries.Our results suggest that: (i) On average, banks chosen for privatization have a lower economicefficiency, and a lower solvency than banks kept under government ownership. (ii) In the post-privatization period, profitability increases but, depending on the type of owner, efficiency, riskexposure and capitalization may worsen or improve. However, (iii) Over time, privatizationyields significant improvements in economic efficiency and credit risk exposure. (iv) We alsofind that newly privatized banks that are controlled by local industrial groups become moreexposed to credit risk and interest rate risk after privatization.� 2005 Elsevier B.V. All rights reserved.

JEL classification: L33; G21; G28; G32

Keywords: Bank privatization; Performance; Risk-taking; Ownership

0378-4266/$ - see front matter � 2005 Elsevier B.V. All rights reserved.doi:10.1016/j.jbankfin.2005.03.003

* Corresponding author. Tel.: +1 514 340 6872; fax: +1 514 340 6987.E-mail address: [email protected] (J.-C. Cosset).

mailto:[email protected]

2016 N. Boubakri et al. / Journal of Banking & Finance 29 (2005) 2015–2041

1. Introduction

Privatization has been instrumental in reducing state ownership in many countriesand many sectors. A closer look at the privatization experience across countries andindustries suggests that there exist considerable differences in the way privatization isimplemented. Most developing countries launched their privatizations focusing pri-marily on competitive firms rather than strategic sectors such as utilities, telecommu-nications and banking.

The literature on the impact of privatization on the financial and operating per-formance of firms is extensive and thoroughly reviewed by Megginson and Netter(2001) and Djankov and Murrell (2002). Most empirical studies document enhancedpostprivatization performance by newly privatized firms. Such evidence is providedfor firms in developed and developing countries, as well as in transition economies.

Multi-national and single-country studies on privatization often include banks intheir samples, but they fail to provide a clearcut portrait of the actual behavior offinancial firms after privatization. In fact, several arguments suggest that the privati-zation of banks is so particular that it calls for a separate analysis. For example,

• Bank privatizations, particularly in developing countries, are often concomitantto a large and complex process of ‘‘financial liberalization’’ that changes funda-mentally the way the entire financial sector is managed. Specifically, liberalizationcan affect the value of the banking charter, the growth opportunities and riskexposure of banks, and hence the performance of banks.1

• Secondly, for banks, the postprivatization risk exposure is a key variable becausebanks enjoy explicit (or implicit) deposit insurance that makes the state a residualstakeholder in the equity of the banks. Yet, bank risk exposure after divestiture isusually overseen in the current literature on privatization.

• Thirdly, if the privatization reform of banks is unsuccessful, it can result in a lossto depositors and a liability to tax payers, and ultimately in a banking crisis.Therefore, the way privatization is prepared (e.g., setup of an efficient supervisorybody) and managed (e.g., privatization procedures), and the postprivatizationcorporate governance of banks (e.g., ownership structure, foreign participation)may be key determinants of the success or failure of a bank privatization.

Banks are also important in their own right due to the key role they assume in theeconomy. According to Levine (1997), the ownership structure of banks and theirinstitutional role in the national economy is a crucial variable in the process of finan-cial deepening and economic growth. Banks play a major role in determining the ex-tent of success of privatization itself, since they are instrumental in the restructuringof newly privatized firms. In addition to providing the much needed financing forrestructuring, they are also expected to play a major monitoring role, especially in

1 Demirguc-Kunt and Detragiache (1998) find that financial liberalization increases the likelihood of abanking crisis. This is consistent with the argument that financial liberalization allows banks to expandrisk-taking activities that may eventually contribute to a crisis.

N. Boubakri et al. / Journal of Banking & Finance 29 (2005) 2015–2041 2017

institutionally weak environments. Unsurprisingly then, the design of privatizationin the banking sector has become a cornerstone of stabilization programs.

An important issue in privatization in general, and in banks in particular, is own-ership and corporate governance. The choice of ownership structure, particularlyforeign versus local investors is important in the context of privatization since theset of incentives to which a local investor or a foreign investor may be subjectedto, is different, hence potentially yielding divergent privatization outcomes. The factthat state ownership of banks is still a pervasive phenomenon around the world de-spite extensive privatizations everywhere (La Porta et al., 2002) points to the impor-tance of developing a better understanding of the impact of ownership structure onthe performance of newly privatized banks.

In this paper, we pursue two goals:

(1) First, using a panel of 81 banks from 22 developing countries, we investigatewhether or not privatization improves bank performance, and whether it hasan impact on the risk-taking behaviour of banks.2 We assess the relative per-formance and risk-taking of newly privatized banks in comparison to a controlsample of banks that are still under full government ownership (i.e., not priv-atized banks).

(2) Second, we focus on the postprivatization ownership structure and assesswhether the postprivatization performance and risk-taking of banks is relatedto the identity of the dominant owner (foreign investor, industrial group or thestate).

In our analysis, we focus on the privatization experience of banks in developingcountries, and exclude banks from ‘‘transition economies.’’ Several reasons dictatethis choice: First, the starting conditions, the way privatization is implemented,and hence the factors that contribute to the success or failure of privatization are dif-ferent in both sets of countries.3 Second, the structure of corporate governance infirms from developing countries is different from what is observed in transition econ-omies. For example, more than half of the assets of banks are in the hands of foreigninvestors in eight out of the 11 transition countries considered by Bonin et al.(2005a). In developing countries, foreign ownership of newly privatized firms andbanks gravitates around 18% as documented by Boubakri et al. (2005). Additionally,privatization has been proceeding slowly and partially in these countries comparedto the extensive, continuous divestiture efforts of governments in transition econo-mies. Therefore, the state is still a stakeholder in most privatizations in developingcountries. Finally, one important feature of privatization in these countries is theparticipation of large local ‘‘industrial groups’’ (IGs) in the privatization process.

2 In this paper, the term ‘‘performance’’ encompasses profitability and intermediation margin thatmeasures the contribution of a bank to economic development (Demirguc-Kunt and Huizinga, 1999).3 For a discussion of the specificity of bank privatization in transition countries and a review of the

empirical evidence on bank privatization in these economies, see Megginson (2005).


In fact, these groups are a characteristic feature of corporate organization in mostnon-transition developing countries. According to Boubakri et al. (2005), localIGs hold an average significant stake of 30% in newly privatized firms, three yearsafter divestiture.

Our results suggest that: (i) On average, banks chosen for privatization have alower economic efficiency, and a lower solvency than banks kept under governmentownership. (ii) In the postprivatization period, profitability increases but, dependingon the type of owner, efficiency, risk exposure and capitalization may worsen or im-prove. However, (iii) Over time, privatization yields significant improvements in eco-nomic efficiency and credit risk exposure. (iv) Newly privatized banks that arecontrolled by local industrial groups become more exposed to credit risk and interestrate risk after privatization. (v) Banks controlled by local industrial groups and for-eign investors also exhibit a higher economic efficiency. Finally, we find evidence thatthe prevailing macroeconomic and institutional settings also explain the postprivati-zation bank performance.

Overall, our results are consistent with a contemporaneous study by Otchere (2005)who shows, for a sample of 18 banks, that privatization yields marginal improvementsin the postprivatization operating performance. Altogether, the results of both studiessuggest that continued government ownership may drive these findings.

The remainder of the paper is organized as follows. In the next section, we discussthe related literature. In Section 3, we describe the sample, and our data. Section 4presents the results on the postprivatization performance of newly privatized bankswhile the last section concludes and provides some policy implications.

