ABSTRACT TÜRK BANKACILIK SEKTÖRÜNDE KÂRLILIK VE REKABETİN DEVAMLILIĞI THE PERSISTENCE OF PROFITABILITY AND COMPETITION IN THE TURKISH BANKING SECTOR

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1 158 Ercyes Ünverstes İktsad ve İdar Blmler Fakültes Dergs, Sayı: 30, Ocak-Hazran 008, ss THE PERSISTENCE OF PROFITABILITY AND COMPETITION IN THE TURKISH BANKING SECTOR ABSTRACT Muhttn KAPLAN * Tuncay ÇELİK ** There s a fast growng emprcal lterature on the dynamcs of competton and the determnants of proftablty dfferences, whch undertakes tme seres analyss of corporate rates of returns usng the methodology of 'the persstence of proftablty' (PP) studes. However, ths lterature s manly concentrated on non-fnancal sector and the studes employng the PP methodology to the fnancal sector, namely bankng, are very lmted. Ths paper reports on tmeseres analyss of the persstence of proftablty and the regresson analyss that relates the dfferences n proftablty across banks to proftablty persstency n the Turksh Bankng Sector. Contrary to the prevous works on the subject, emprcal results suggest that the short term persstence of profts are moderate and above normal profts dsappears n the long-run mplyng the presence of hgh competton n the sector. Keywords: Competton, Persstence of Proftablty, Determnants of Proftablty, Bankng TÜRK BANKACILIK SEKTÖRÜNDE KÂRLILIK VE REKABETİN DEVAMLILIĞI ÖZ Rekabetn dnamkler ve karlılık farklılıkların belrleyenlern konu alan, 'karlılığın sürekllğ' (KS) metodolojs yardımı le frmaların getr oranlarının zaman sers analzn çeren amprk lteratür hızlı br şeklde gelşmektedr. Bununla brlkte, bu lteratür genel olarak fnansal sektör dışındak sektörlerde odaklanmış ve KS metodolojn bankacılık gb fnans sektörüne uygulayan çalışmaların sayısı oldukça sınırlıdır. Bu çalışma, Türk bankacılık sektörü çn, karlılığın sürekllğnn zaman sers analznden ve bankalar arası karlılık farklılıklarını karlılığın sürekllğ le lşklendren regresyon analznden elde edlen bulguları çermektedr. Bu konudak öncek çalışmalardan farklı olarak bu çalışmada sunulan amprk bulgular, karların kısa dönem sürekllğnn ılımlı olduğunu ve uzun dönemde aşırı karların kaybolduğunu ve halyle sektördek rekabetn oldukça yüksek olduğunu göstermektedr. Anahtar Kavramlar: Rekabet, Kârlılığın Sürekllğ, Karlılığın Belrleyenler, Bankacılık * Yrd. Doç. Dr., Nğde Ünverstes, İİBF, İktsat Bölümü ** Yrd. Doç. Dr., Nğde Ünverstes, İİBF, İktsat Bölümü Makalenn gelş tarh: Ekm 007, kabul tarh: Şubat 008 INTRODUCTION Ths paper examnes the nature and ntensty of competton n the Turksh bankng sector emprcally and provdes evdence on the determnants of the observed proftablty dfferences among the Turksh banks. Understandng the ntensty of competton s partcularly mportant n the bankng sector of the economy. Ths s due to the mportance of bankng sector n the modern economes as beng ntermedary n the transfer of funds from savers to borrowers, evaluatng borrowers, and provdng lqudty (Gorton and Wnton, 003). As competton ncreases n the sector, banks wll be forced to operate effcently and allocate ther resources where t s requred the most, thereby contrbutng sgnfcantly to the performance of the economy. In addton, favorable compettve envronment helps banks to strengthen ther postons and makes the economy less prone to fnancal crss. Despte the undsputed mportance of the subject, there has been relatvely lttle emprcal research on tme seres analyss of persstency of profts n bankng sector. Most of the studes n the exstng lterature on the ntensty of competton n Turksh bankng carred out usng cross-secton or panel data concludes that Turksh bankng ndustry s characterzed wth the olgopolstc market structure. However, competton