Privatization, State Ownership, and the Performance of Egyptian Banks*



                                Mohammed Omran a...
Privatization, State Ownership, and the Performance of Egyptian Banks

                                        Abstract

R...
1. INTRODUCTION

A healthy financial sector, able to attract and support foreign and local direct investment,

is crucial ...
The role of bank privatization in improving the financial sector is not yet clear and very

little is known regarding this...
No doubt, the economics of privatization is a broad topic, so we had to limit the scope of

our investigation1. We intend ...
to the impact of ownership structure on bank performance, and whether they should go

further and privatize state-owned ba...
2. THE HISTORY OF THE BANKING SECTOR IN EGYPT

Not so integrated as banks in developed markets, the financial services ind...
changes unfavorably affected the banking sector. The year 1960 witnessed the start of

massive and successive waves of nat...
in competition and innovation. Consequently, banking reform became a critical element

of the economic reform program adop...
2002. On the other hand, non-commercial banks are segmented into business and

investment banks (whose main activities are...
income from investments in government securities, primarily treasury bills and bonds5.

The new tax code, while inevitable...
percent or more. Out of the seven fully state-owned banks, four were commercial banks,

and the rest were specialized bank...
represent an attractive alternative, particularly, since the government allows majority

foreign ownership of JVBs, this h...
4. LITERATURE REVIEW ON BANK PRIVATIZATION

As mentioned previously, in the past few years a moderate amount of theoretica...
large commercial bank out of the monobank system is an obstacle for the bank

privatization process; (ii) recapitalization...
efficiency in the banking sector. More precisely, the results indicate that banking sectors

in these countries became mor...
The empirical work on bank privatization in developed countries tends to be very rare,

but we were able to identify two: ...
sample period ended in 1999 because we needed at least two years post-privatization data

to measure performance changes.
...
from the financial information provided by the Kompass Egypt Financial Year Books

(Fiani and Partners, various issues). T...
individual privatized bank, excluding the year of privatization (year 0)8. Therefore, the

minimum time interval data for ...
statistics follow a Student’s t-distribution if the sample is normally distributed. Since the

sample size is small (only ...
comparisons are valid.          Therefore, we calculated the post-privatization performance

relative to the pre-privatiza...
different levels: (i) unadjusted results, (ii) matched-adjusted results, and (iii) post-

privatization comparison between...
percent of sample banks. Nevertheless, the improvement in the first two ratios and the

deterioration in the latter one ar...
banks outperform its bank counterparts in terms of ROE, while only 33 percent of

privatized banks exceeds the MPVBs in te...
efficiency ratios. Our sample banks outperform their counterparts in terms of liquidity

only, which might be due to the f...
at the ten and five percent level, respectively. Furthermore, return on loans of privatized

banks increase relative to th...
gradually. As a result, the analysis of post-privatization performance is likely to yield an

incomplete picture of the ef...
significantly higher for MPVBs at the one percent level. Again, all efficiency ratios are

higher for PVBs and MPVBs at di...
for liquidity, the results show no significant differences between privatized banks and

MSTBs, while STBs holds significa...
involvement, we can model this relationship by having the percentage of each type of

ownership as a determinant of bank p...
differentiate between the situation in each year considered in the sample and corroborate

the existence of significant he...
which indicate that PVBs and MPVBs perform better than MSTBs and STBs during our

period of study19. Nevertheless, our fin...
that in terms of profitability, privatized banks outperform MSTBs, but underperform

STBs. The results from analyzing the ...
Summing up, with all respect to the findings from comparing the relative performance