2. Related literature

The health and efficiency of the financial sector are crucial to economic growth(Levine, 1997; Rajan and Zingales, 1998). The main function of the banking sectoris to ensure that resources and credit are directed to the most productive and efficientprojects that will contribute to future growth. It also monitors the performance offirms, plays a crucial role in corporate governance by enforcing contracts and isthe support of the payment system. The role of the government within the financialsystem is to ensure that financial institutions serve these vital functions as efficientlyas possible through regulation and close monitoring of banks. Not surprisingly then,in developing countries (DCs), state ownership of banks is widespread (Barth et al.,2000; La Porta et al., 2002; Megginson, 2005).

Recent evidence points to the costs of government ownership of banks: Barth et al.(2000) show that greater state ownership of banks tends to be associated with less effi-cient and less developed financial systems. In a related study, La Porta et al. (2002)find that government ownership of banks in 1970 is associated with slower subsequentfinancial development, lower growth of per capita income and productivity. They alsonote that these negative associations are not weaker in less developed countries.

In the same vein, Demirguc-Kunt and Huizinga (1999) argue that DCs haveless developed banks and stock markets in general. Using bank-level data for 80


countries over the period 1988–1995, they investigate the impact of financial devel-opment on banks profitability and margins. They show that higher bank develop-ment is related to lower bank profitability and interest margins, which reflects anincreased efficiency resulting from a greater competition among banks. Morerecently, Cornett et al. (2000) examine performance differences between privatelyowned and government-owned-banks (GOBs) in South Korea, Indonesia, Malaysia,the Philippines and Thailand for the period 1994–1997. They find that governmentownership is associated with significant inferior performance. With the recessionstarting in 1997, the performance of GOBs is worse than that of privately-ownedbanks. Likewise, in his review of the empirical evidence on state versus private owner-ship, Megginson (2005) concludes that ‘‘state ownership of commercial banks yieldsfew benefits, yet is associated with many negative economic outcomes’’.

The academic literature has only recently devoted attention to the outcomes ofprivatization in the banking industry (e.g., Clarke and Cull�s (2002) study on Argen-tina, and Unal and Navarro�s (1999) study on Mexico). A first multinational studyon the performance of newly privatized banks (NPBs) is by Verbrugge et al. (1999).The authors find that privatization yields limited bank performance improvements.However, their sample is largely dominated by OECD countries and includes onlysix banks from DCs. Thus their results cannot be generalized to the specific experi-ence of DCs. More recently, Otchere (2005) analyzed the pre- and postprivatizationoperating performance of privatized banks and their rivals in middle- and low-in-come countries. Using a sample of 18 banks from nine countries, he finds marginalimprovements in the postprivatization operating performance of the privatizedbanks. He attributes the lack of strong performance improvements to two possibleexplanations: (1) the sample is drawn from middle- and low-income countries whereprivatized banks may face less capital market monitoring; (2) most sample banks arepartially privatized and hence continued government ownership may have reducedthe managers� ability to restructure the banks.

The most recent evidence on the reforms in transition economies also provides uswith valuable insights. Several studies on bank privatization provide results that gov-ernment-ownership is less efficient than private (mostly foreign) ownership. Forexample, Bonin et al. (2005a) show that privatization by itself is not sufficient to in-crease bank efficiency, but foreign-owned banks appear to be the most cost-efficient.A study by the International Monetary Fund (2000) also shows that profitability (re-turn on equity) of foreign banks is significantly higher than that of domestic banks intransition economies. This result is more recently confirmed by Grigorian andManole (2002) who find that banks controlled by foreign investors are more efficient.Bonin et al. (2005b) also investigate the impact of privatization on bank perfor-mance, and find that financial performance is significantly improved after divesti-ture, and that ‘‘the new owners, mainly foreign, incur the costs to upgrade thetechnology and develop new business lines’’.4

4 Likewise, Haber (2005) shows that the entry of foreign investors and the enactment of accountingreforms in the second round of privatization in Mexico lead to a more stable and efficient banking sector(e.g., a decline in the level of non-performing loans).


In this study, we try to provide some insights into the impact of privatization onbank performance in the specific context of DCs, and explore whether the risk-takingbehaviour of NPBs has changed after divestiture, and whether the identity of thecontrolling shareholder has an impact on such behaviour.

3. The sample, variables and methodology

3.1. The sample

Our sample comprises 81 banks from 22 developing countries. These banks havebeen privatized between 1986 and 1998. To identify the banks in our sample, we re-lied on the World Bank Privatization Transactions Database and Megginson�s(2003) appendix. Once these banks are identified, we collect the necessary data onperformance and ownership from the financial statements and prospectuses thatthese banks sent to us. We also use other databases such as Economatica on LatinAmerica and Bankscope to collect information on performance and ownership.Worldscope Disclosure, the Asian, Brazilian and Mexican company handbooks as wellas the Guide to Asian Companies allow us to draw additional information on finan-cial indicators and ownership.

For each bank, we use accounting measures of performance around the date ofprivatization which we define as follows: it is the date on which the government di-vested some (or all) of its stake in the bank for the first time. Thus, according to thisdefinition, privatization does not necessarily imply relinquishing control. Partialprivatizations without relinquishing control are very common in DCs.5 Indeed,75% of our sample banks were partially privatized.

As reported in Table 1, the Latin American region dominates the sample with 39NPBs, followed by the Asian and African and the Middle Eastern Region with 15banks each. These figures point to the extensive privatization efforts that have beenundertaken in the banking sector by most countries in Latin America. For example,Mexico privatized the entire banking sector (16 banks). In the European region, Por-tugal has been the most active privatizer with eight NPBs. We also note from Table 1that most privatizations in our sample occurred in 1991–1992 (29). The trend seemsto pick up again by the end of our sample period, in 1997–1998.

The countries that we consider in the sample are diversified in terms of economicdevelopment. Based on the World Bank classification (2000), we have 33 NPBs fromlow-income countries, 40 NPBs from upper and lower middle-income countries (30and 10, respectively), and eight NPBs from high-income countries. Furthermore,most banks in our sample were privatized through share issued privatizations(63%), the rest being privatized through private sales (37%).6

5 For a specific study on partial privatizations, see Gupta (2005).6 We were unable to identify the method of sale for 6 out of our sample of 81 banks.

Table 1Description of the sample of privatized banks in developing countries

Distribution of privatizations

By country

Country N Percentage

Africa and the Middle East 15 18.52

Kenya 3 3.70Lebanon 1 1.23Malawi 1 1.23Morocco 1 1.23Nigeria 7 8.64Uganda 2 2.47

Asia 15 18.52

India 8 9.88Indonesia 1 1.23Korea, Rep. 1 1.23Pakistan 2 2.47Philippines 1 1.23Sri Lanka 2 2.47

Latin America 39 48.15

Argentina 5 6.17Brazil 5 6.17Colombia 7 8.64Guyana 1 1.23Jamaica 1 1.23Mexico 16 19.75Peru 2 2.47Venezuela, RB 2 2.47

Europe 12 14.81

Portugal 8 9.88Turkey 4 4.94

Total 81 100

By year

Year

1986 1 1.231989 2 2.471991 15 18.521992 14 17.281993 8 9.881994 6 7.411995 5 6.171996 6 7.411997 15 18.521998 9 11.11

Total 81 100(continued on next page)


Table 1 (continued)

Distribution of privatizations

By incomea

Country income N Percentage

Low 33 40.74Low-middle 10 12.35Upper-middle 30 37.04High 8 9.88

Total 81 100

By privatization method

Method

Share issue privatization (SIP) 47 62.67Private sale (PS) 28 37.33

Total 75 100

This table provides some descriptive statistics on the sample of 81 privatized banks from 22 developingcountries. We report the distribution of privatizations in the countries in our sample by country, year, andincome.a World Bank classification.


