Ownership Structure, Performance and Risk in Indian Commercial Banks

Author:Kalluru, Siva Reddy

This paper examines the effect of ownership on performance and risk of commercial banks in India during the period 1995-2007. The study, using t-test, fixed effects and random effects models, examines whether there exists any significant difference in the performance and risk among State-Owned Banks (SOBs), Domestic Private Banks (DPBs) and Foreign Banks (FBs), controlling other factors. The... (see full summary)


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Ownership structure of an economic unit is explained through two main dimensions. First, the degree of ownership concentration: units may differ because their ownership is more or less dispersed. Second, the kind of owners: given the same degree of concentration, two units may differ if the government holds a majority stake in one unit; similarly a stock firm with dispersed ownership is different from a mutual firm (Iannotta et al., 2007). Indian banking industry consists of different ownership structures: State-Owned Banks (SOBs), Domestic Private Banks (DPBs) and Foreign-Owned or Foreign Banks (FBs). Although their ownership is different, they are not apparently different in terms of the kind of services they provide. They provide full-fledged banking services, thereby competing in the same markets under the same regulatory conditions.

Over the years, a considerable number of studies have debated the relationship between firm ownership and performance. The conclusion relies on various theoretical explanations starting from property rights and agency theory to managerial rewards and public choice theory. According to property rights hypothesis, private enterprises perform better than public enterprises (Alchian, 1965 and De Alessi, 1980) because of principal agent problems, which imply that management in private enterprises are supposed to be more restrained by capital market discipline (William, 2004). Public choice theorists (Niskanen, 1975; Aharoni 1986 and Levy, 1987), while complementing the property rights perspective, point out that government ownership usually yields specific inefficiency factors irrespective of market conditions. The argument is straightforward: a lack of capital market discipline weakens the owners' control over management, making the management free to pursue their own interests rather than the interests of the public at large. Common reasons for different ownership forms leading to different performance levels are often extensively discussed in the literature, which include: (1) pay differentials between state-owned enterprises and private enterprises, (2) poor accountability, (3) ownership dispersion and constraints on transfer of property rights, (4) inadequate monitoring by state, and (5) protection and subsidization of poorly performing state-owned enterprises using public funds (Ramaswamy, 2001).

However, this stream of studies theoretically argue that privately-owned enterprises usually perform better than state-owned enterprises; however, this argument is not without its critics.1 Many studies which examined the performance effects of bank ownership type- whether an institution is state-owned, private domestic or foreign-found very significant differences among these types. A study by Vining and Boardman (1992) reviewed 54 studies that compared the performance of firms' between private and state ownership and found that 36 studies concluded that private firms perform better; six studies revealed that state-owned banks perform better; and 16 studies did not support either form of ownership. On the contrary, several studies, such as Caves and Christensen (1980), Borcherding et al. (1982), Millward (1988), and Ramaswamy (2001), argued that ownership does not matter in the presence of sufficient competition between state and private enterprises. Further, a survey by Millward and Parker (1983) concluded that there is no systematic evidence to support the perception that public enterprises are less effective than private enterprises.

Further, Bearle and Means (1932) found that the separation of ownership and control may lead to conflict of interests between owners and managers. Jensen and Meckling (1976) argued that as managers' equity decreases and ownership becomes more dispersed as a result, the agency cost of deviation from value maximization will increase. Fama (1980) argued that if capital market is efficient and the dispersed ownership goes along with the public trading of the firm's securities, that will likely discipline the firm's management. Regarding the nature of owners, Shleifer and Vishney (1997) argued that state-owned enterprises that are technically controlled by the public, are run by bureaucrats who may think of having very controlled rights rather than significant cash flow rights. He also pointed out that political bureaucrats maximize personal goals which often results in conflict with public interests, as it is dictated by political interests.

In the specific case of banking industry, Bonin et al. (2005a and 2005b) for Eastern European banks found that FBs performed better than DPBs and SOBs. However, Yildirim and Philippatos (2007) in a study on transition countries found mixed results that FBs are more cost-efficient, but less profit-efficient than both DPBs and SOBs. Using 28 developing nations, Berger et al. (2004) found that FBs have highest profit-efficiency and DPBs have high cost-efficiency over SOBs. Using the data of Argentine banks prior to the crisis in 2002, Delfino (2003) and Berger et al. (2005) found that FBs and DPBs are on average equally efficient...

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