process and proftablty are dynamc process and statc measures of concentraton cannot represent competton ntensty adequately. Compettve dynamcs may be better captured by undertakng tme seres analyss of corporate rates of returns usng the well-establshed methodology of 'the persstence of proftablty' (PP) studes n ndustral organzaton (Glen et. al., 003). There s a fast growng emprcal lterature on the persstence of proftablty n non-fnancal sector (Muller, 1977; Muller, 1990; Maruyama and Odagar, 00; Gerosk and Jacquemn, 1988; Glen et. al., 001; Glen et. al., 003; Yurtoglu, 004; Gschwandtner, 005). However, the studes that appled the persstence of proftablty methodology to non-fnancal sector, namely bankng, are very lmted n number. Bektas (007) measured the ntensty of competton n the Turksh bankng sector usng the PP methodology and employng the data from 8 banks over the perod of 1989 to 003. The author reports that the short-run persstency coeffcent has a mean value of 0.4 and profts above norm erode n the long-run. Taken together, the author concludes that competton s moderately hgh n Turksh bankng sector. Ths study ams to nvestgate the ntensty of competton and ts relatonshp wth frm characterstcs n the Turksh bankng sector and extends the prevous studes n a number of ways. Ths study employs tme seres data coverng the perod of 1980 to 1998, delberately excludng the remanng perod of 1999 to today. The reason s that wdespread fraud and lootng began n 1999 led to the deepest bankng crss of 001 n the hstory of modern Turkey. In ths perod, as well documented by Soral et. al. (006), bank owners

2 The Persstence of Proftablty and Competton n The Turksh Bankng Sector Ercyes Ünverstes İktsad ve İdar Blmler Fakültes Dergs, Sayı: 30, Ocak-Hazran 008, ss lent to ther own companes above the legally set lmts usng ntermedary frms, and other banks (back-to-back lendng among banks). Later, these companes announced bankruptcy leavng many banks nsolvent. For ths reason, the balance sheet of many banks cannot be trusted, especally durng the perod of 1999 to 001. For example, most of the banks (about 80 percent of the survvng banks) reports negatve profts rangng from -64 per cent to 3 per cent averagng -8.5 per cent n 001. The data set used n ths study wll enable us to test f the fndngs of Bektas s (007) study are senstve to the sample perod employed. More mportantly, we wll apply regresson analyss to examne to what extend frm characterstcs explan the observed proft persstency across banks. I. METHODOLOGY The methodology of the paper follows the methodology employed n the persstence of proftablty studes of Mueller (1986), Glen et. al. (001), Maruyama and Odagar (00), Glen et. al. (003), and Yurtoglu (004). These studes, adoptng the Schumpetaran perspectve on the competton process, take competton as a dynamc process n whch the forces of entry and ext erode profts n the long-run. Intutvely, f competton s ntense the above average profts n one perod wll be eroded n the subsequent perods. Otherwse, frms earnng above average profts wll be able to mantan the same level of profts n the subsequent perods mplyng the presence of persstence of profts. In PP studes, these deas are formulated wthn the followng frst order auto-regressve equaton. P P + u t = + t 1 α (1) t where Pt s the proftablty of frm at tme t, α s constant and s the parameter that represents the speed of adjustment coeffcents of excess profts to the norm and u t s the usual error term. Assumng that s n the range of (-1,1), the equlbrum or long-run proftablty level of frm ( P LR ) wll be P = α /( 1 ) LR. The vrtue of equaton (1) s that t allows the analyss of competton dynamcs wthout requrng unobservable