A comparison of our sample distribution to the population of privatized banksaround the world shows that our sample is largely representative. The entire popu-lation of NPBs appears in the World Bank Privatization Transactions Database: 144banks were privatized in 32 DCs, non-transition economies, between 1988 and 1999.We were not able to collect detailed ownership data and pre-privatization perfor-mance for 63 NPBs out of 144. Therefore, our sample of 81 NPBs represents 56%of the World Bank list of privatized banks. Moreover, our sample distribution byregion, year, and country income level corresponds to some extent to that of theWorld Bank list. For example, the Latin American region involves the most activeprivatizing countries (39.6% of the total World Bank sample), followed by Africaand the Middle East (31.9%), Asia (22.9%), and Europe (5.6%). We also note that97.9% of the privatization transactions occurred in the 1990s. Finally, when weexamine the income distribution in the World Bank list, we find that 36.3% of thefirms come from low-income countries, 13.2% from low-middle income countries,and 30.6% from upper-middle income countries. These figures are comparable tothose that appear in Table 1.

To investigate the impact of privatization on performance, we compare the per-formance of newly divested firms to banks still under full government ownership.7

This will provide a more meaningful comparison than considering private bankssince GOBs are usually among the largest banks in their respective countries (Boninet al., 2005b). We draw our data on the ownership and performance of our controlsample of GOBs from Bankscope.

7 We thank the referee for suggesting this procedure.


3.2. Variables

Below, we discuss the main categories of variables we use, namely: indicatorsof performance, ownership structure variables, and bank and country levelvariables.

3.2.1. Performance variables

To examine the impact of privatization on the performance of NPBs, we followthe literature and rely on four aspects of bank performance (see Cornett and Tehr-anian, 1992):

Profitability: We measure profitability by the return on equity (net income toequity) ratio.Efficiency: We measure economic efficiency by the net interest margin (NetInt-Marg) that equals the average interest rate on loans minus the average rate on lia-bilities (see Demirguc-Kunt and Huizinga, 1999).Risk exposure: We use a measure of credit risk (PassDLoan) that is equal tothe past due loans to total loans ratio, and a measure of interest rate risk (Dol-GAP) that is equal to short term assets minus short term liabilities over totalassets.Capital adequacy: We measure capital adequacy by the ratio of risky assets(loans) to equity (LoanTEq). While PassDLoan and DolGAP measure expo-sure, LoanTEq measures the ‘‘cushion’’ available to absorb shocks due toexposure.8

3.2.2. Ownership, bank level and country level variables

To analyze the ownership structure of NPBs, we examine four main categories ofstakeholders: the government, foreign investors, industrial groups and individualinvestors. We derive this typology from Boubakri et al. (2005) who document thepostprivatization corporate governance of formerly government-owned firms in alarge sample of DCs. Contrary to what is documented in Bonin et al. (2005b) fortransition countries, foreign penetration is less important in DCs. For instance, whenwe consider a control sample, from Bankscope, of non-privatized banks from our 22sample countries, we find 227 listed banks. In these banks, the foreign investors�stake is very low compared to what is observed in transition economies. The averageforeign ownership in the 21 countries in our sample (excluding Uganda which is notcovered by Bankscope), is 18%. This goes along the evidence provided by Boubakriet al. (2005) who find that the three-year postprivatization average stake of foreigninvestors is 17.1% in financial and non-financial firms. The average stake held by thelargest foreign investor in our sample banks is 30.19%. Next, when we consider a

8 Other measures of risk could also be of interest but were not considered for reasons of parsimony (e.g.,measures of liquidity risk) or absence of data (e.g., exchange risk).

Table 2The ownership of newly privatized banks

Before privatization Privatization After privatization

One year Year 0 One year Two years Three years

N Mean Median N Mean Median N Mean Median N Mean Median N Mean Median

Government 76 0.876 1.000 75 0.336 0.340 73 0.278 0.300 72 0.258 0.254 71 0.254 0.245Foreign 66 0.026 0.000 70 0.119 0.000 64 0.131 0.000 64 0.146 0.000 64 0.153 0.000Industrial groups 73 0.005 0.000 63 0.423 0.510 64 0.457 0.525 65 0.475 0.560 66 0.463 0.528Individuals 68 0.034 0.000 31 0.110 0.000 32 0.085 0.000 36 0.099 0.005 34 0.099 0.000

This table presents summary statistics on the evolution of ownership structure for a sample of 81 privatized banks from 22 developing countries for the period1986–1998. We consider four types of investors: the government, foreign investors, industrial groups, and individuals. Several complementary sources ofownership structure were used: Boubakri et al. (2005), Megginson (2003), the offering prospectus (the preprivatization ownership data), annual reports andother additional sources such as Asian, Brazilian and Mexican Company Handbooks, Worldscope Disclosure, BankScope, and The Guide to Asian Companies.N refers to the number of observations.

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sample of 50 listed banks from the transition economies considered in Bonin et al.(2005a)9, we find that the average stake held by foreign investors is 55%, and thatthe average stake held by the largest foreign investor is 70.70%. This further indicateshow foreign entry differs in magnitude in both sets of countries.

Table 2 reports the evolution of the ownership structure of newly privatized banksin DCs.

According to Table 2, the government holds an average stake of 87.6% beforeprivatization. Upon divestiture, this stake falls to 33.6%, and continues to de-crease down to 25.4% after three years. This finding is consistent with the pre-dominance of partial, staggered sales (Perotti, 1995; Boubakri et al., 2005). Acloser look at the control structure of privatized banks, shows that the govern-ment is the controlling shareholder (more than 50% of shares) in 17% of the sam-ple after three years.

Foreign investors reap an average stake of 11.9% on the year of privatization, upfrom 2.6% before privatization. Three years onwards, they hold an average share of15.3%. Industrial groups benefit the most from government divestiture as their aver-age share increases from less than 1% before privatization to 46.3% three years on-wards. Individuals on the other hand, own close to 11% on the year of privatizationand their stake remains virtually unchanged over time, reaching close to 10% threeyears after privatization.

Overall, these figures on the ownership structure of NPBs show that partial priv-atizations dominate, foreign penetration is indeed less significant in DCs, comparedto transition economies (Bonin et al., 2005a), and that a major role is played byindustrial groups instead.

3.3. Methodology

To examine the impact of privatization and ownership structure on the perfor-mance of NPBs, we proceed with traditional univariate tests and panel data esti-mation techniques. We conduct our univariate tests of performance changes in thesame spirit of Megginson et al. (1994). We determine the performance measurespresented above for a period of seven years (three years prior to privatizationand three years postprivatization, including the year of privatization itself). Wethen compute the means before and after privatization for each performance mea-sure. As noted earlier, we consider the privatization date to be that on which thegovernment divests, for the first time, a certain amount of shares. To assess thesignificance of performance changes, we use the two-tailed Wilcoxon signed-ranktest.