changes of privatized banks with the...
REFERENCES

Abarbanell, J. and Bonin, J. (1997) Bank Privatization in Poland: The Case of Bank Slaski.
Journal of Comparat...
Isik, I. And Hassan, K. (2002). Technical, Scale and Allocative Efficiencies of Turkish
Banking Industry. Journal of Banki...
Table 1
                                                                 Structure of the Egyptian Banking System
The tabl...
Table 2
                                                         Aggregate Balance Sheet of the Egyptian Banking Sector
Th...
Table 3
                Details of Joint Venture Bank Privatization Offers (1996 - 1999)
The table shows the privatization...
Table 4
                                    Ownership Structure of Privatized Banks
The table provides detailed informatio...
Table 5
                                    Ratios Used to Analyze Banking Performance
The table presents details on each ...
Table 6
                                                                  Descriptive Statistics: Privatized Banks
The tab...
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  1. 1. Privatization, State Ownership, and the Performance of Egyptian Banks* Mohammed Omran a,b a Arab Academy for Science & Technology, College of Management & Technology, PO Box 1029, Alexandria, Egypt b Arab Monetary Fund, Economic Policy Institute, PO Box 2818, Abu Dhabi, United Arab Emirates E-mail: momran@aast.edu Paper to be presented at the World Bank Conference on “Bank Privatization in Low and Middle Income Countries”, Washington DC, November 20-21, 2003. * The views expressed in this paper are those of the authors and do not necessarily reflect the views of the Arab Monetary Fund (AMF). The author gratefully acknowledges Miss Ayten Feteheldin at the Economic Policy Institute of the AMF for her excellent research assistance.
  2. 2. Privatization, State Ownership, and the Performance of Egyptian Banks Abstract Researchers have widely documented that privatization leads to enhancing the financial and operating performance of state-owned enterprises (SOEs) following divestiture. As a policy, privatization could not only motivate privatized SOEs but, equally important, it could also motivate public firms, including banks, to readily face future changes in the economic system through its spillover effects. However, little is known about bank privatization around the globe, in general and in the Middle East and North Africa (MENA), in particular. This study addresses the financial performance of a group of twelve Egyptian banks from 1996-1999, during which control was transferred from the state to the private sector Following privatization, the unadjusted results indicate that some profitability and liquidity ratios decline significantly, whereas other performance measures- asset quality, capital risk indicators, operating efficiency, and asset growth- show insignificant changes. On the other hand, the results for the privatized banks- relative to matched adjusted private-owned and majority private-owned banks- indicate, mainly, similar results as the unadjusted data. This is pervasive, particularly for profitability and efficiency indicators. As for adjusted results, using majority state–owned and fully state- owned banks as benchmarks, we document that privatized banks perform better relative to the former benchmark and worse than the latter. Nevertheless, the results from both post-privatization and entire periods provide strong evidence that banks with higher private ownership involvement are associated with better performance. Key Word: Banks, Privatization, Financial Performance, and Egypt JEL Classification: G21, G32, L33 2
  3. 3. 1. INTRODUCTION A healthy financial sector, able to attract and support foreign and local direct investment, is crucial to creating a favorable investment environment in any economy. Although it seems that no generally accepted model exists to describe the relationship between financial development and economic growth, an increasing number of studies provide more corroboration that financial development promotes economic growth (see among others, King and Levine, 1993; Hermes, 1994; Levine, 1997; Rajan and Zingales, 1998; and Levine, Loayza and Beck, 2000). Moreover, the evidence suggests that financial systems yield larger benefits; and hence, contribute more to economic growth when their activities are directed by the private sector (Beck and Levine, 2000; and Levine and Zervos, 1998). The transfer of ownership from public entities to the private sector increases competition in markets, which induces firms to be more efficient and profitable. On the other hand, an anemic and less developed financial sector cannot allocate the needed capital resources effectively, which in the long-run adversely affects economic growth and makes financial markets less stable. Taking a close look at the banking sector, it is argued that banks could well identify profitable activities, exert corporate governance, mobilize resources, facilitate transactions, and manage risk. However, in many developing countries, where banks are still state controlled, we see that the inefficient and often politically-motivated use of the banking sector eventually frustrates efforts toward achieving economic development. Of course, heavy state involvement in the banking sector hinders economic growth because governments are usually inefficient and unsuccessful in the management of financial and other economic sectors. 3
  4. 4. The role of bank privatization in improving the financial sector is not yet clear and very little is known regarding this issue. Unlike non-financial firms, where researchers have extensively studied the impact of privatization on the financial and operating performance of state-owned enterprises (SOEs), bank privatization around the globe tends to be under-studied in academia. Of course, data limitation and the smaller number of privatized banks (compared with non-financial SOEs) might explain why this topic has not yet attracted more researchers. As we will see later in Section 4, in the past few years a moderate amount of theoretical and empirical work on bank privatization has emanated. Two facts can be extrapolated from the literature. First, we know very little about the bank privatization process and the impact of privatization on bank performance in the post-privatization period, compared with what we already know about non-financial privatization. Second, the little we know about bank privatization comes, mainly, from transition economies and Latin American countries, and the literature is extremely limited on this issue in other regions, such as the Middle East and North Africa (MENA) region. As such, we believe that a study on bank privatization in a MENA country is very important for both researchers and policy makers in this region. Like many emerging markets, banks in Egypt are the dominant financial institutions, as they control most of the financial flows and possess most of the financial assets. Consequently, the issue of bank privatization is of valid concern to the Egyptian economy, in particular, since there has been an ongoing discussion about the quality of bank loans, investment portfolios, and the sufficiency of their reserves. 4
  5. 5. No doubt, the economics of privatization is a broad topic, so we had to limit the scope of our investigation1. We intend to focus only on examining whether privatization improves the performance of privatized banks and thus, if any of the benefits of privatization predicted by economic theory is achieved. If transferring the ownership control from the state to the private sector affects performance, we expect to see changes in various accounting measures for these privatized banks. More precisely, we examine how privatized banks perform in the post-privatization period compared to their performance in the pre-privatization period. The performance changes in privatized banks are tested on both an unadjusted basis and a matched adjusted basis, in which the latter allows us to examine the performance changes in privatized banks irrespective of any industry-wide factors that might be affecting the performance. The study, thus, contributes to the literature on privatization by providing additional evidence on the impact of privatization on the performance of privatized banks in emerging markets, concentrating on the Egyptian experience. Equally important, narrowing the focus and testing the performance of privatized banks in a single country adds insight into this topic as accounting measures of financial performance tend to be homogeneous, and there is no place for weakness of cross-country data2. Additionally, we do not limit our analysis to privatized banks, but we extend it to cover private-owned banks (PVBs), state-owned banks (STBs), and combined-ownership banks with majority private-ownership (MPVBs) or majority state- ownership (MSTBs). By doing so, we should be able to draw the policy makers’ attention 1 There are many issues, that we will not cover, that deserve further investigations. For example, the most effective way to privatize banks, public and political reasons behind bank privatizations, the impact of international institutional investors on privatized banks, and the role of bank privatization in enhancing the financial sector and promoting economic growth. 2 The sources of weaknesses of cross-country data could be due to several reasons, for example, using different currencies in the analysis, and the variation of financial reporting standards among countries. 5
  6. 6. to the impact of ownership structure on bank performance, and whether they should go further and privatize state-owned banks. In this paper, we examine the performance of twelve Egyptian joint venture banks (JVBs) that witness full or partial privatization from 1996 through 1999. The unadjusted results indicate that some profitability and liquidity ratios decline significantly, whereas other performance measures- asset quality, capital risk indicators, operating efficiency ,and asset growth- show insignificant changes. At the same time, the results for the privatized banks -relative to matched adjusted PVBs and MPVBs- indicate, mainly, similar results as the unadjusted data. This is pervasive particularly for profitability and efficiency indicators. As for the adjusted results using MSTBs and STBs as benchmarks, we find that privatized banks perform better relative to the former benchmark but worse than the latter. Nevertheless, the results from both post-privatization and entire periods provide strong evidence that banks with higher private ownership involvement are associated with better performance. The remainder of the paper is organized into six sections. Section 2 provides an overview of the Egyptian banking history, followed by a background of the bank privatization process in Section 3. In Section 4 we provide a brief summary of bank privatization literature and the main findings of previous research studies. The sample construction is described in Section 5, and in Section 6 we introduce and explain the performance measures and methodology used in this study. Results are presented and discussed in Section 7, and Section 8 concludes the paper. 6
