Efficiency and risk in Spanish banking

Resumen

After a decade of rapid economic growth, Spain and other European countries entered a long and deep recession whose effects have barely started to recede by the beginning of 2014. The consequences of the crisis, of which the burst of a huge housing bubble was largely responsible, have been diverse, and only few of the macroeconomic indicators are now improv ing. In this scenario, the purpose of this Thesis is to contribute to a better understanding of Spanish banking efficiency over the last few years which, as stated, have been characterized by a strong economic and financial crisis. Specifically, three different chapters, apart from those corresponding to the introduction and the concluding remarks, will be presented in order to provide some new insights on the efficiency of Spanish banking firms during the crisis years and the preceding ones, as well as studying some relevant related issues which, as far as we are concerned, have received relatively little attention. The second chapter presents an efficiency analysis focusing on both the cost and revenue sides of bank activities (i.e. banking firms might try both to minimize costs and maximize revenues) and the different types of financial institutions¿commercial banks, savings banks and credit unions. While there is a large literature analyzing efficiency in Spanish banking, most of the contributions have focused on either cost or input technical efficiency, whereas the analysis of profit efficiency has received less attention. In the case of revenue efficiency, the number of contributions is close to zero. For this, I consider Free Disposal Hull (FDH), which is the non-convex variant of one of the most heavily-used and heavily-cited methodologies to measure efficiency, namely, Data Envelopment Analysis (DEA) (Charnes et al., 1978), which is also a novelty in the particular case of Spanish banking, and has several advantages over DEA. Compared to previous literature, I also extend the period of analysis to the crisis years, during which Spanish banking firms have gone through strong difficulties (especially savings banks). I also extend the analysis to the three types of organizational types, namely, private commercial banks, savings banks, and credit unions. In the following two chapters I examine two particular issues which have proved to be particularly relevant during the crisis years. Specifically, in the third chapter, after having analyzed cost and revenue efficiency in banking in the second chapter, I deal with their natural complement, namely, profit efficiency. However, I do not deal exactly with profit efficiency but rather consider a frontier approach to analyze profits in banking, which allows assessing the inefficiency losses in terms of return on assets (ROA). I extend this analysis to control for risk, which has been disregarded by many studies in banking (usually due to the lack of data), but which turns out to be very relevant (Hughes and Mester, 2009), especially during the crisis years. In the case of Spanish banking (in which a poor handling of risk partly underlies the housing bubble and its final burst) the issue is particularly relevant. Apart from the general goal dealing with risk when measuring the ROA lost due to inefficiency, I try to contribute to the literature in three main ways. First, I deal with risk in my own specific way, using different variables to estimate risk to avoid the accounting problems due to manipulating practices which usually plague loan loss provisions. As indicated by Berger and DeYoung (1997), non-performing loans might be a better option to measure bank risk, nevertheless, the lack of data of non-performing loans leads us to use loan loss provisions. However, in order to avoid the manipulation accounting problems of this variable, I consider some modifications. Second, I adopt a profit efficiency approach which takes explicitly into account the quality of those variables which affect the measurement of bank profits. Third, my profit efficiency approach allows considering three different scenarios depending on whether banks are allowed to set prices and/or quantities. An issue which has barely received attention is how banks' efficiency might be related to some of their borrowing firms' characteristics. Whereas there literature of banks' efficiency and productivity and other literatures in which information on firms is also taken into account (for instance, the literature on relationship banking), there have been few attempts, if any, to combine both stems of research. These are the aims of the fourth chapter. Specifically, its objective is to disentangle some of the links between banks' efficiency and some of their borrowing firms' characteristics, with a particular focus on the issue as to whether the most inefficient banks lent to riskier firms and, if that was the case, if it was offset via higher interest rates. For this, I extend the information used in the two preceding chapters in order to include also different characteristics of the borrowing firms. I deal with the general issue in this chapter considering three hypotheses. First, I test explicitly if the most inefficient banks adopted riskier behaviors when selecting their borrowing firms, a hypothesis which we further decompose in two additional ones, namely, if the most inefficient banks lent to less profitable or more inefficient firms, and if the firms that obtained loans from inefficient banks had more probability of going bankrupt. The second hypothesis is devoted to analyze if the interest rates charged by the most inefficient banks are higher due to their risk taking behavior. Finally, I consider a hypothesis that applies to savings banks only, but I judge it as relevant given the central role these banking firms have had in the crisis. Specifically, taking into account the magnitude of the territorial expansions adopted by most of these banks, I analyze if the inefficiency of the savings banks will affect the type of borrowers depending on whether they are located in the savings bank's home or new markets. Each chapter has its own section devoted to outline its specific conclusions. The final chapter (Chapter 5) is devoted to summarize and provide a general view on the findings of the Thesis. In this last chapter I also in- clude a section devoted to sketch some future lines of research. Given the turmoil affecting European banking, in general, and the Spanish banking system in particular, the research opportunities in the field are still high, both in number and relevance. Bibl: Charnes, A., Cooper, W.W., and Rhodes, E. (1978). Measuring the efficiency of decision making units. European Journal of Operational Research, 2(6): 429-444 Fethi, M.D. and Pasiouras, F. (2010). Assessing bank efficiency and performance with operational research and artificial intelligence techniques: A survey. European Journal of Operational Research, 204(2):189-198 Hughes, J. P. and Mester, L. J. (2009). Efficiency in banking: Theory, practice, and evidence. In Berger, A. N., Molyneux, P., and Wilson, J., ed- itors, The Oxford Handbook of Banking, Oxford Handbooks in Finance, chapter 18. Oxford University Press, Oxford.