To investigate whether the changes in performance vary with the identity of thepostprivatization controlling owner, we analyze the differences in performance be-tween three groups of partitioned samples according to government control, foreign

9 We do not include Latvia because it is not featured in Bankscope.


control, and industrial group control. As in Megginson et al. (1994) and Boubakriand Cosset (1998), we use a 50% control threshold for the government. However,we retain a 30% control threshold for foreign and industrial groups� ownership.As demonstrated earlier, the largest foreign investor holds on average 30% in NPBsfrom DCs. The results remain unchanged if we use the 50% threshold for foreign andindustrial groups� control but we have much fewer banks with such participation.

In our multivariate analysis, we estimate the following general model using panelestimation techniques:

PERFit ¼ a þ b1NPBit þ b2 PRIVit þ b3 TTit þ b4 PSi þ b5 PRIVit �OWNit

þ b6 CVit þ ti þ si þ eit;

where PERFit is the performance of bank i at time t, namely: (i) profitability(RetOnEquity), (ii) economic efficiency (NetIntMarg), (iii) credit risk (PassDLoan)and interest rate risk (DolGAP) exposure, and (iv) a capitalization measure veryclose to the Bank for International Settlements�s (BIS) ‘‘solvency ratio’’ (Loan-TEq). NPB, PRIV, TT and PS are privatization-related variables: NPB is a dum-my variable that equals one for newly privatized banks and zero otherwise. PRIVis a dummy variable that takes the value of one in the postprivatization periodand zero otherwise, and captures the postprivatization performance changes ina given indicator. TT is a variable that captures time since privatization and isequal to the number of years since the year of privatization.10 PS is a dummy var-iable that is equal to one when the bank is privatized through private sale, andzero otherwise.11

PRIV * OWN refers to the interactions of PRIV with ownership variables. Weconsider, as described earlier, three categories of controlling owners: foreign inves-tors (FORCONT), local industrial groups (IGCONT) and the government itself(GOVCONT).

CV refers to the set of control variables. Specifically, we control for (1) the relativesize of the bank in the economy (total assets standardized for size of the economy,the GDP, RELSIZE), (2) public policy such as fiscal policy (budget deficit overGDP, DEFICITGDP),12 (3) economic growth (GDPG) to capture the businesscycle,13 (4) the level of development of the economy (log of GDP per capita, LGDPC),(5) concomitant economic reforms such as financial liberalization (LIB) proxied by a

10 For example, if we assume that our period extends over four years, and that Bank i is privatized inperiod 3, then the three dummies are constructed as follows: NPB: 1 1 1 1; PRIV: 0 0 1 1; and TT: 0 0 1 2.11 Boubakri et al. (2005) show that the privatization method explains the postprivatization performanceof multi-industry sample of privatized firms.12 An expansionary fiscal policy is likely to have a positive impact on profits and on loan portfolioperformance. With an increase of the liquidity available to the economy, demand for goods produced bythe private sector should also increase making projects more profitable.13 An increase in GDP growth is likely to affect positively loan portfolio performance and credit demand.


dummy that takes the value of one after liberalization, and (6) the level of institu-tional development proxied by the International Country Risk Guide (ICRG) lawand order index (LAW).14,15 ti and si accounts for individual and time effects, andeit is an error term.

We start with a simple model for each of our five dependent variables using fixedeffects (FE) and some key time-varying privatization variables, namely PRIV andTT.16 In this first set of regressions, we do not include variables that identify thepostprivatization controlling owners. On these regressions, we perform a Hausman(1978) specification test to check for efficiency and bias in the estimation of coeffi-cients obtained either with fixed effects (FE) by demeaning, or with random effects(RE) based on a generalized least squared (GLS) estimation procedure (Hsiao,1986, p. 78). In all cases, we find that the GLS-based RE estimation produces unbi-ased coefficients. Due to its advantages (i.e., more efficient estimates and the possi-bility of introducing time invariant dummies), we adopt the RE estimationprocedure for the remainder of the analysis. We also perform ANOVA tests onthe residuals of the regression to verify the presence of residual time effects. Thisis often the case judging by the highly significant F-statistics we obtain. Thus, theGLS is adapted to weight residuals for both individual and time effects.

The results of the regressions of the performance and risk dependent variablesagainst NPB, PRIV and TT, unreported here but available from the authors, yieldno significant coefficients.

In a second step, we add to these basic regressions a set of control variables, asdiscussed above, but do not control for ownership effects yet. All regressions are esti-mated using GLS/RE with explicit consideration of both individual and time effects.Using GLS/RE allows us to introduce dummies for countries that have a strong rep-resentation in the sample, namely Colombia, India, Mexico and Nigeria, in order to

14 We considered several other institutional and social aspects such as the level of corruption, economicfreedom, the legal system (common versus civil law) and existence or not of deposit insurance. We alsoconsidered variables related to the banking system and the stock market, such as the level of credit by theprivate sector to GDP, the stock market capitalization to GDP, the stock market turnover, bankconcentration, banking system wide intermediation margin and the Gini (poverty) index. However, mostof these variables are highly correlated with, and captured by LAW.15 For the sake of parsimony, we eliminate as many variables as possible as long as a t-test or a likelihoodratio (LR) test – in the case of groups of variables – does not suggest otherwise. Furthermore, we includelagged variables for fiscal policy and economic growth on the grounds that banks� behaviour adjustsslowly to changes in such variables. No more than one lag is necessary – the LR test of another lag is notsignificant. The regressions we show are those where we keep the most significant variables.16 Due to the relatively large number of individuals in the sample, in the estimation of the fixed effectsmodel we used a ‘‘demeaning’’ rather than a ‘‘dummy’’ approach (Hsiao, 1986, p. 31). This approachprecludes the use of variables that are independent of other regressors, the extreme case being the use ofdummies that are not time varying for at least some individuals over the whole period. The most obviouscases are the country dummies, a dummy that distinguishes between government banks that are privatizedand those that are not (NPB), and dummies representing other institutional characteristics such as legalsystem (common versus civil law). In all these cases, the coefficients would be either inefficient orunidentifiable (Davidson and MacKinnon, 1993, p. 323).


correct for any overrepresentation bias. Coefficients for these dummies are notreported.

In the final stage of the analysis, we introduce, in addition to the control variablespreviously considered, the set of ownership variables that control for the type of con-trolling owner. We discuss the results of this analysis in the next section. Throughoutwe control for outliers by eliminating observations with residues exceeding threestandard deviations.

4. The results

In Section 4.1, we discuss the performance changes for our sample of 81 banks.We then discuss the results for different ownership partitions. In Section 4.2, we re-port and discuss the regression results (Table 3).

4.1. The postprivatization performance of NPBs: Univariate analysis

We first compute three-year averages for each performance indicator aroundthe privatization date (i.e., three-year averages for before and after privatization).Table 4 reports the postprivatization performance of NPBs. We report unadjusted(raw) and adjusted results. The adjustment procedure is as follows: we contrast agiven performance indicator for NPBs to that of a control sample of GOBs in agiven country. The adjusted ratio is obtained by substracting the GOBs� medianperformance measure from the corresponding NPBs performance measure. Wethen assess whether the difference is significant using a non-parametric Wilcoxontest.

Table 4 shows that the performance of NPBs is not significantly different from be-fore to after privatization, except for the credit risk measure. Indeed, the mean (med-ian) three-year average of PassDLoan increases from 24.6% (5.7%) to 31.6% (11.2%)after privatization. However, once we adjust for the performance of GOBs, no dif-ference is documented for either the performance or risk measures. In other words,NPBs and GOBs perform identically in terms of profitability, economic efficiency,risk-taking behaviour and capital adequacy after privatization.