  7. 7. 2. THE HISTORY OF THE BANKING SECTOR IN EGYPT Not so integrated as banks in developed markets, the financial services industry in Egypt is still relatively promising, although there is no single institution that offers a full range of financial products to its customers. However, the Egyptian banking sector is presently undergoing several changes. For example, most of the banks are currently targeting retail banking as a new service, thus offering products, such as consumer loans and retail banking activities, which help generate fees and commissions income. The Egyptian banking industry is entirely governed by the Central Bank of Egypt (CBE). Established in 1960, the CBE acts as the regulating body for the banking system and is responsible for formulating and coordinating domestic monetary, credit, and banking policies as well as supervising their implementation. However, in November 2001, the Cabinet of Ministers approved the new CBE draft law. The law provides for the CBE to act as an independent entity reporting directly to the President. The law also reaffirms the CBE's goals to put the bank in charge of national liquidity management and to direct credit to true economic needs. Meanwhile, the CBE will undertake the management of the foreign exchange system and external debt, as well as the supervision of the national payment system in cooperation with non-banking financial institutions, such as the capital market authority and insurance firms. Accordingly, the CBE is required to issue a quarterly assessment of monetary and banking developments to the President and the People's Assembly. Insert Table 1 near here More than 50 years ago, when Egypt was under British occupation, the banking sector in Egypt was dominated by foreign banks, but after the revolution of 1952, significant 7
  8. 8. changes unfavorably affected the banking sector. The year 1960 witnessed the start of massive and successive waves of nationalization, which left the whole banking sector in Egypt consisting only of the Central Bank of Egypt (CBE), five commercial banks, and three specialized banks, all of which were fully owned by the government. Not contented with ownership, the government resorted also to various controls and repressive measures including (among others): interest rate ceilings on bank loans and deposits; preferential rates and allocations of credit to public, industrial, and agricultural enterprises; and high reserve requirement ratios. As seen in Table 1, prior to 1970, there was no single, private, joint venture, or offshore bank in Egypt. The “open-door” policy of 1974 reflected the realization that improving the efficiency and competitiveness of the banking sector was essential to mobilize private and foreign resources needed to fuel further development. Therefore, Law 120 of 1975 was thereby enacted authorizing the establishment of private and joint venture banks, foreign bank branches, and offshore institutions. As can be seen in Table 1, this resulted in the establishment of a vast majority of private sector and joint-venture banks during the mid 1970s. Many of these banks were presumably designed to promote international investments by providing banking services to foreign entities operating within the country. However, the significant increase in private, foreign, and mixed-ownership banks did not witness a similar evolution in financial services. The CBE continued to control interest rates, credit allocations, and banking service charges. Also, the relatively large network of public sector bank branches allowed them to dominate the process of savings mobilization. As a result, the banking system remained highly segmented and lacked both 8
  9. 9. in competition and innovation. Consequently, banking reform became a critical element of the economic reform program adopted in late 1990; and as a result, the Egyptian banking system entered yet another phase of development. The reform program involved the financial sector in several ways, beginning with the elimination of the repressive measures that had been in practice since the early 1960’s. Therefore, loan and deposit rates were liberalized in January 1991, followed by the removal of ceilings on bank loans to the private sector in October 1992. Also, service fees and bank charges were freed up; the reserve requirement ratio was reduced; and majority foreign ownership was permitted. And since 1993, foreign banks were allowed to conduct local currency businesses provided that they are capitalized at a minimum of US $15 million3. The authorities also focused on developing indirect monetary instruments, and to that purpose the CBE instituted weekly auctions of treasury bills and longer maturity bills in order to mobilize savings and to create a market mechanism for interest rate determination.4 Currently, as Table 1 shows, the Egyptian banking sector can be broken down into two main segments- commercial and non-commercial banks- with an average of 46 branches per bank as of 2002. There are 28 commercial banks registered with the CBE in Egypt: four STBs and 24 PVBs and JVBs. The four public-sector commercial banks are by far the largest in the Egyptian banking sector. As of 2002, they boast the most extensive geographical coverage in Egypt and dominate the market with an average of 230 branches per bank. They control approximately 60, 70, and 65 percent of deposits, assets, and loans, respectively (Central Bank of Egypt, 2002). Lagging behind their public sector counterpart, the 24 private and joint venture commercial banks have 367 branches as of 3 See CBE (1994). 4 For more detail on banking system reform, see CBE (Various Issues). 9
  10. 10. 2002. On the other hand, non-commercial banks are segmented into business and investment banks (whose main activities are surprisingly the same as commercial banks) and specialized banks. There are 31 banks in the former and only 3 in the latter, totaling 34 non-commercial banks as of 2002. Insert Table 2 near here The performance of the banking sector in the past few years has been somewhat disappointing. Equity capital, which historically has been over 5 percent of assets, began to deteriorate by the end of 2001, falling to a low of 4.8 percent in 2002, mainly because of bank provisions for bad loans. Indeed, loan loss provisions, as a percentage of loans, has been climbing since 2000, reflecting the impact of the current economic slowdown in the banking industry. After several clients started defaulting on their loans, banks augmented their base provisions accordingly. As for efficiency measures, the banking industry has been gaining ground over the past decade as the loan-to-deposit ratio improved tremendously from 65.4 percent in 1991 to 87.1 percent in 2000. This is a result of banks using their deposit base to grow their lending business. However, with more retail-banking strategies implemented by Egyptian banks, coupled with slower growth in loans, the ratio receded to 78.1 percent by 2002. Nevertheless, the environment surrounding the banking system in Egypt is uncertain. Several new legislations and regulations have been introduced and others await approval - all of which will have an impact on the banking industry in Egypt one way or another. Among these regulations are the changes in Egypt's tax code, which dramatically affected the banking sector profits. Prior to 1998, banks enjoyed a tax exemption on earned 10
  11. 11. income from investments in government securities, primarily treasury bills and bonds5. The new tax code, while inevitable as a part of the government's ongoing economic reform program, came at a particularly difficult time for a banking industry already overwhelmed by intense competition and shrinking margins. Currently, the banks are scrambling for ways to maintain their profitability while repositioning themselves in the market. 3. BACKGROUND OF THE BANK PRIVATIZATION PROCESS IN EGYPT In market-based economies, the financial sector is an important means of mobilizing savings and reallocating resources, an avenue for domestic and foreign investment promotion, and a significant source of capital formation and business financing. With reference to the contemporary Egyptian economy, the market’s role is of particular significance as a means of privatization and extending economic asset ownership to broaden the base of investors, therefore achieving economic goals and objectives. Consequently, with the introduction of the economic reform program, the Egyptian government recognized the role of the banking sector in economic development, and that role became instrumental in the success of this program. Therefore, as part of the comprehensive economic liberalization, a plan to privatize the banking sector was designed to remove any constraints hindering the development of this essential sector. Prior to the bank privatization process, the government controlled thirty banks, of which seven were fully-owned and twenty-three were JVBs with the state’s shares was at 51 5 Banks were entitled to deduct the amount of income they received from treasury bills and bonds from their taxable income. In other words, investments in government securities resulted in a double tax exemption, so most banks took advantage of the situation to severely reduce their tax burden. 11
