Regulation’s influence on EU banking efficiency: An evaluation post crisis

Abstract

This paper examines the impact of regulatory policies on banking market efficiency using a sample of 678 commercial banks from 21 European Union countries for the post-crisis year 2010, controlling for bank-specific and country-specific variables. Data on regulation, supervision and monitoring variables, and activity restrictions are from the most recent Bank Regulation and Supervision Survey database conducted by the World Bank, published 2012. Besides these we incorporate bank size, equity, market share, government ownership, and growth of Gross Domestic Product per capita, employing an Ordinary Least Squares method. Focus is on two alternative measures of banking market efficiency: net interest margin and overhead costs (operating expenses to assets). Elevated levels of these two ratios should indicate a low level of banking efficiency. The evidence suggests that the link between capital regulation and banking efficiency is not robust enough to control for other regulatory variables. Results confirm that activity restrictions have a negative and significant impact on banking efficiency. Policies encouraging official supervisory power do not enhance efficiency of the banking sector. The only approach positively and statistically significantly associated with efficiency is private monitoring. This leads to the suggestion that government regulation and supervision should be more focused on promoting transparency of information.

Keywords:

• banking
• efficiency
• regulation
• European Union

JEL Classifications:

• G14
• G21
• G28

PUBLIC INTEREST STATEMENT

This article focuses on the important topic of banking efficiency, which has wide-ranging implications for fairness and effectiveness of banking services for customers and other stakeholders. Key determinants of banking efficiency include the quality of banking regulation and supervision in a given jurisdiction, as well as the scrutiny of market participants and investors (private monitoring) in relation to the structure of a banking system. The study presented here concludes that, for banks in the European Union, the most meaningful influence on efficiency is that of private monitoring, which has implications for regulatory and government policy in promoting efficiency of a banking system.

Notes

1. The study uses inefficiency as proxy for banking efficiency in the DEA approach. Instead of measuring how close the bank is from the non-parametric efficient frontier, the study measures how far it is. By definition, the best practice banks are 100% efficient, therefore inefficiency equals the difference between 100 and the efficiency score.

2. The definition of financial conglomerates adopted in this paper is the same proposed by Laeven and Levine (2007).

3. See, for example, King and Levine (1993) and Levine (1997) for empirical evidence.

4. The study separated financial crisis into three categories: banking crisis, currency crisis and debt crisis. ⁵ Bank charter value is defined as the value that would be foregone in case of closure. The study measures bank charter value with Tobin’s Q ratio.

5. The 28 EU countries are: Austria, Belgium, Bulgaria, Croatia, Cyprus, Czech Republic, Denmark, Estonia, Finland, France, Germany, Greece, Hungary, Ireland, Italy, Latvia, Lithuania, Luxembourg, Malta, Netherlands, Poland, Portugal, Romania, Slovakia, Slovenia, Spain, Sweden and United Kingdom.

Additional information

Funding

The authors received no direct funding for this research.

Notes on contributors

Edward Bace

Edward Bace is a senior lecturer in finance at Middlesex University London’s

Business School. He has an MBA from New York University, and a PhD from The

University of Michigan, is a CFA, Chartered MCSI, and a Member of the Professional Risk Managers’ International Association (PRMIA). He has been involved with the EBRD, CFA Institute, BTRM, and the Chartered Institute for Securities & Investment.

Ana Ferreira

Ana Ferreira earned a Master’s degree in Banking and Finance from Middlesex University, and has a Bachelor’s degree in Business Administration from University of Porto, specialising in economics and financial management. She now works in audit and assurance for KPMG Portugal.