These results seem to suggest that privatization may not necessarily lead to signif-icant improvements in bank performance, in contrast to recent findings on the priv-atization effects on financial and non-financial firms from DCs. For example, usingadjusted and unadjusted performance indicators, Boubakri et al. (2004) show thatprivatization yields significant performance improvements. Nevertheless, our resultsgo along recent evidence that privatized banks realize indeed negligible performancegains after divestiture (Otchere, 2005; Clarke et al., 2005).

We now examine the performance changes of NPBs while controlling for the iden-tity of the new controlling owner. Table 5 reports the results for different partitionsaccording to the prevailing dominant owner.

In Panel A of Table 5, we split our sample of banks in two categories: those wherethe government is a controlling shareholder and those where the government relin-

Table 3Summary of the variables

Variable Definition Source

Panel A. Privatization and ownership structure variables

NPB Dummy variable that takes the value of one ifthe bank is privatized and zero if the bank is state-owned

Authors� calculations

PRIV Privatization dummy that takes the value of one inthe postprivatization period and zero otherwise


TT Timing indicator that takes the value of the numberof years since privatization


PS Dummy variable that takes the value of one if the bankis privatized via private sales andzero otherwise (public share offering)

World Bank Group�sPrivatization TransactionDatabase and Boubakriet al. (2004, 2005)

GOVCONT Dummy variable that takes the value of one if thegovernment keeps control of the privatizedbank and 0 otherwise

Authors� calculationsbased on varioussources (Table 2)

FORCONT Dummy variable that takes the value of one if foreigninvestors are in control of the privatized bankand 0 otherwise (30% threshold)


IGCONT Dummy variable that takes the value of one if industrialgroups are in control of the privatized bank and 0otherwise (30% or 50% threshold)


RELSIZE The ratio of total assets standardizedfor size of the economy (GDP)


Panel B. Macroeconomic and institutional control variables

LAW Law and order: an assessment of the strength andimpartiality of the legal system (law component) andof popular observance of the law (order component)

International CountryRisk Guide (ICRG)

LIB Dummy variable that takes the value of one afterfinancial liberalization and zero otherwise.

Demirguc-Kunt andDetragiache (1998)

LGDPC Logarithm of GDP per capita World DevelopmentIndicators

GDPG Real GDP growth World DevelopmentIndicators

GDPG1 Lagged real GDP growth World DevelopmentIndicators

DEFICITGDP Overall budget deficit (% of GDP) World DevelopmentIndicators

DEFICITGDP1 Lagged overall budget deficit (% of GDP) World DevelopmentIndicators

This table describes the variables used in our regression analysis to investigate the determinants of theperformance of privatized banks.


quished control (i.e., revenue versus control privatizations) (Megginson et al., 1994;Boubakri and Cosset, 1998). The results show no significant differences in behaviourbetween both sub-samples, except for profitability: when the government relin-quishes control, profitability gains are lower. In Panel B, we consider a foreigncontrol threshold of 30% and split the sample accordingly: banks with and withoutforeign ownership control. The results are not significantly different between both

Table 4Postprivatization performance of privatized banks

Performance Raw Adjusted

N Mean(Median)before

Mean(Median)after

Z-stat. forchangein median

N Mean(Median)before

Mean(Median)after

Z-stat.for changein median

RetOnEquity 77 0.016 0.068 �0.838 39 �0.008 �0.028 �0.030(0.148) (0.120) (0.038) (0.042)

NetIntMarg 51 0.044 0.048 0.696 19 0.037 0.044 0.569(0.044) (0.042) (0.033) (0.037)

PassDLoan 55 0.246 0.316 2.074** 28 0.046 0.168 1.237(0.057) (0.112) (�0.015) (0.001)

DolGAP 77 �0.460 �0.469 �0.004 37 �0.020 �0.034 �0.541(�0.518) (�0.528) (0.013) (�0.012)

LoanTEq 77 10.574 9.645 �0.571 39 4.905 3.476 �1.029(9.395) (8.141) (3.877) (3.342)

This table presents raw and adjusted results for the complete sample of 81 privatized banks in 22 devel-oping countries for the period 1986–1998. Adjusted performance measures are obtained by subtracting thecountry�s SOBs median performance measure from the NPB�s performance measure. The measures ofperformance are RetOnEquity (net income/common equity), NetIntMarg ((interest income � interestexpenses)/total assets), PassDLoan (pass-due loans/total loans), DolGAP ((current assets � current lia-bilities)/total assets), and LoanTEq (loans/common equity). For each performance measure, it providesthe number of usable observations, the mean and the median values for the three-year period before andafter privatization. We report the Wilcoxon Z-statistic for the difference in medians.** Significant at the 5% level.


sub-samples, except for PassDLoan that is significantly higher for banks with no for-eign control, thus suggesting that foreign controlled banks have lower credit risk.

Panel C compares the performance changes for banks with and without industrialgroup control, and shows that performance changes are not significantly different be-tween both subsamples when we consider a threshold of 30%, except for PassDLoanthat is higher for banks under industrial group control (i.e., credit risk is higher).

Overall, these results suggest that performance changes are generally independentof the identity of the controlling owner, except for risk. Such a result comes as nosurprise in the context of DCs, as evidence in Boubakri et al. (2004, 2005) suggeststhat foreign involvement is generally low and has no significant impact on the prof-itability and efficiency of newly privatized non-financial firms from DCs. In transi-tion economies however, evidence in Bonin et al. (2005a) shows that, althoughprivatization per se is not sufficient to increase bank efficiency, foreign-owned banksappear to be the most cost-efficient. The authors specifically note that compared todomestic private banks, banks with majority foreign ownership are more efficient bycost and profit measures, while the involvement of a strategic foreign investor im-proves only cost efficiency.

Since the results in this section are only bivariate relations, they do not control forother potential explanatory variables such as the macroeconomic environment, andthe characteristics of the privatization process that might affect the postprivatizationbehaviour of NPBs. We conduct such multivariate analysis in the following section.

Table 5Postprivatization performance of privatized banks: the role of ownership structure

Measures of performance RetOnEquity NetIntMarg PassDLoan DolGAP LoanTEq

Panel A. Control versus revenue privatization

CONTROLMean change �0.092 0.004 0.012 0.005 0.131Median change �0.046 0.005 0.034 0.021 0.485N 49 33 39 48 49

REVENUE

Mean change 0.201 0.003 0.117 �0.041 �0.429Median change �0.002 0.000 0.026 �0.044 �1.242N 22 15 12 23 21

p-Value Kruskal–Wallis test for

difference between subsamples

0.078* 0.586 0.941 0.383 0.257

Panel B. Performance changes for privatized firms with or without foreign ownership control (control > 30%)

NFO CONTROLMean change �0.024 0.004 0.090 �0.009 �0.238Median change �0.029 0.003 0.056 0.010 �0.101N 55 38 36 56 54

FO CONTROLMean change 0.126 �0.003 0.003 �0.039 0.599Median change 0.011 �0.004 0.001 �0.059 �0.152N 12 9 10 12 11

p-Value Kruskal–Wallis test for

difference between subsamples

0.360 0.808 0.043** 0.421 0.958

Panel C. Performance changes for privatized firms with or without industrial group control (>30%)

NIG CONTROLMean change 0.086 0.005 �0.075 �0.051 �1.153Median change �0.012 �0.002 �0.018 0.010 �1.002N 28 18 16 28 26

IG CONTROLMean change �0.107 0.000 0.071 0.005 0.778Median change �0.033 0.005 0.054 0.010 0.540N 34 26 28 34 34

p-Value Kruskal–Wallis test fordifference between subsamples

0.315 0.943 0.030** 0.641 0.107

This table presents comparisons between the performance changes of several partitions of privatized banks basedon ownership structure variables. The measures of performance are RetOnEquity (net income/common equity),

NetIntMarg ((interest income � interest expenses)/total assets), PassDLoan (pass-due loans/total loans), DolGAP((current assets � current liabilities)/total assets), and LoanTEq (loans/common equity). Panel A compares theperformance changes of control privatization (more than 50% of the company is privatized) and revenue priv-atization (less than 50% of the company is privatized). Panel B compares the performance changes of privatizedfirms without foreign ownership control (NFO CONTROL) or with foreign ownership after privatization (FOCONTROL). Panel C compares the performance changes of privatized firms without industrial group control

(NIG CONTROL) or with industrial group control (IG CONTROL) after privatization. For each performancemeasure, it provides the number of usable observations, the mean and the median values for the three-year periodbefore and after privatization, and the number of observations. It also presents the p-value of the Kruskal–Wallistest for the difference between the two subsamples.