varable of the threat of entry. As shown by Gerosk (1990), equaton (1) can be regarded as the reduced form of the two equatons model. In the frst equaton, the ext of frms or the threat of entry ths year s assumed to be a functon of the dfference between the actual proft rate and the long-run proft rate n the prevous year. In the second equaton, ths entry threat (ext of frms) s assumed to reduce (ncrease) the proft rate n the current year. In order to control for the busness cycle and other common factors whch affect all banks, a normalzed proftablty measure ( π = P P ), s employed t t t n the regresson analyss. The measure π represents the devatons of bank ' s proftablty at tme t from the average proftablty across banks P ) at tme t. Then, the persstency of proft model s gven as: = α + π + π ε t 1 ( t 1) ( t ) t () π + whereα, 1 and t are coeffcents and the ε t are random errors. In our emprcal analyss, we estmated the followng Dckey-Fuller regresson for equaton () and recovered the persstency coeffcent, from equaton (3). π = α + β π + γ π + ε t = ( t 1) ( t 1 ) t (3) where π π π ( 1) and comparng the model wth (), t t t β = 1 ) = (1 ) and γ =. ( 1 To explan the underlyng reasons for the dfferences n persstence proftablty across frms, the equaton below, whch relates the persstency coeffcents to bank characterstcs, s estmated. SOLV BOND+ e (4) = θ0 + θ1 + θlka + θ3size + θ4size + θ5ini + θ6 where SOLV represents the solvency rato defned as equty captal over total assets, LKA s the lqudty rsk and defned as the ratos of lqud assets to total assets, SIZE represents the sze and defned as the natural logarthm of total assets, SIZE s the square of sze varable, INI s the rato of total nterest ncomes to total nterest expenses, and BOND represents the rato of nterest earnngs from bonds to total nterest earnngs. The explanatory varables ncluded n equaton (4) are chosen smlar to the emprcal studes of Molyneux and Thornton (199), Berger (1995) and Okumus (00) on the determnants of proftablty n bankng sector. The rato of equty captal to total assets ( SOLV ) s a measure of the captal adequacy of the bank whch reflects the solvency rsk born by the depostors and ultmately shareholders of the bank. The hgher SOLV reflects a lower rsk n the sense that the bank s asset portfolo s not expanded beyond what the bank can afford n terms of captal adequacy. Hence, the coeffcent for ths varable s expected to be negatve. Total assets ( SIZE ) can be consdered as a proxy for bank sze ( t

3 The Persstence of Proftablty and Competton n The Turksh Bankng Sector Ercyes Ünverstes İktsad ve İdar Blmler Fakültes Dergs, Sayı: 30, Ocak-Hazran 008, ss and they are expected to be postvely related to proftablty performance. The rato of lqud assets to total assets ( LKA ) s used n as a measure of lqudty. Although optmal lqudty rato s expected to have a postve effect on bank proftablty, an excess value of ths rato may have a negatve effect mplyng a lost n nterest ncome. Hence, the sgn of ths varable may be postve or negatve. The other explanatory varables effectng bank proftablty are total nterest ncomes to total nterest expenses ( INI ) and nterest earnngs from government bonds to total nterest earnngs. These varables coeffcents are expected to be postve, because an ncrease n the value of these varables rases the bank proftablty. II. THE DATA AND UNIT ROOT TESTS Before undertakng the econometrc analyss of the persstency of profts and ts determnants, ths secton ntroduces the data and ts tme seres propertes subject to emprcal analyss. The data s obtaned from the 'Banks n Turkey' publshed annually by the Banks Assocaton of Turkey. The data set nvolves a sample of 4 survvng banks