  12. 12. percent or more. Out of the seven fully state-owned banks, four were commercial banks, and the rest were specialized banks. Starting in 1994, in an attempt to reduce market concentration and enhance competition, the Egyptian government embarked on an active bank privatization program, as one element of economic reform. Bank privatization in this economy is being carried out along two separate paths, privatization of JVBs and privatization of STBs. As far as JVBs privatization is concerned, in 1994 the government issued directives to the four state-owned banks to sell their holdings in twenty-three JVBs, or at least to reduce their holdings to less than 51 percent. However, no major activity occurred until early 1996 when the government approved amendments to the banking and credit law, lifting the limitation on foreign ownership and allowing foreigners to own more than 49 percent of a JVB. As a direct consequence of this ministerial declaration and the amendments to the banking and credit law, a number of successful sales took place using various privatization methods, including the sale of shares on the stock market, increases in capitalization by existing private sector owners, and private placement of shares to local and foreign partners. However, in 1999 the bank privatization process began to experience a difficult time, as many factors contributed to the apparent lack of enthusiasm for selling off JVB shares. Further, the recent lackluster performance of the stock market has reinforced the government’s decision to delay its privatization program in its entirety, including bank privatization. It has been argued that the government may be waiting for better market conditions and higher multiples before selling shares in public offerings. Although privatizing JVBs through direct sales to existing major private-sector owners may 12
  13. 13. represent an attractive alternative, particularly, since the government allows majority foreign ownership of JVBs, this has not taken place. The change in the income tax code of 1998, mentioned previously, eliminated the ability of banks to earn tax-free income on government securities, which has resulted in a significant decline in the profitability of banks, hence, the reduced attractiveness of the banking sectors as a whole. Additionally, some JVBs have by-laws that restrict the sale of shares. Until these bylaws are amended, further privatization is not possible as in the case of the Export Development Bank, where the state still owns over 50 percent. While the privatization of JVBs witnessed significant progress in its early years, the challenge of privatizing one state-owned bank is yet to be met. In early 1997, the government agreed with the IMF to privatize one of the four state-owned commercial banks before the end of the year. Although this was a strong indication of the government’s apparent commitment to bank privatization, no announcement has been made to date regarding which bank will be the first candidate, or how it will be sold. The reasons given include the need to first issue executive regulations and the need to do an internal valuation of the banks (rumored to be underway). However, it seems that many officials are still concerned about the loss of state control over the banking sector. It is argued that the concern is directed at handing the state’s assets over to international players who are better positioned than the local players to bid for the big four state- owned banks; therefore, the government must cautiously handle the politics to drive its privatization program through. In sum, the prospects of privatizing any of the four state- owned banks in the near future remain, at best, questionable. 13
  14. 14. 4. LITERATURE REVIEW ON BANK PRIVATIZATION As mentioned previously, in the past few years a moderate amount of theoretical and empirical work on bank privatization has emerged. We observe that all work on this topic looks at (i) transactional structures and the technical process of bank privatizations, (ii) post-privatization performance of privatized banks, or (iii) both issues together. Unal and Navarro (1997) thoroughly examine the technical process of bank privatization in Mexico and provide a detailed explanation of this process. They argue that the lack of a previously enhanced legal and regulatory framework was a major obstacle in the full achievement of bank privatization objectives set by the government. Consequently, their paper sheds lights on the need to build a better regulatory and supervisory environment long before the privatization process starts since the needed groundwork is usually slow and gradual. Additionally, the paper claims that the privatization model that the Mexican government adopted- selling banks at random rather than selling all of them at one time- would maximize its return. The paper, somehow, does not offer any information on the impact of privatization on bank performance. In another study, Meyendorff and Snyder (1997) examine the transactional structures of privatization in three monobanks from Central Europe and Russia. By examining three main issues: (i) antecedent actions, (ii) ownership transfer and governance, and (iii) ongoing government intervention, they find that governments are not working seriously toward breaking up the socialist monobank system. The states in this region still control monobanks; hence, the former monobanks retain dominant market shares in most transitional economies. Their paper offers several policy implications: (i) creating one 14
  15. 15. large commercial bank out of the monobank system is an obstacle for the bank privatization process; (ii) recapitalization and privatization of banks should be closely linked in order to maximize their value and decrease the expectation of future bailouts; (iii) there are benefits from rapid privatization through allowing market forces to influence the structure of privatized banks; and (iv) corporate governance, market competition, and strategic foreign investors can contribute to the efficiency and health of privatized banks. In sum, their paper argues that various transactional structures could have significant effects on a bank’s microstructure, strategy, and post-privatization performance. Abarbanell and Bonin (1997), Bonin and Wachtel (1999) Hasan and Marton (2003), and Bonin, Hasan, and Wachtel (2003) provide evidence of the difficulty of bank privatization in transition economies. This is because of (i) the problems of political instability, (ii) huge bad loans, (iii) the problem of creating a competitive system to replace the monobank system, and (iv) the lack of expertise in economic and banking issues. Regardless of these difficulties, Hasan and Marton (2003) study the experiences and developments of the Hungarian banking sector during its transition from a centralized economy to a market-oriented system. The empirical findings of this paper show that early reorganization initiatives, flexible approaches to privatization, and liberal policies towards foreign bank involvement, were among factors that strengthened the banking sector in a short time. Of particular importance here is that banks with larger foreign ownership involvement were associated with higher efficiency. Again, Hasan with Bonin and Wachtel (2003) in a more comprehensive study from 1996-2000 that covers eleven transitional countries with 220 banks, find support that foreign ownership leads to more 15
  16. 16. efficiency in the banking sector. More precisely, the results indicate that banking sectors in these countries became more efficient and more competitive toward the end of the 1990s. They provide strong evidence that ownership structure really matters in the banking sector. The private banks in these countries are more efficient than their state- owned bank counterparts, and the gap increases when private banks are controlled by foreign ownership. Furthermore, the participation of international institutional investors in foreign-owned banks yields even greater efficiency and impact. Looking at another continent, Latin America, we find that studies by Clarke and Cull (1999a and 1999b) on bank privatization in Argentina are very well executed. In their paper (1999a), they analyze the pre- and post-privatization performance of publicly- owned Argentinean provincial banks. Concentrating on financial performance, the study finds that privatized provincial banks operate, on one hand, quite differently from public provincial banks, and on the other hand, similarly to the ten largest private banks in Argentina during the post-privatization period. For example, the privatized provincial banks improved their ratio of operations to costs and the quality of their portfolio. Equally important, the paper also emphasizes the need to improve regulations as a prerequisite for successful bank privatization. In contrast to the successful bank privatization in Argentina, Makler (2000) identifies some factors that have impeded Brazil’s attempts to privatize its state-owned banks. Among these factors are the collapse and acquisition of private banks, foreign participation, and globally oriented financial markets. 16
  17. 17. The empirical work on bank privatization in developed countries tends to be very rare, but we were able to identify two: (i) one on bank privatization in Italy and (ii) another that covers several countries from developed and emerging economies. Farabullini and Hester (2001), for a group of six Italian privatized banks, find positive changes in the organizational structure and profitability of these banks in their post-privatization period. They conclude that privatization leads to improved operating performance and more innovation in Italian banking. Last, Verbrugge, Megginson, and Ownes (1999) investigate the performance of bank privatization in 25 developed and emerging economies. In the post-privatization period, they document limited improvement in profitability, operating efficiency, leverage, and non-interest revenues. They also find significant initial returns for investors, although the seasoned issues are not significantly underpriced. Additionally, they argue that substantial state ownership remains after privatization in most privatized banks, and this raises serious problems for establishing market-oriented systems. From the above-given literature, it is obvious that most bank privatization studies focus, mainly, on transition economies and Latin American countries. The aim of our paper is to fill this gap by studying a country in the MENA region, a part of the world that is much understudied in the area of financial economics. This is what we address next. 5. SAMPLE CONSTRUCTION This study examines the performance of JVBs from 1996-1999, during which control was transferred from the state to the private sector. We define bank privatization here by the transfer of at least a proportion that makes the state ownership less than 50 percent. The 17