Significance at the 10%, and 5% level is noted by * and ** respectively.


Table 6Determinants of bank performance

Panel A: Model without ownership control variables Panel B: Model with ownership control variables

Profitability Economicefficiency

Risk Capitaladequacy

Profitability Economicefficiency

Risk Capitaladequacy

RetOnEquity(1)

NetIntMarg(2)

PassDLoan(3)

DolGAP(4)

LoanTEq(5)

RetOnEquity(6)

NetIntMarg(7)

PassDLoan(8)

DolGAP(9)

LoanTEq(10)

Constant �0.4584*** 0.0074 �0.8593 �0.4052*** 6.1335*** �0.3599*** 0.0097** �0.8827 �0.4026*** 5.9456***

(�6.768) (1.548) (�1.528) (�16.762) (7.015) (�5.397) (2.005) (�1.536) (�17.52) (6.584)NPB 0.096 0.0354*** �0.1038 �0.0198 3.7454*** 0.0756 0.0374*** �0.1172 �0.0196 3.5326***

(1.305) (8.230) (�0.585) (�0.558) (3.545) (1.035) (8.474) (�0.629) (�0.555) (3.251)PRIV 0.1295* 0.0084*** 0.0620* �0.0115 �1.3249** 0.0804 0.0201*** �0.0705 0.0688** �1.9045*

(1.866) (4.001) (1.731) (�0.617) (�2.114) (0.706) (4.137) (�1.170) (2.033) (�1.737)TT �0.0447 �0.0070*** �0.0311** �0.0112 0.0381 �0.0486 �0.0073*** �0.0221 � 0.0097 �0.0081

(�1.387) (�7.761) (�2.017) (�1.248) (0.129) (�1.519) (�7.588) (�1.412) (�1.054) (�0.027)PS �0.1484* �0.0103*** 0.0302 0.0272 �0.853 � 0.1576* �0.0052 0.0272 0.0152 �0.1529

(�1.724) (�3.436) (0.671) (1.153) (�1.038) (�1.820) (�1.611) (0.5728) (0.631) (0.179)PRIV * GOVCONT 0.0584 �0.0079 0.0444 �0.0796** 0.2261

(0.438) (�1.566) (0.587) (�2.058) (0.172)PRIV * FORCONT 0.1503 �0.0113*** �0.0826 �0.0228 �2.9969***

(1.348) (�2.877) (�1.229) (�0.681) (�2.735)PRIV * IGCONT �0.0332 �0.0122** 0.2048*** �0.0854*** 1.6347

(�0.285) (�2.609) (3.179) (�2.486) (1.429)RELSIZE 0.0694 �1.7283 �0.7801 0.0625 �0.6762 �1.3633*

(0.574) (�0.651) (�0.966) (0.508) (�0.249) (�1.689)

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DEFICITGDP �0.0119* �0.0001 0.0066 �0.0532 �0.0092 �0.0001 0.0035 �0.094(�1.628) (�0.240) (1.378) (�0.769) (�1.289) (�0.059) (0.736) (�1.326)

DEFICITGDP1 �0.0022 0.0005** �0.0099** 0.1002 0.0004 0.0004* �0.0129*** 0.1118(�0.314) (2.096) (�2.493) (1.509) (0.064) (1.707) (�3.132) (1.618)

GDPG 0.0211*** 0.0002 �0.0092*** �0.0502 0.0192*** 0.0001 �0.0060** �0.0214(3.410) (1.243) (�3.586) (�0.901) (3.222) (0.641) (�2.297) (�0.381)

GDPG1 0.0467*** �0.0001 �0.0017 0.1641*** 0.0330*** �0.0001 0.0023 0.1615***

(7.709) (�0.794) (�0.647) (2.991) (5.572) (�0.577) (0.836) (2.937)LAW �0.0036*** 0.0201 �0.0038*** �0.0081

(�3.393) (0.965) (�3.463) (�0.377)LIB 0.0088*** 0.0662 0.0080*** 0.0967**

(3.234) (1.401) (2.937) (2.029)LGDPC 0.1551** 0.1620**

(2.108) (2.153)

Adj R2 0.296 0.865 0.937 0.691 0.684 0.294 0.868 0.941 0.686 0.698No. of obs. 1123 1032 1035 1356 1127 1099 1009 1021 1324 1103v2 (1) – LR 1220.9*** 236.19*** 350.61*** 339.83*** 223.63*** 418.0*** 172.05*** 310.04*** 298.74*** 324.84***

v2 (1) – Wald 7.46 126.21*** 7.05 4.25 16.99*** 2.59 14.10*** 13.64*** 7.57** 9.92**

This table presents the results from regressions conducted to determine the sources of performance changes of privatized banks in developing countries. Thesample consists of privatized (NPB = 1) and non-privatized government owned banks. Estimations were performed using generalized least squares (GLS).Panel A presents the results without including the ownership control variables while Panel B includes these variables. Outliers with residues in excess of threestandard errors were eliminated. t-Statistics are in parentheses. Variable definitions for the acronyms are reported in Table 3. Significance at the 10%, 5%, and1% level is noted by *,** and *** respectively.Note. (1) The v2 is for the LR and Wald tests whether the privatization variables (NPB, PRIV, TT and PS) in the first model and the control variables(PRIV * GOVCONT, PRIV * FORCONT, and PRIV * IGCONT) are jointly significant.

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4.2. Multivariate analysis

We present the results for multivariate regressions in Table 6. Results in Panel Ado not control for ownership while results in Panel B do.

4.2.1. The average effect of privatization on bank performance and risk exposure

From Panel A of Table 6, we first note that NPBs present on average a significantlyhigher NetIntMarg (lower economic efficiency) and a significantly lower capital ade-quacy than GOBs. This suggests that governments privatize worse-off public banks.17

The dummy PRIV that captures the average postprivatization impact on perfor-mance suggests significant average improvements in profitability, a decrease in effi-ciency, and increase in credit risk exposure. Capital adequacy improvespostdivestiture (i.e., the coefficient of PRIV for LoanTEq is negative and significant).We also find a privatization time effect reflected by the variable TT. Recall that TTincreases as time elapses since privatization. We actually find that the long run effectof privatization is to decrease NetIntMarg (thus increase economic efficiency) andPassDLoan (decrease in credit risk exposure).18 Thus, although the short run effectof privatization on economic efficiency and credit risk exposure is mixed, a beneficialadjustment will occur in the long run for both these aspects. However, as we will seebelow, the effect is not uniform for all forms of ownership.