over the perod The proftablty, P t, varables subject to the emprcal analyss are defned as earnngs dvded by total assets. The defnton of the other varables s gven n the prevous secton. We now provde tme seres characterstcs of the data employed n the emprcal analyss. A. UNIT ROOT TESTS All emprcal work undertaken wth non-statonary seres faces the danger of beng spurous. Contegraton analyss, developed n the md-80 s, ntroduced the dea that even f underlyng tme seres are non-statonary, lnear combnatons of these seres mght be statonary. For ths reason, emprcal work nvolvng tme seres data should start by searchng for the level of ntegraton of the seres. For ths reason, we employed ADF unt root test and the more powerful Im, Pesaran and Shn's 't-bar' test statstcs. The standardsed t-bar test proposed by Im, Pesaran and Shn (003), henceforth IPS, ncreases the power by explotng the panel structure of the data, and t s employed n ths study to avod the crtcsm related to the low power of the ADF test. The t-bar test s based on the average value of the Augmented Dckey-Fuller statstcs, t ˆ T ( p, γ ), = 1,,..., N, where p s the order of ADF regresson, T s the number of observaton n the sample and γˆ s the estmated vector of coeffcents on the augmented lag changes. IPS (003) show that under the null hypothess, when N and T are large and N / T small, ths E t T p,0) and statstc has a standard normal dstrbuton. The values of [ ] ( [ t T p,0)] V ( are tabulated n IPS. Usng equaton (3), we calculated two sets of tests of the unt root hypothess for each of the 4 banks; In the frst (unrestrcted) set, Y ( t 1) s ncluded n all regressons whle, n the second (parsmonous) set, we employed a specfcaton search whch nvolves the use of the Schwarz-Bayesan Crteron (SBC) to decde whether or not to exclude the lagged Y ( t 1) term. In both cases, the standardsed t-bar statstcs s calculated and compared to the relevant table values. The results of the ADF unt root test suggest that the null hypothess of unt root s rejected n most of the cases. The normalsed t-bar test results provde strong support for the statonarty process for the persstency varable. Usng the Schwarz Bayesan Crteron (SBC) to determne the order of augmentaton n the ADF regressons, when appled to the return on assets, the normalsed t-bar statstcs was ndcatng the rejecton of unt root hypothess. The crtcal t- bar value s and -1.8 at the 1 percent and the 5 percent level of sgnfcance respectvely for 19 observatons and 4 banks. Combnng the test results, provded by the ADF and t-bar statstcs, the evdence suggests that the data employed n emprcal analyss has no unt root. III. RESULTS Ths secton, frst, presents the emprcal evdence on the persstence of proftablty n Turksh bankng, and then provdes evdence on the underlyng frm characterstcs that s related to persstent proftablty dfferences across banks. Table 1 provdes summary results for persstency varable obtaned from the estmaton of equaton (3) and recoverng the persstency coeffcent, from equaton (3) usng the equaton () across all banks followng the specfcaton search descrbed above. The results ndcate that the ncluson of the lagged dependent varable n the model s not requred for out of 4 banks for the persstency model. Secondly, the regressons have reasonable fts wth R that s about 0.85 on average and lower than 0.10 for only 3 of 4 banks. The Adf gves the t-values assocated wth β n equaton (3). The average value for s 0.36 mplyng the presence of relatvely compettve envronment n the bankng sector. The long-run persstency of profts whch s calculated as π LR = α /( 1 ) s very close to zero and not statstcally sgnfcant ndcatng that profts above the norm erode over tme.