  18. 18. sample period ended in 1999 because we needed at least two years post-privatization data to measure performance changes. Insert Tables 3 and 4 near here As seen in Tables 3 and 4, we were able to identify 14 privatization processes for JVBs through 1999. Interesting, the state owns 20 percent or less in only 4 out of the 14 banks, and only one bank has become 100 percent private. Also, from the tables, we see that 50 percent of bank privatizations took place in 1997 but slowly declined afterwards because of poor economic conditions. However, we excluded the Export Development Bank from our sample because the state ownership is still above 50 percent. Moreover, we were not able to find sufficient pre-privatization data for another bank, namely, Credit Internationale d’Egypt. Therefore, the final sample consists of 12 JVBs, 11 of which are commercial banks. Should we find that the performance of privatized bank improves or declines in the post-privatization period, we need to keep in mind that the results may be due to industry-wide factors, rather than the privatization event, itself. To check for this possibility, we identify subsamples of benchmark banks that were not involved in the privatization process. In particular, we identify four group counterparts: private-owned banks (PVBs), combined-ownership banks6 with private majority (MPVBs), combined- ownership banks with state majority (MSTBs), and the four big state-owned commercial banks (STBs)7. The accounting data of the sample privatized banks and the group counterparts are drawn 6 Although most banks in this group are classified as business and investment banks, rather than commercial banks, in real terms their primary activity is commercial banking. 7 We excluded the other three state-owned banks (specialized banks) because they have their own characteristics that differ substantially in nature than commercial and investment banks. 18
  19. 19. from the financial information provided by the Kompass Egypt Financial Year Books (Fiani and Partners, various issues). This rich source of financial information displays the financial statistics of respective banks in Egypt in a consistent manner, so that selected performance measures are on a comparable basis, following the international accounting standards (IAS). 6. PERFORMANCE MEASURES AND METHODOLOGY The methodology used in this paper incorporates many accounting performance measures to allow for comparison between pre-and post-privatization performances. The measures we use are, mainly, those from Cornett, Ors, and Tehranian (2002) in addition to some of those from Verbrugge, Megginson, and Owens (1999). More precisely, to identify the performance changes in our sample banks following the privatization date, we evaluate the following six common bank performance indicators: i. Profitability- measures the overall performance; ii. Capital risk- reflects the ability of a bank to extend loans while meeting the regulated capital standards; iii. Asset quality- indicates the bank’s loan quality and risk; iv. Operating efficiency- measures the bank’s ability to generate revenue and pay expenses; v. Liquidity risk- indicates the cash position of the bank; and vi. Growth- reflects the bank’s change in assets. Insert Table 5 near here Table 5 provides the specific measures used to represent the above six indicators. For each ratio, we calculate the mean prior to and after the date of privatization for each 19
  20. 20. individual privatized bank, excluding the year of privatization (year 0)8. Therefore, the minimum time interval data for each bank is five years (from at least year –2 to year +2). We also compute the mean values of each bank in the four group counterparts, identified previously, prior to and after the privatization date of each privatized JVB9. Insert Tables 6-8 near here Tables 6, 7, and 8 show summary statistics for the accounting performance measures in the pre- and post-privatization period of privatized JVBs and their group counterparts. It seems that the performance changes in mean (median) values of privatized JVBs lagged behind many of their group counterparts, in particular the profitability and operating efficiency indicators. Also, the descriptive analysis shows clearly that profitability and operating efficiency indicators of PVBs outperform other groups in both pre- and post- privatization period. The tables also present the results of two tests used to determine whether performance measures could be adequately modeled by a normal distribution. Since the results show that the values of the standardized skewness and the standardized kurtosis for most of the measures do not exceed the range of +2 or -2, these performance variables tend to be normally distributed10. After calculating the pre- and post-privatization performance measures for the privatized sample, we test the null hypothesis that the cross-sectional average performance changes are equal to zero for a sample of n privatized JVBs. Under the null hypothesis, these test 8 We exclude year 0 because it includes both the public- and private-ownership phases of privatized banks. 9 That means each bank counterpart has three pre-and post-privatization mean values: one based on 1997 as year 0 or the year of privatization, and the other two values based on 1998 and 1999 as year 0. By doing this, we could match each JVB to its group of bank counterparts according to its specific privatization date. 10 For robustness, chi-square goodness of fit and Shapiro-Wilks W test for normality were also used. Both tests yielded similar results. 20
  21. 21. statistics follow a Student’s t-distribution if the sample is normally distributed. Since the sample size is small (only 12 banks) and some performance measures are not normally distributed, we also employ the non-parametric Wilcoxon signed-rank test to test the null hypothesis that the median performance changes are equal to zero. As argued earlier, it is of interest to understand whether any observed performance changes in privatized banks are due to privatization, itself, irrespective of any industry- wide factors. Of course, any industry trends would affect values for bank means and medians; thus, a change in unadjusted performance measures may be due to factors other than privatization. We tried to follow Barber and Lyon’s (1996) methodology by matching our sample privatized banks to control banks based on industry, size, and past performance history. However, given the data limitations, we were not able to follow this methodology. Instead, we were able to match our sample banks to different control groups of banks. Our first matched adjusted comparison group includes fully private- owned banks (PVBs), the second group consists of combined-ownership banks with majority private (MPVBs), the third matched group are those of combined-ownership banks with majority state (MSTBs), while the fourth and last matched group incorporates the four big state-owned commercial banks (STBs). We decided to test the adjusted performance methodology based on several specifications to overcome the problem of the size and, to some extent, the industry differences11. As for past financial history, to overcome the problem of the differences in pre-privatization performance between privatized banks and their group counterparts, we adjusted the data to ensure that such 11 With the exception of the third matched control group, all other groups are commercial banks. 21
  22. 22. comparisons are valid. Therefore, we calculated the post-privatization performance relative to the pre-privatization for each bank, privatized and non-privatized, as follows12: RPC = ( Pi ,t − Pi ,t −1 ) / Pi ,t −1 (1) where RPC is the relative performance change, Pi ,t is the mean performance in the post- privatization period, and Pi ,t −1 is the mean performance in the pre-privatization period. Having computed the RPC for each performance measure and each bank, we again employ the parametric and the non-parametric test statistics mentioned-above. However, an interesting question could be raised should we find privatized banks perform better or worse relative to their group counterparts: Should the government go ahead and carry on privatizing the rest of the banking sector? The statistical results from both unadjusted and adjusted data might not be sufficient to answer this question. In fact, it might be of interest to see if there are any significant differences in performance, not performance changes, between privatized banks and their group counterparts in the post-privatization period. By doing this, we could shed light on which ownership structure performs better regardless of the performance changes between the pre- and post-privatization period. Therefore, we also compare the mean post-privatization performance of privatized banks relative to each one of the four group counterparts. 7. RESULTS In this section, we attempt to examine whether or not privatized banks are more profitable and efficient in the post-privatization period. We deal with this issue at three 12 As a check on the robustness of this method, we employ the absolute performance method instead. We, however, find similar results. For the sake of space, we did not present the statistical tests and the findings from this method, but they are available from the author upon request. 22
  23. 23. different levels: (i) unadjusted results, (ii) matched-adjusted results, and (iii) post- privatization comparison between privatized banks and different group of bank counterparts according to their ownership structure. Insert Table 9 near here As for the first level, unadjusted results, Table 9 presents the comparison between pre- and post-privatization performance of privatized banks based on both the parametric t test and the non-parametric Wilcoxon signed-rank test. On the profitability front, the results reveal that both profitability ratios, return on assets (ROA) and return on equity (ROE), decrease after divestiture of privatized banks. The mean and median ROA and ROE decrease from 0.017 and 0.23 to 0.014 and 0.16, respectively. While the decrease in ROA is not significant, the statistical tests pass the critical values of significance at the one percent and the five percent level for ROE using the t test and the Wilcoxon signed-rank test, respectively. The decreases in the above-mentioned profitability ratios are achieved by 67 percent of the sample banks for the first ratio and 83 percent for the latter one. Surprisingly, such decline in profitability ratios is not accompanied with similar decline in loan losses to loan ratio, i.e., improvement in asset quality. In contrast, the loan losses to loan ratio increases slightly after privatization, but not at any level of significance. As for capital risk indicators, we find an insignificant increase in core capital to assets, and an insignificant decline in loans to total capital, which refers to a steady position in capital risk indicators for privatized banks. On the operating efficiency front, privatized banks improve their net interest margin (NIM) and return on loans in the post- privatization period, and this is achieved by 75 and 67 percent of sample banks, respectively. While the non-interest revenue production declines after privatization for 67 23