As an additional characteristic of the privatization process, we control for themethod of divestiture. Indeed, Clarke et al. (2005) suggest that private sales to strategicinvestors will lead to higher performance gains than share issued privatizations. Theirargument is that private sales generally lead to a concentrated ownership structure andhence, more incentives on the part of the controlling owner to monitor the banks�man-agers in order to spur performance improvements. By contrast, share issue privatiza-tions usually result in a dispersed ownership among individual owners who have lessincentives tomonitor themanagers� efforts, hence higher agency costs, and a poorer per-formance achievement. Our results confirm Clarke et al.�s (2005) hypothesis and showthat banks that are privatized through share issued privatizations are less efficient.

Furthermore, our results show that fiscal expansion reduces PassDLoan (thusreducing credit risk) and increases NetIntMarg (thus reducing economic efficiency).Consistent with Boubakri et al. (2004), we find that economic growth is associatedwith significant improvements in profitability and credit risk exposure. Similarly,we find that LAW has a negative effect on NetIntMarg suggesting that when theinstitutional environment is better, NPBs become more efficient. A similar result ap-

17 Boehmer et al. (2005) thoroughly investigate the political and economic determinants of bankprivatization using a comprehensive sample of 101 countries from 1982 to 2000. They show that whileeconomic factors are significantly associated with the likelihood of bank privatization in both developedand developing countries, political factors are only important for DCs.18 In the last two rows of the table, we present the results of LR andWald tests of setting equal to zero thecoefficients of the four privatization variables (NPB, PRIV, PS and TT) in Panel A, and the three controlvariables (PRIV * FORCONT, PRIV * IGCONT and PRIV * GOVCONT) in Panel B. Note that the LRtest rejects the hypothesis of a non-binding restriction in all regressions, while the Wald test rejects it in sixtimes out of 10.


pears in Boubakri et al. (2004) for non-financial newly privatized firms. Finally, theresults show that financial liberalization (LIB) is associated with lower economic effi-ciency. The sign of this coefficient is consistent with arguments (Hellman et al., 2000)that liberalization causes an immediate shock on the franchise value of the bank anda reduction in deposit rates, other things equal.

In this section, we explored the impact of privatization on performance and risk-tak-ing, but did not take into account the identity of the controlling owner. The next sectionexamines whether the privatization effects vary with the type of controlling owner.

4.2.2. The impact of ownership control

In this section, we re-run our regressions while taking into account the identity ofthe controlling shareholder of the NPBs. We identify three dominating owners: for-eign banks (FORCONT), local industrial groups (IGCONT) and the government it-self (GOVCONT). By far, most privatized banks in DCs are bought either by aforeign bank or by a local investor. Among the latter, most banks are bought by ulti-mate – mostly family controlled – owners of groups of enterprises that operate simul-taneously in industry, commerce and finance. Accordingly, we include threeinteraction terms: PRIV * FORCONT refers to NPBs controlled by foreign inves-tors, PRIV * IGCONT refers to NPBs under industrial-group control andPRIV * GOVCONT refers to NPBs under government control. This procedure al-lows us to assess whether the identity of the controlling owner has an impact on per-formance or risk-taking after privatization. This issue is particularly important sincegovernments have a choice as to whom they allocate the privatizing banks. The expe-rience of bank privatization in Mexico is an appalling example. The privatization of1992 was directed at local investors and explicitly limited foreign access. A few yearslater, almost the entire privatized banking system collapsed, resulting in a burden totaxpayers of at least $US 500 per Mexican (Unal and Navarro, 1999). A ‘‘secondwave’’ of privatization – not included in our sample – that capitalized on the expe-rience of the first, targeted a wider investor base, particularly foreign investors. PanelB of Table 6 reports the results.

4.2.2. A – Profitability and economic efficiency

Privatization studies in general posit that divestiture should result in higher profitsand efficiency. As it induces a dramatic change in the ownership structure, the set ofincentives that affect management behaviour will also evolve. Under state owner-ship, the control of management is loose, providing it with the opportunity forentrenchment. In particular, managers are interested in insuring survival of the firmthey manage19 by keeping failure risk low.20 Privatization is likely to change this

19 Recent discussion and review of the literature on poor corporate governance and managementincentives in state owned enterprises, particularly in DCs, appears in Clarke et al. (2005).20 The same argument has been advanced in the case of United States banks with diffuse publicownership. Some authors have argued for and tested the hypothesis that in banks with diffuse ownership,managerial risk aversion may in fact offset the excessive risk-taking incentive that stems from moral hazardincentives by shareholders (e.g., Anderson and Fraser, 2000; Demsetz et al., 1997; Saunders et al., 1990).


behaviour as new shareholders will better monitor the management, especially withrespect to risk-taking. Supporting evidence exists for the Mexican case (Lopez-de-Silanes and Zamarripa, 1995) where privatization was accompanied by a reductionof agency costs. Nevertheless, private shareholders are also likely to engage in higherrisk activities to maximize the value of the option/share. Through our ownershiptypology, we are able to determine whether this effect varies with the type of domi-nant shareholder. The results in Table 6 suggest that the identity of the controllingowner is unrelated to RetOnEquity (column (6)). However, the economic impact ofprivatization, measured by the NetIntMarg, is significantly affected by privatizationand by the ultimate dominant owner (column (7)). Consistent with the results re-ported in Panel A, we observe a highly significant decrease in NetIntMarg (increasein economic efficiency) over time (the coefficient of TT is negative and significant atthe 1% level). Ownership structure variables also show significant effects on Netint-Marg. For example, ownership control by foreign investors or industrial groups issignificantly related to a higher economic efficiency of NPBs. This confirms Clarkeet al. (2003) who argue that foreign entry increases competition and efficiency.

4.2.2. B – Credit risk and interest rate risk exposure

In the case of credit risk (PassDLoan), while the average effect after privatization(PRIV) is not significant we observe a relatively large and highly significant (at the1% level) increase in PassDLoan in the case of NPBs that are controlled by IGs.We can rationalize this evidence as follows: if banks are related to establishedIGs, to the standard incentives to engage in risk with the purpose of maximizingthe value of the option/share, one must add that the bank becomes a financinginstrument of the industrial group. The group management has now the incentivesto expropriate banks and all other corporate assets in order to maximize the wealthof ultimate owners. Another potential risk of banks falling into the hands of indus-trial groups, is that the latter have the capacity to reduce the effective equity investedin the bank – and thus the charter value – by leveraging paid-in capital with loans tothe group (Rojas-Suarez and Weisbrod, 1996). While the regulation – and supervi-sion – of such practices is improving, it is by no means universal because it remainshard to implement. Bongini et al. (2001) document that ‘‘connections’’ to industrialgroups (or influential families) increase significantly the likelihood of distressedbanks. Thus, our regressions support both predictions. As for the presence of a dom-inating foreign bank owner, it yields no supplemental effect to that of PRIV, and thecoefficient is insignificantly different from zero.

Alternatively, the fact that the banks are under government control has a positivebut insignificant effect on PassDLoan. This result is consistent with the hypothesisthat government residual ownership has an effect on banks� risk exposure. First, ifgovernments keep a share of control over the privatized banks, it is a signal thatit seeks to influence the policies of the institutions including the allocation of creditto specific sectors of the economy, risk-taking strategies, etc. Thus, partial privatiza-tion is likely to dampen changes in both performance (Clarke et al., 2005) and riskmeasures. Further, the price that prospective buyers are willing to pay for a partic-ular bank is likely to be lower. This type of effect was, for example, observed in the


privatization of the Commonwealth Bank of Australia where bank share price per-formance was related – among many other factors – to the government residual own-ership (Otchere and Chan, 2003).

