Political uncertainty and bank efficiency

An important challenge for bank policymakers across the world is the design of effective political institutions that improves bank performance in financial markets. An efficient cost management is better controlled if we can empirically disentangle the relative importance of push factors that are internal to bank ownership and political uncertainty. This paper contributes to the debate on what drives bank efficiency by estimating a stochastic frontier approach (SFA) cost efficiency of individual banks over 10 years across 20 emerging economies.

The dataset used in this study is composed of individual bank data soured from unconsolidated statements of banks operating in the 20 emerging market countries, as made available through the Bankscope database of Bureau van Dijk. We find evidence that political uncertainty during national election years are associated with lower cost efficiency of banks in emerging countries compared with non-election periods. We use an empirical testing model to analyze the data. We carry out the system generalized-method-of-moments (GMM) estimator that is appropriate for dynamic panel model specifications (Roodman, 2009). We also apply the two-step standard errors with the Windmeijer (2005) finite-sample correction, which is somewhat better than one-step GMM for lower bias and standard errors. In order to reduce instrumental weakness of specification, we also limit the number of instruments by restricting the lag range used in generating them at three as suggested by Roodman (2009). The result, however, does not display a statistically significant effect of political uncertainty on bank efficiency around election years (i.e. before and after an election year). As in the role of ownership structure, we find that state-owned banks tend to have lower efficiency than comparable private banks, while no difference exist in cost efficiency between foreign-owned and domestic private banks. We are also able to predict a lower efficiency for banks located in civil law countries as well as in countries with parliamentary systems during the election years. Our findings have several implications. We show bank performance in emerging economies should be aware of the potentially increased-political objectives, which enhance uncertainty and opaqueness regarding government policy and therefore reduce the level of bank efficiency. Assessing the effects of ownership structure and political uncertainty for bank efficiency has direct implications in the context of this debate. From a policy perspective, our findings suggest that banks’ supervisors and regulators should consider the effect of ownership structure when evaluating the impact of political uncertainty on bank efficiency.