  24. 24. percent of sample banks. Nevertheless, the improvement in the first two ratios and the deterioration in the latter one are not significant at any level. The liquidity indicator, measured by investment securities to total assets, declines significantly at the five percent level for both the parametric and the non-parametric tests, and this is achieved by 75 percent of the sample banks. Last, the results reveal insignificant decline in the asset growth ratio for privatized banks following privatization. At this point, we cannot draw conclusions from the above-mentioned results because the data used in the analysis do not adjust for industry factors that may be affecting the performance measures of privatized banks. Of course, any trend would affect the performance measures, so changes may be due to factors other than the privatization event itself. So the question now is: Are the changes in performance measures of privatized banks due to new ownership structures? Or, are they attributable to external factors, other than privatization? Consequently, to account for the impact of contemporaneous events, we also report matched adjusted performance measures in Tables 10 and 11. Insert Tables 10 and 11 near here Table 10 reports results for the relative performance changes of privatized banks relative to matched adjusted private-owned and majority private-owned banks. It is remarkable that there are statistically significant differences in relative changes of ROA and ROE between privatized firms and their bank counterparts. The relative performance changes in ROA and ROE for privatized banks are substantially lower than those of PVBs and MPVBs at the one and the ten percent level of significance for the first ratio and at the one percent level for the latter one. We also notice that none of our sample privatized 24
  25. 25. banks outperform its bank counterparts in terms of ROE, while only 33 percent of privatized banks exceeds the MPVBs in terms of ROA. While the relative performance changes in profitability ratios decline relative to their private and majority-private bank counterparts, we do not see any improvement in the asset quality indicator. In contrast, the loan losses to loan ratio of privatized banks is above their bank counterparts slightly, although not significantly. As for capital risk indicators, it seems that privatized banks improve their core capital to assets relative to their matched banks although such an improvement is not significant relative to PVBs but is significant at the ten percent level relative to MPVBs 13. In the meantime, the relative change in loans to total capital of privatized banks is not significantly different from their bank counterparts at any level. On the operating efficiency front, we could conclude that- apart from NIM, which improves slightly for privatized banks relative to their bank counterparts, but not significantly- the non-interest revenues and return on loans of privatized banks decline relative to their bank counterparts although significant, only, for the first ratio relative to PVBs. While the liquidity indicator improves for privatized banks relative to both PVBS and MPVBs at the ten percent level, we find no significant difference in relative changes in the asset growth rate between our sample banks and their counterparts. We could, however, draw some conclusions from the above analysis. Most importantly is that the relative performance changes of privatized banks are lagged behind their bank counterparts (PVBs and MPVBs), particularly, in terms of profitability and some 13 Of course, the privatized banks need to have their capital adequacy match Basel requirements (8 percent). Therefore they have to increase their capital. while we see that the capital adequacy of PVBs and MPVBs already meet this ratio. Moreover, this ratio is around 15 percent for MPVBs. 25
  26. 26. efficiency ratios. Our sample banks outperform their counterparts in terms of liquidity only, which might be due to the fact that the bank counterparts reduced their investment because of the poor performance of the Egyptian stock market after 1998. Nevertheless, since we compare our sample banks relative to bank counterparts with 100 percent private ownership or majority private ownership, such results might be expected if we believe that privatized banks need more time to improve their performance and catch up to the same level of already private or majority private banks. So, it is interesting to see how our sample privatized banks perform relative to majority state and state owned banks. As seen in Table 11, the results tend to be inconsistent, somewhat surprising and hard to explain. On one hand, our sample privatized banks perform relatively better than MSTBs in terms of ROA and ROE, and the statistical tests pass the critical values of significance at the five percent level for ROE only. On the other hand, we find that the relative changes in profitability ratios of privatized banks are significantly lower relative to STBs at the one percent level. More surprising is that such underperformance in profitability is accompanied with a significant decrease in asset quality at the ten and five percent level using the parametric t test and the non-parametric Wilcoxon singed-rank test, respectively. As for capital risk indicators, we find insignificant differences in relative performance changes between privatized banks and their bank counterparts. However, when we look at the operating efficiency indicators we see mixed results. The privatized banks outperform MSTBs and STBs in terms of NIM at the one percent level of significance for the first counterpart, while it is not significant at any level for the latter one. Additionally, they underperform MSTBs and STBs in terms of non-interest revenue 26
  27. 27. at the ten and five percent level, respectively. Furthermore, return on loans of privatized banks increase relative to their bank counterparts, although significant only relative to STBs at the one percent level. While liquidity declines for privatized banks relative to both MSTBS and STBs at the ten and the five percent level, respectively, we find no significant difference in changes in asset growth rates between our sample banks and their counterparts. So far, in comparing the relative performance changes of our sample privatized banks relative to MSTBs and STBs, the results do not provide us with a clear conclusion. Concentrating on the most important measures, profitability and efficiency, we find that our sample banks outperform MSTBs and underperform STBs in terms of profitability, while we have inconsistent results in terms of operating efficiency. It is hard to explain why privatized banks improve their profitability relative to MSTBs in contrast to their lower performance relative to STBs. We could, however, argue that STBs are usually less profitable than privatized banks; as a result, STBs can improve profitability more rapidly. So the deck might be stacked against privatized banks. Given the results from our analysis of Tables 10 and 11, our question remains without a definite answer. To privatize or not to privatize? The results seem to be against privatized banks since they underperform PVBs and MPVBs in terms of profitability and operating efficiency, and STBs in terms of profitability. However, such disappointing performances might be due to the transition period beginning with moving from state-control to private- control. In other words, we have to take into consideration that privatization, particularly in the financial sector, takes time to unfold given that state ownership is reduced 27
  28. 28. gradually. As a result, the analysis of post-privatization performance is likely to yield an incomplete picture of the effects of privatization. Only when we have a reasonable post- privatization period can we reach conclusive evidence. However, one could argue that with respect to the findings so far, the statistical results regarding the superior relative performance changes in profitability ratios of STBs relative to our sample privatized banks does not confirm whether or not they perform better than the sample banks. To check for this proposition, we compare the post-privatization performance, not performance changes, of privatized banks with their bank counterparts to determine which group of banks performs better. We report the results in Tables 12 and 13. Insert Tables 12 and 13 near here Tables 12 and 13 present the means and the medians of variables in the post-privatization period, both performance measures and bank characteristics, by ownership group, along with t-statistics and z-statistics, and significant levels for comparison between privatized banks and each one of the four ownership categories. Examining first, Table 12, we find that the results continue to corroborate the previous findings in which PVBs and MPVBs perform significantly better than privatized banks in the post-privatization period. We find that both the ROA and ROE are significantly higher for PVBs at the five percent level compared with privatized banks. In the same vein, MPVBs have higher ROA and ROE compared with our sample banks although it is only significant for ROE at the five percent level. However, asset quality, as measured by loan losses to loans, of privatized banks is significantly better compared with both PVBs and MPVBs, at the ten and the one percent level, respectively. Both capital risk indicators show insignificant differences between privatized banks and PVBs and MPVBs, but only core capital to assets is 28
  29. 29. significantly higher for MPVBs at the one percent level. Again, all efficiency ratios are higher for PVBs and MPVBs at different significant levels. Meanwhile there are no significant differences in liquidity between privatized banks and their bank counterparts, while the asset growth rate is significantly higher for PVBs only at the one percent level. Insert Table 13 here Moving to Table 13, the results clearly indicate that privatized banks substantially outperform both MSTBs and STBs in terms of ROA and ROE at the one and five percent levels, respectively. In the meantime, there is no significant indication that such superior performance is achieved at the expense of asset quality, as comparing loan losses to loans between privatized banks and their bank counterparts shows no significant differences between them at any level. The capital risk indicators show that MSTBs and STBs have significantly higher loans to total capital compared with privatized banks at the one percent level. It might be argued that state-controlled banks still have a large quantity of loans that have already been provided to SOEs and not yet repaid. However, the core capital to assets is sufficient for privatized banks (8.2 percent) although significantly below those reported for MSTBs (11.2 percent) at the one percent level but significantly higher than those reported for STBs (4.8 percent) at the one percent level. The findings from operating efficiency indicators show that privatized banks perform significantly better than MSTBs, in terms of NIM and non-interest revenues at the five and the ten percent levels, respectively. In addition, their performance is superior to STBs in terms of NIM and return on loans, and all statistical tests are significant at the one percent level. However, we do not find any significant differences between privatized banks and MSTBs and STBs in terms of return on loans and non-interest revenues, respectively. As 29