4 The Persstence of Proftablty and Competton n The Turksh Bankng Sector Ercyes Ünverstes İktsad ve İdar Blmler Fakültes Dergs, Sayı: 30, Ocak-Hazran 008, ss Table 1: Persstence of Profts: Summary of Results of Tme Seres Analyss α Adf R π LR Mean (st. error) (0.003) 0.36 (0.048) (0.134) Medan St. Dev Mn Max A= B= 1 C=0 D=0 E= 0 Note: Estmated coeffcents, α, corresponds to the parameters of equaton (3), where β 1. Reported statstcs ndcates the dstrbuton of the statstcs across banks n the = sector. Standard errors are n parentheses. A shows the number of frms for whch γ = 0, B ndcates the number of frms for whch R exceeds 0.1, C shows the number of frms for whch π LR s sgnfcantly postve (at the 5% level), D shows the number of frms for whch π LR s sgnfcantly negatve (at the 5% level) and E shows the number of regressons whch are dynamcally unstable. It s worth mentonng that the total number of frms s 4. Comparng these fndngs wth Bektas s (007) study, one can conclude that the average coeffcent of determnaton s consderably hgh (0.9 aganst 0.15) and the average persstency coeffcent s more accurately estmated (tvalue of 7.5 aganst 1.7) n ths study. Ths study supports the fndng of Bektas (007) ndcatng that the ntensty of competton s hgh n the Turksh bankng sector. However, the result of our study show that competton s more ntense n the Turksh bankng sector than reported by Bektas (007), who fnds equal to 0.4 on average. Taken together, all these fndngs suggest that the ncluson of crss years mght have partally affected the results reported n Bektas (007). Table presents the results obtaned from the estmaton of equaton (4) as well as the summary and dagnostc statstcs assocated wth the determnants of proft equaton. Taken together, the results provde some mportant nsghts nto the frm characterstcs related to persstent proftablty dfferences across banks. The examnaton of Table shows that the estmated equaton has acceptable dagnostcs and explans a consderable amount of varaton n the persstency of proftablty across banks wth R that s equal to The results ndcate that the solvency (SOLV) and lqudty (LKA) varables, although they assumed the expected sgns, have no power n explanng proftablty dfferences across banks. It seems that those banks whch nvested large share of ther funds to hghly-yeldng and less rsky government bonds acheved to have above normal profts. Ths fndng supports the dea that the bankng sector was heavly dependent for ts earnngs on hghly-yeldng government bonds n the sample perod (Akyüz and Boratav, 003:155). Table : Determnants of Persstence of Proft Ratos, Regressors Coeffcents Standard Error T-rato (Probablty) Constant (0.179) SOLV (0.0) LKA (0.467) SIZE ** (0.10) SIZE 0.07 ** (0.075) INI 0.00 * (0.03) BOND 1.49 ** (0.096) Summary and Dagnostc Statstcs R 0.56 χ (1) S.E χ (1) DW.141 χ () F (7,65) χ (1) sc ff N Het Notes: (*) and (**) ndcate that coeffcents are sgnfcant at the 5% and the 10% levels respectvely. The varables employed to control for sze are hghly sgnfcant mplyng a non-lnear relatonshp between the sze and proftablty of banks. The coeffcent of SIZE s negatve and sgnfcant mplyng the mportance of scale economes n explanng proftablty dfferences across banks. The negatve sgn on SIZE and the postve sng on the SIZE varable together mply that as a bank grows n sze, an ncrease n management complextes reduces the bank's proftablty at frst. However, after a certan pont, ths effect s reduced, leadng to hgher proftablty for very large banks, probably, due to ncreased specalzaton and technologcal advantages. Smlar fndngs are reported for the US bankng ndustry (Hermaln and Wallace, 1994) and for the UK Insurance ndustry (Hardwck and Adams, 003).

