The effect of bank m&As on efficiency: the portuguese experience victor Mendes

Keywords: Banking; Mergers; Acquisitions; Efficiency; Portugal

1. Introduction

Improvements in communication technology allow greater dissemination of information; lower costs of communication strengthen competition insofar as physically distant institutions become active competitors. In the words of Moore and Siems (1998) “The two forces of technology and deregulation, working together, have fueled change that increasingly blurs accepted boundaries of time, geography, language, industries, enterprises, economies and regulations” (p.3). Berger and Mester (1997) suggest that economies of scale in the banking industry may have increased in the nineties relative to the eighties; this could possible be explained by technological progress.

Improvements in banks’ financial conditions may help increase the volume of M&As. In the USA, bank profitability was very high in the nineties. In Europe that was not necessarily true. However, in some European countries (Belgium, the Netherlands, Norway, Sweden and UK) bank return on equity figures reach very high levels in the mid-1990s (Molyneux, 1999).

Excess capacity might be reduced or eliminated through consolidation. In Europe there appears to be indicators of excess capacity (Berger et al 1999, Molyneux 1999). As for the international consolidation of markets, Berger et al (1999) argue that “the transfers of securities, goods, and services in international markets creates demands for currency deposit, loan, and other services by international financial institutions” (p.150).

Europe has undergone substantial deregulation. The European Banking directives have created new opportunities for banks to operate across national boundaries. The advent of EMU may also foster bank consolidation in Europe. However, the political dimension of M&As in Europe cannot be forgotten. “A fundamental belief that financial institutions should not be controlled by foreigners has (so far) almost prevented any cross-border merger” (Boot 1999, p.610).

All the above mentioned changes in the regulatory and technological environment seem to exist in Portugal in the nineties¹. As regards consolidation, the nineties witnessed the reprivatization process and the first merger operation in Portuguese banking in the last 15 years. This paper aims at studying the effect of such acquisitions on cost efficiency. We also study the effect of merger operations on efficiency, simulating the 1998-BPI merger operation as well as some other possible merger operations. The paper is structured as follows. Section 2 reviews the literature on the behavior of European and Portuguese banks. Section 3 describes the models we use to estimate efficiency and section 4 contains the results. Section 5 concludes.

2. Review of the literature

Bank consolidation may be justified in terms of the ‘getting bigger’ argument, allowing increased market power in setting prices on retail services². Some studies have found that banks in more concentrated markets pay lower rates on deposits and charge higher interest rates on small business loans (Berger and Hannan, 1997; Hannan, 1991). However, other studies have found that this relationship lacked intensity in the nineties (Hannan, 1997; Radecki, 1998). On the other hand, recent research for the USA (Radecki, 1998) shows that large banks sometimes set uniform rates for a state or region, not for the local market. As for the effect of concentration on performance, Maudos (1998) in his study on the Spanish banking industry during 1990-93 concludes that “the results obtained allow us to accept the so-called ‘modified efficient structure hypothesis’ since efficiency positively affects profitability, although market power, reflected in market share, does so as well” (p. 199). Goldberg and Rai (1996) with a sample that includes the bigger banks in 11 European countries during 1988-91 concludes: “We do not find a positive and significant relationship between concentration and profitability” (p.745). In Molyneux and Forbes (1995) a pool of banks from 18 European countries for the years 1986 to 1989 is used. The conclusion is that “the results presented here generally support the traditional SCP approach. That is, results suggest that concentration in the European banking market lowers the cost of collusion between firms and results in higher than normal profits for all market participants” (p.158).

In a study on Portuguese banking for the period 1990-97, Mendes and Rebelo (1999) concludes: “we cannot reject the hybrid collusion/efficiency hypothesis in Portuguese banking during the nineties. In line with these results, we could argue that the known difficulty that Portuguese banks experienced in the period under scrutiny to rapidly decrease nominal interest rates could be the result of a collusion process, either tacitly or explicitly negotiated amongst the banks of the system. The spatial competition and branch location variables are not significant, suggesting that local market power and rural branch networks do not lead to superior performances.”

Some other studies have focused their attention on the effects of size on efficiency. Although studies on US banking using data for the 80s show little or no cost-efficiency improvement following M&As, evidence for the nineties is mixed. As for profit-efficiency, the evidence is even more inconclusive. However, the few existing European studies point towards the same general direction: increased efficiency following M&As (Vander Vennet 1996, Altunbas et all 1997, Resti 1998, Haynes and Thompson 1999).

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