  30. 30. for liquidity, the results show no significant differences between privatized banks and MSTBs, while STBs holds significantly better liquidity position compared with our sample banks at the one and the five percent levels, using t-statistics and z-statistics, respectively. Last, privatized banks seem to expand their business more than their bank counterparts, as the asset growth rate is significantly higher for privatized banks at the ten percent level. So, what can we determine from the above-given analysis? Collectively, the results reported in Tables 12 and 13 reveal that private-owned banks and banks having majority private ownership, including privatized banks, are unanimously more profitable and efficient than state- and majority state-owned banks. If we would like to rank these banks according to their ownership structure, the conclusion drawn here is that the greater the private ownership involvement, the more profitable and efficient the banks are14, and vice-versa, i.e., the greater the state ownership involvement, the less profitable and efficient the banks are. Such findings tend to be consistent with many previous research studies, in which state ownership of banks is asserted to be less efficient than private ownership (see for example; Bonin, Mizsei, Szekely, and Wachtel, 1998; Isik and Hassan, 2002; and Bonien et al., 2003). Further Evidence As we mentioned earlier, since ownership structure seems to affect bank performance, and since this effect outcome is conditioned by the degree of state or private ownership 14 The data (not reported here) on ownership structure of privatized banks and majority private-owned banks show clearly that the private ownership involvement in latter banks are higher relative to privatized banks. 30
  31. 31. involvement, we can model this relationship by having the percentage of each type of ownership as a determinant of bank performance. So, to test the effects of ownership structure on bank performance and to validate the parametric and non-parametric tests, we employ several cross-sectional regressions. We cover the entire period from 1995-2001 and include size and industry as control variables15. We estimate the following three models: PM i ,t = α i + β 1OWN i ,t + ε i ,t (2) PM i ,t = α i + β 1OWN i ,t + β 2 SIZEi ,t + ε i ,t (3) PM i ,t = α i + β 1OWN i ,t + β 2 SIZEi ,t + INDi ,t + ε i ,t (4) where PM i ,t is the performance measure of bank i at year t (ROA, asset quality, NIM, and asset growth)16, OWN i ,t is the percentage of state, private, and foreign ownership in bank i at year t, SIZEi ,t is the log of total assets of bank i at year t, and INDi ,t is a dummy variable that takes one if bank i is commercial at year t and zero if it is investment. To control for year-specific effect, and before we proceed with the above three models, it is important to test if α i , i = 1, , N , are constant coefficients specific to each year. Their presence assumes that differences across the considered years appear by means of differences in the constant term. So, the point is to prove whether the individual coefficients, α i , i = 1, , N , are not all equal. This is particularly interesting if we want to 15 Size is measured as the log of total assets while we treat industry as a dummy variable that takes one if the bank is commercial and 0 if it is investment. 16 Although we estimate the regression models for all performance measures, for the sake of space, we limit our presented results to those variable that represent the most important measures. However, the results for other performance measures corroborate the findings presented in Table 14, and they are available from the author upon request. 31
  32. 32. differentiate between the situation in each year considered in the sample and corroborate the existence of significant heterogeneity across years. The Fisher test validates the fixed- effects specification in favor of random-effects, that is the presence of individual effects is not equal. However, when we perform the Hausman specification test17, it is proven that, under the null hypothesis, the two estimates from fixed-effects and random-effects models could not differ systematically since they are both consistent. Nevertheless, since we need to consider heterogeneity across years, we adopt the fixed effects specifications18. Insert Table 14 here Panel A shows that the percentage of state ownership has a significant negative impact on ROA, NIM, and asset growth at the one and five percent levels for the first two ratios and the latter one, respectively. Also, the asset quality decreases with the increase of state ownership involvement, although not significantly. However, when we estimate the same regression utilizing foreign ownership and other private ownership, the results reveal that they have a significant positive impact on ROA, NIM, and asset growth, whereas their positive impact on asset quality is not significant. In Panels B and C, we include some control variables: size in Panel B and then size and industry in Panel C. They provide a robustness test for our results since the coefficients of ownership variables (our variables of interest) remain the same as in Panel A. So, regardless of bank size and industry, and with respect to their effects on bank performance, the ownership structure still maintains the same sign and significance. These findings add further support to our previous results, 17 Under the null hypothesis, the Hausman statistic is asymptotically distributed as chi-square with k degrees of freedom. 18 We also perform the random-effects specifications, and the results using this technique yield similar findings. We do not report the results from the random-effects specifications for the sake of space, but they are available from the author upon request. 32
  33. 33. which indicate that PVBs and MPVBs perform better than MSTBs and STBs during our period of study19. Nevertheless, our findings seem to contradict the literature because we find that private ownership, rather than foreign ownership, tends to have greater impact on bank performance because the coefficient of most performance measures is higher for private ownership relative to foreign ownership. 8. CONCLUSION In this paper we examine the performance of twelve Egyptian joint venture banks (JVBs) that experience full or partial privatization from 1996 through 1999. We test the performance changes on both an unadjusted basis and matched adjusted basis, in which the latter allows us to examine the performance changes in privatized banks irrespective of any industry-wide factors that might be affecting their performance. We also compare the post-privatization performance, not performance changes, of privatized banks relative to several bank counterparts according to their ownership structure. The results based on an unadjusted data show significant declines in some profitability, and liquidity, while the changes in other performance measures are not significant at any level. However, the matched adjusted data show that the relative performance changes of privatized banks lag behind their bank counterparts of PVBs and MPVBs, particularly, in terms of profitability and some efficiency ratios. Meanwhile, the privatized banks outperform PVBs and MPVBs in terms of liquidity, while there are no significant differences in relative performance changes for the other ratios. As for comparing the relative performance changes of privatized banks relative to MSTBs and STBs, we find 19 We also estimated the same 3 models given in Table 14 year-by-year, and we find that results are qualitatively similar. We did not report the findings from these regressions here for the sake of space, but they are available from the author upon request. 33
  34. 34. that in terms of profitability, privatized banks outperform MSTBs, but underperform STBs. The results from analyzing the operating efficiency ratios fail to provide us with a clear conclusion of whether privatized banks outperform or underperform their bank counterparts of MSTBs and STBs. Given the above results, we then face an unsolved question. Should we encourage the government to move forward and privatize state-controlled banks, or should they continue to control these banks? Of course, it might be understandable that the relative performance changes in privately-controlled banks outperform privatized banks, and that privatized banks outperform majority state banks. If, however, the results had provided evidence that privatized banks also outperform state-owned banks, we would have concluded that privatization does matter. Surprisingly, we find that the relative performance changes of state-owned banks outperform privatized banks. Consequently, we need more evidence to decide which approach we should adopt regarding privatization. We then look at the post-privatization performance of banks according to their ownership structure. The results document that private-owned banks and banks having majority private ownership, including privatized banks, are more profitable and efficient than state- and majority state-owned banks. Furthermore, the results we obtain from fixed-effects regression over the entire period provide further evidence that private ownership is associated with better performance. In conclusion, there is great support that ownership structure really matters and that bank performance depends, mainly, on the degree of state ownership involvement. 34
  35. 35. Summing up, with all respect to the findings from comparing the relative performance changes of privatized banks with their corresponding bank counterparts, we still believe that reducing state ownership stakes in banks is associated with better performance. This paper provides a first step towards a complete analysis of the impact of privatization and ownership structure on bank performance in Egypt. It might be fruitful to revisit these results and do further research when we have a longer post-privatization period and the sample of privatized banks increases. We might, then, be able to reach more conclusive evidence. 35