5 The Persstence of Proftablty and Competton n The Turksh Bankng Sector Ercyes Ünverstes İktsad ve İdar Blmler Fakültes Dergs, Sayı: 30, Ocak-Hazran 008, ss CONCLUSION Ths paper examnes the ntensty of competton and the relatonshp between persstence of proftablty and frm characterstcs by applyng the PP methodology to the data for 4 Turksh banks. The emprcal results suggest that the short-run persstence of profts are moderate and above normal profts dsappear n the long-run mplyng the presence of hgh competton n the sector. In addton, the results of the regresson analyss ndcate that those banks that nvested n hgh payng government bonds wth almost no rsk earn profts above the norm. It seems that the solvency and the lqudty are not related to the persstence of proftablty across banks. In the face of decreasng real nterest on government bonds and ncreasng competton due to the admsson of foregn banks to the sector, those banks that are heavly dependent for ther earnngs on hghly-yeldng government bonds wll face a danger of decreasng proftablty. For ths reason, the regulatons n the bankng sector should be tghtened and the banks should develop more effcent rsk management technques to avod credt defaults. REFERENCES AKYUZ, Y. and K. BORATAV; (003), "The Makng of Turksh Fnancal Crss", World Development, 31, pp BEKTAŞ, E.; (007), "The Persstence of Profts n The Turksh Bankng System, Appled Economcs Letters, 14, pp DEMSETZ, H.; (1974), "Two Systems of Belef About Monopoly", n Industral Concentraton: The New Learnng (Eds) H. GOLDSCMID, H. MANN and J. WESTON, Lttle Brown, Boston, pp DEMSETZ, H.; (1989), Effcency, Competton and Polcy: The Organsaton of Economc Actvty, Vol., Blackwell Publshng, Oxford, p.30. GEROSKI, P. A.; (1990), "Modellng Persstent Proftablty", n The Dynamcs of Company Profts: An Internatonal Comparson, (Ed.) D. C. MULLER, Cambrdge Unversty Press, Cambrdge, pp GEROSKI, P. and A. JACQUEMIN; (1988), "The Persstence of Profts: A European Comparson", Economc Journal, 98, pp GLEN, J., K. LEE, and S. SINGH; (001), "Persstence of Proftablty and Competton n Emergng Markets", Economcs Letters, 7, pp GLEN, J., K. LEE and S. SINGH; (003), "Corporate Proftablty and The Dynamcs of Competton n Emergng Markets: A Tme Seres Analyss", Economc Journal, 113, pp GORTON, G. and A. WINTON; (003), "Fnancal Intermedaton", n Handbook of the Economcs of Fnance, (Eds) D. G. M. CONSTANTINIDES and M. HARRIS, and R. STULZ, Elsever B. V., pp GSCHWANDTNER, A.; (005), "Proft Persstence n The 'Very' Long Run: Evdence From Survvors and Exters", Appled Economcs, 37, pp HARDWICK, P. and M. ADAMS and H. ZOU; (003), "Corporate Governance and Cost Effcency n The Unted Kngdom LfeInsurance Industry", EBMS Workng Paper, EBMS/003/1, pp.1-31 HERMALIN, B. E. and N.E. WALLACE; (1994), "The Determnants of Effcency and Solvency n Savngs and Loans", Rand Journal of Economcs, 5, pp

6 The Persstence of Proftablty and Competton n The Turksh Bankng Sector 167 IM, K. S. and M.H. PESARAN and Y. SHIN; (003), "Testng For Unt Roots n Heterogeneous Panels", Journal of Econometrcs, 115, pp MARUYAMA, N. and H. ODGARI; (00), "Does The 'Persstence of Profts' Persst?: A Study of Company Profts n Japan, ", Internatonal Journal of Industral Organzaton, 0, pp MUELLER, D.; (1990), The Dynamcs of Company Profts: An Internatonal Comparson, Cambrdge Unversty Press, Cambrdge, pp SORAL, B. H. and T.B. ISCAN and G. HEBB; (006), "Fraud and Bankng Crses: Evdence From Mcro-Level Transactons Data", European Journal of Law and Economcs, 1, pp YURTOGLU, B. B.; (004), "Persstence of Frm-Level Proftablty n Turkey", Appled Economcs, 36, pp BERGER, A. N.; (1995), "The Proft-Structure Relatonshp n Bankng Test of Market-Power and Effcent-Structure Hypotheses", Journal of Money, Credt and Bankng, 7, pp OKUMUS, H. S.; (00), "Market Structure and Effcency as Determnant of Proftablty n The Turksh Bankng Industry", Yapı Kred Economc Revew, 7, pp MOLYNEUX, P.; (1993), "Market Structure and Proftablty n European Bankng, The Insttue of European Fnance, no: 93/5, p.3