Finally, the results show that financial liberalization (LIB) is associated withhigher credit risk. Two potential explanations for this finding: First, when one elim-inates restriction on the risk parameters of a bank (interest rates, exchange rates)volatility increases, thus affecting loan performance. Second, liberalization also elim-inates restrictions on behavior of banks, under liberalized regime they can allowthemselves to take on more risk because now they can adjust asset-side rates upwardaccording to risk. The result is consistent with Demirguc-Kunt and Detragiache (1998).

With respect to DolGAP, the negative and significant sign of the coefficient for IGcontrol means that banks that fall under IGs� control increase their exposure to inter-est rate risk: the coefficient is negative with a relatively large and significant (at the1% level) coefficient. This is so because a large negative DolGAP represents potentiallosses (gains) with an increase (decrease) in interest rates. If we consider that privati-zation is often accompanied by liberalization, and thus interest rate increases, we canconclude that IG-controlled NPBs are creating a dangerous interest rate exposureposition following privatization. We finally note that, surprisingly, interest rateexposure is also higher when the bank is controlled by the government.

4.2.2. C – Capital adequacyAlthough insignificant, the positive coefficient for the IGs control variable in the

regression for LoanTEq, suggests that the increase in – credit and interest rate – riskexposure is accompanied by a reduction of capital available to cushion the risk: theylent 16 cents more per each dollar of capital than any other bank, while foreign con-trolled banks reduced lending by 30 cents per dollar of capital, and NPBs that re-mained under government control increased lending by only 2 cents per dollar ofcapital. Based on this evidence, we can conclude that banks under foreign controlare significantly less exposed to insolvency than any other type of owner.21

In summary, these results suggest that domestic owners respond differently fromforeign owners to incentives that arise from the prevailing ownership structure andregulatory environment. For example, domestic owners can exploit more freely theweaknesses in the regulatory, supervisory and deposit insurance framework than for-eign owners. Further, the government is less likely to engage substantial resources torescue a foreign-owned distressed bank. This additional room for manoeuvre avail-able to domestic owners can be exploited by manipulating risk-taking on and off

21 To insure the robustness of our results, we run several robustness checks. We particularly, checkedwhether our results remained robust to the use of a particular control threshold for IGs and foreigninvestors (50% or 30%). For the government, control is always beyond 50%. All our results remainessentially the same. We also used alternative proxies. For example, exchanging LAW with a variablemeasuring corruption; exchanging RELSIZE with an absolute measure of size (log of assets); adding anumber of – non-significant – variables; or adopting the approach by Cornett and Tehranian (1992) ofusing identical block of regression for all variables of interest, introduced no substantial changes in results.All introduced minor variations in value and significance of key coefficients.


balance sheet positions to maximize the value of equity.22 Additionally, governmentsare often reluctant to let the banking system fall into foreign hands. This reluctanceis due to the strategic importance of the banking system in the economy, particularlyif ‘‘bank-based’’ financing structures dominate, which is the case of most DCs. Bykeeping privatized banks under control of national interests, they create conditionsthat may result in a banking crisis. Thus, such a strategy should be used only if anefficient regulatory and supervisory (R&S) framework is in place. In light of our evi-dence, we can interpret the Mexican banking crisis as a possible outcome of (1) thegovernment�s choice to sell GOBs to local entrepreneurial investors, and (2) the lackof an efficient R&S framework. Our results also suggest that foreign banks appear tobe more cautious in risk-taking strategies.

5. Conclusion

Mounting evidence on the costs of public ownership highlights the need for bankprivatization and the potential benefits of shifting to private ownership, especially inlow-income countries where state ownership is high (La Porta et al., 2002). Ironicallythough, while privatization of banks in developed countries was initiated as early asthe mid-1980s, most developing countries started selling their banks a decade later.The process of bank privatization has been held back by a combination of factorsincluding the extent of bad debt portfolios of state banks and opposition by vestedinterest, since state ownership generally enables officials to use banks as a source ofpatronage jobs, or to direct credit to supporters. In addition, the evidence on bankprivatization indicates that it is important to complement the process by institutionalchanges in order to strengthen the overall incentive environment and lead to a moreefficient sector (World Bank, 2001, 2002).

In this paper, we provide an empirical analysis on the postprivatization perfor-mance and risk-taking behaviour of banks in developing countries. Our panel dataencompassing both the pre and postprivatization periods for 81 privatized banksin 22 countries allows us to examine this issue.

We pay particular attention to separate the effect of privatization�s impact on per-formance from other ongoing reforms such as financial liberalization. A controlsample of government-owned banks allows us to determine how newly privatizedbanks behave compared to their state-owned counterparts. We investigate thechange in the profitability, economic efficiency, risk-taking behaviour and capitaladequacy of newly privatized banks while controlling for differences in their owner-ship structures.

Our results allow us to draw the following main conclusions: On average, bankschosen for privatization appear to have a lower efficiency, and a lower capital ade-quacy than government-owned banks. Hence, the government does not seem to have

22 Large off balance sheet positions are positively related to the likelihood of a banking crisis (Garcia-Herrero, 1997). The presence of supplemental forbearance for large domestic banks – often associated withlarge local business – has been reported in the last East Asian financial crisis (Bongini et al., 2001).


divested the ‘‘family jewels.’’ Compared to their level of performance before privati-zation, newly privatized banks exhibit an increase in profitability, but a significantdecrease in efficiency and more credit risk exposure. Nevertheless, we find that astime elapses after privatization, there is a long term significant improvement in effi-ciency and credit risk exposure.

When we control for the type of ownership, we find that industrial groups-con-trolled banks have the highest risk exposure – credit and interest – accompaniedby lower levels of capitalizations compared to foreign controlled or government con-trolled banks. This result is particularly important with respect to the allocation ofdivested shares. Selling to local industrial groups is likely to yield a higher level ofexpropriation by these owners and hence create conditions that lead to a bankingcrisis. Thus, an appropriate and efficient regulatory and supervisory system needsto be put in place before the divestiture of banks is implemented. The Mexican bank-ing crisis in the early nineties is an example of what happens when these conditionsare not fulfilled. Kikeri and Nellis (2004) also point to the Chilean financial crisis inthe late seventies as an outcome of a poorly designed and implemented bank privati-zation process in a weak regulatory environment. Our results also suggest thatforeign banks� entry can be beneficial since foreign owners are more cautious inrisk-taking strategies, and seem to have a positive impact on the efficiency of newlyprivatized banks. Finally, our results suggest that the prevailing macroeconomic andinstitutional settings matter in explaining the postprivatization bank performance.

Acknowledgments

This paper has benefited from valuable comments from George Clarke, AlainCoen, Robert Cull, Bill Megginson, and especially, from an anonymous referee.We are also thankful for insightful comments from participants at the 2004 FinancialManagement Association European Conference in Zurich, Switzerland, and the2004 Northern Finance Meeting in St. John�s, Newfoundland. The valuable researchassistance of Mouaffak Abada is gratefully acknowledged. We also acknowledgefinancial support from the Social Sciences and Humanities Research Council of Can-ada. This paper was completed while Klaus Fischer was a visiting scholar at the BCInstitute for Co-operative Studies, University of Victoria.

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