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  38. 38. Table 1 Structure of the Egyptian Banking System The table shows the structure of the Egyptian banks over several time intervals. We provide the number of banks according to their industry classification: commercial banks and non-commercial banks. We also breakdown the non-commercial banks into business and investment banks and specialized banks. Commercial Banks Non- Commercial Banks Year Business & Investment Banks Specialized Banks Total* Private & Public Sector Total Egyptian Principal Bank for Joint Venture Private & Joint Off-Shore Total Industrial Real Estate Development & Total Venture Development Agricultural Credit 1970 5 0 5 0 0 0 1 2 17 20 25 1975 4 0 4 1 2 3 1 2 17 20 27 1980 4 15 19 7 21 28 1 2 1** 4 52 1995 4 24 28 11 21 32 1 2 1 4 64 1996 4 24 28 11 21 32 1 2 1 4 64 1997 4 24 28 11 21 32 1 2 1 4 64 1998 4 24 28 11 20 31 1 2 1 4 63 1999 4 24 28 11 20 31 1 2 1 4 63 2000 4 24 28 11 20 31 1 1*** 1 3 62 2001 4 24 28 11 20 31 1 1 1 3 62 2002 4 24 28 11 20 31 1 1 1 3 62 Source: Central Bank of Egypt (Various issues). * Egyptian banks abroad are not included. Also, two banks established under private laws are not registered with the Central Bank of Egypt. ** In 1976, the government grouped the 17 banks together and established the bank as the general holding authority. *** The Egyptian Real Estate Bank was merged with the Arab Land Bank on 6/21/1999. 38
  39. 39. Table 2 Aggregate Balance Sheet of the Egyptian Banking Sector The table provides the major items from the aggregate balance sheet of the Egyptian banks since 1991-2001. The covered period represents the economic reform program era and thus shows the balance sheets of the entire banking sector prior to and after the introduction of this program in late 1990. Millions of Egyptian pound Items 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 Assets Cash 1,353 1,492 2,192 2,507 2,688 2,984 3,210 3,121 3,220 3.431 3,484 Securities and Investments, of which: 17,312 35,458 47,180 149,683 38,381 41,470 53,088 65,148 60,114 60,818 71,142 Treasury Bills 3,113 12,568 23,472 28,872 22,827 24,504 28,956 35,295 21,342 20,600 28,441 Other Government Securities 11,292 19,566 19,445 15,805 9,682 10,040 13,614 13,962 19,187 19,888 20,899 Balances with Banks in Egypt 30,658 28,991 29,274 30,710 35,549 37,703 42,608 44,607 45.098 49,401 67,047 Balances with Banks Abroad 32,844 36,392 35,177 33,733 36,578 32.694 32,931 23,121 18,106 17,776 16,252 Loans and Discounts 60,831 58,249 67,594 79,834 108,813 128,826 152,189 172,379 204,132 226,776 241,469 Other Assets 13,314 14,284 16,853 14,695 16,855 17,441 17,993 21,186 22,956 24,136 28,966 Assets = Liabilities 156,312 174,886 198,250 211,162 236,664 261,118 302,019 329,562 351,626 382,338 428,360 Liabilities Capital 5,484 5,627 5,909 7,096 7,680 8,358 9,137 10,566 11,373 11,763 12,038 Reserves 1,971 2,313 2,657 2,903 3,219 3,607 4,435 7,132 8,132 9,227 10,158 Provisions 6,859 8,722 11,300 13,117 15,799 17,910 20,744 23,392 25,984 27,555 31,200 Long-Term Loans and Bonds 1,377 1,716 1,782 2,139 2,252 3,329 4,807 1,354 9,148 10,579 11,922 Obligations to Banks in Egypt 21,022 19,011 24,167 24,768 27,304 28,075 29,156 29,744 21,413 24,211 28,158 Obligations to Banks Abroad 9,936 8,166 4,582 3,088 2,268 2,793 6,814 11,121 11,307 9,970 11,485 Total Deposits 93,078 110,171 129,374 139,205 158,535 174,858 200,574 216,468 237,342 280,430 291,225 Other Liabilities 16,585 19,140 18,479 18,846 21,607 22,188 26,352 23,787 26,927 28,605 32,178 Source: Central Bank of Egypt (Various issues) 39
  40. 40. Table 3 Details of Joint Venture Bank Privatization Offers (1996 - 1999) The table shows the privatization transactions of the privatized joint venture banks from 1996-1999. For each bank, we provide the date of privatization, the offer size, the number of shares listed, the market capitalization, and the market value of the total assets, where applicable. Offer Size Number of Market Date of Total Assets Banks No. of Shares Shares Listed Capitalizatio Privatization As % ($000's) (000's) (000's) n ($ 000's) Alexandria Comm.& Mar. Bank 1997 27% 300 1,125 64,714 1,093,587 Bank du Caire et de Paris 1997 27% 7 26 68,451 1,173,412 Cairo Barclays Bank 1999 11% 55 500 206,490 2,890,335 Commercial International Bank 1998 25% 16,250 65,000 733,791 13,277,290 Credit Internationale d'Egypte 1996 11.5% 82,445 717,000 76,109 920,558 Egyptian American Bank* 1997 20% 2,400 12,000 460,177 5,307,541 Egyptian Commercial Bank 1999 10% 963 9,626 114,092 1,945,184 Export Development Bank* 1996 24% 600 2,500 300,147 2,500,475 Misr Exterior Bank 1997 39% 2,847 7,300 324,012 5,422,964 Misr International Bank 1997 20% 4,500 22,500 667,965 8,979,760 Misr Romania Bank 1998 18% 900 5,000 n.a. 1,563,443 National Bank for Development 1998 26% 5,200 20,000 48,600 6,205,061 Nationale Societe Generale 1997 10.5% 1,050 10,000 133,038 3,079,483 Suez Canal Bank* 1997 34% 3,400 10,000 235,841 7,370,071 *The reduction in state ownership was achieved via increases in capitalization by the private sector. 40
  41. 41. Table 4 Ownership Structure of Privatized Banks The table provides detailed information regarding the ownership structure of privatized banks. For each bank, we provide the ownership prior to the privatization date, on the privatization date, and in the post-privatization period, year by year, up to 4 years. We divided the ownership into three main categories, state-, foreign-, and private-ownership. Year * Bank Ownership T-1 T T+1 T+2 T+3 T+4 State 95% 62% 59% 53% 48% 48% Alexandria Comm.& Mar. Bank Private 5% 38% 42% 47% 52% 52% State 51% 22% 22% 22% 22% - Bank du Caire et de Paris Foreign 49% 76% 76% 76% 76% - Private 0% 2% 2% 2% 2% - State 51% 40% 40% 40% - - Cairo Barclays Bank Foreign 49% 60% 60% 60% - - State 80% 45% 45% 25% 25% - Commercial International Bank Foreign 5% 30% 30% 45% 45% - Private 15% 25% 25% 30% 30% - State 51% 40% 19.5% 19.5% 0% 0% Credit Internationale d'Egypte Foreign 39.5% 51% 69.5% 69.5% 88% 88% Private 9.5% 10% 11% 11% 11% 11% State 51% 35% 35% 35% 32% 32% Egyptian American Bank Foreign 41% 41% 41% 41% 41% 41% Private 8% 24% 24% 24% 27% 27% State 35% 25% 13% 13% - - Egyptian Commercial Bank Foreign 40% 40% 40% 40% - - Private 25% 35% 57% 57% - - State 100% 76% 76% 76% 76% 76% Export Development Bank Private 0% 24% 24% 24% 24% 24% State 59% 20% 20% 20% 20% 20% Misr Exterior Bank Private 41% 80% 80% 80% 80% 80% State 63% 43% 43% 36% 24% 24% Misr International Bank Foreign 37% 37% 37% 37% 51% 51% Private 0% 20% 20% 27% 25% 25% State 51% 33% 33% 33% 33% - Misr Romania Bank Foreign 49% 49% 49% 49% 49% - Private 0% 18% 18% 18% 18% - State 62% 34% 34% 23% 23% - National Bank for Development Private 38% 66% 66% 77% 77% - State 51% 36% 25% 25% 19% 19% Nationale Societe Generale Foreign 49% 51% 53% 53% 55% 55% Private 0% 13% 22% 22% 26% 26% State 64% 48% 48% 11% 11% - Suez Canal Bank Foreign 36% 40% 40% 36% 36% - Private 0% 12% 12% 53% 53% - T refers to the year of privatization, T-1 refers to the year preceding privatization, and T+1, T+2, and T+3 refer to one, two and three years following privatization, respectively. 41
  42. 42. Table 5 Ratios Used to Analyze Banking Performance The table presents details on each of the eleven ratios used to analyze the performance of the banks in the pre- and post-privatization periods. The eleven ratios are grouped under six common indicators used to examine bank performance. Proxies Definition Profitability Indicators (1) Return on Assets Net income after taxes as a percentage of book value of total assets (2) Returns on Equity Net income after taxes as a percentage of book value of total equity Asset Quality Indicators (3) Loan losses to loans Charge-offs and allowance for loan losses as a percentage of total loans and leases Capital Risk Indicators (4) Core Capital to Assets Shareholder's equity as a percentage of book value of total assets (5) Loans to Total Capital (x) Total Loans as a percentage of book value of total assets Operating Efficiency Indicators (6) Net Interest Margin Interest exp. minus interest rev. as a percentage total assets (7) Non-interest Revenue Production Non-interest income as a percentage of total assets (8) Return on Loans Interest and fees on loans to total loans and leases Liquidity Risk Indicators (9) Investment Securities to Total Assets Book value of total investment securities as a percentage of book value of total assets Growth Indicators Change in book value of total assets as a percentage of book value of total assets in the (10)Asset Growth Rate previous year. 42
  43. 43. Table 6 Descriptive Statistics: Privatized Banks The table shows some basic descriptive statistics for the performance measures of the privatized banks. It includes measures of central tendency, variability, and shape. We provide the mean, the median, the minimum, the maximum, and the standard deviation values of each performance measure for the pre- and post-privatization period. We also list the standardized skewness and the standardized kurtosis, which can be used to determine whether these performance measures are normally distributed. Mean Median Minimum Maximum Std. Deviation Standardized Kurtosis Standardized Skewness Proxies Pre- Post- Pre- Post- Pre- Post- Pre- Post- Pre- Post- Pre- Post- Pre- Post- Profitability Indicators Return on Assets 0.02 0.01 0.02 0.01 0.01 0.00 0.03 0.02 0.01 0.01 -1.08 -1.40 -0.29 0.06 Returns on Equity 0.23 0.16 0.23 0.16 0.13 0.05 0.31 0.28 0.06 0.08 -1.29 -1.24 -0.42 0.09 Asset Quality Indicators Loan Losses to Loans 0.02 0.02 0.02 0.02 0.00 0.01 0.06 0.04 0.01 0.01 5.45 0.02 2.04 1.00 Capital Risk Indicators Core Capital to Assets 0.08 0.08 0.07 0.08 0.05 0.05 0.16 0.12 0.03 0.02 3.25 0.62 1.61 0.66 Loans to Total Capital (x) 7.35 7.24 7.13 6.91 2.67 4.61 12.17 11.11 2.56 1.91 0.71 0.26 0.38 0.71 Operating Efficiency Indicators Net Interest Margin 0.02 0.02 0.02 0.02 0.01 0.01 0.04 0.03 0.01 0.01 3.89 -0.08 1.58 -0.77 Non-interest Revenue Production 0.02 0.02 0.02 0.02 0.01 0.01 0.04 0.03 0.01 0.00 -0.71 0.55 0.57 -0.46 Return on Loans 0.13 0.13 0.12 0.13 0.10 0.11 0.17 0.17 0.03 0.02 -0.81 1.18 0.79 0.89 Liquidity Risk Indicators Investment Securities to Total Assets 0.13 0.08 0.14 0.07 0.05 0.03 0.21 0.17 0.05 0.05 -1.13 -0.85 -0.27 0.60 Growth Indicators Asset Growth Rate 0.12 0.09 0.11 0.10 0.02 -0.01 0.24 0.20 0.07 0.06 -0.58 0.57 0.45 0.24

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