Financial Deepening and Bank Productivity in Latin America

1
Financial Deepening and Bank Productivity in
Latin America

• Georgios Chortareas
• University of Athens
• Claudia Girardone
• University of Essex
• Jesus G. Garza Garcia
• University of the West of England
• Cass Business School
• Emerging Scholars in Banking and Finance
• December 9th, 2009

2
Introduction

• Financial liberalisation has been a recent
  important trend in the financial sectors in Latin
  America.
• Main idea was to generate a more competitive
  banking sector.
• Aizenman (2005) suggests that financial
  liberalisation gained from increased savings in
  the economy (mainly through foreign capital).
• This increase in savings in the economy was
  expected to increment the level of financial
  deepening in the economy (particularly the credit
  to the private sector).

3
Financial Deepening
Figure 1 Bank Credit to the Private Sector in
terms of GDP, Average Percentage 1999-2006
Data obtained from IFS (International Financial
Statistics) from the IMF (line 32D.ZF).The Latin
American average is calculated using the
following countries Argentina, Brazil, Chile,
Colombia, Costa Rica, Paraguay, Peru, Uruguay and
Venezuela. For Venezuela the average is
calculated from 1999-2004 due to data
availability. The South East Asia average is
calculated using the following countries Brunei,
Cambodia, Malaysia, Laos, Myanmar, Singapore,
Thailand, Hong Kong, South Korea, Philippines and
Vietnam. The average for Brunei and Vietnam was
computed for the years 1999-2005 and for Myanmar
from 1999-2004 due to data availability. The
data for the EURO Area was elaborated including
all the countries in the European Union.
4
Figure 2Financial Deepening in Latin America
Source IFS (International Financial Statistics
from the IMF) The Latin American average is
calculated using the following countries
Argentina, Brazil, Chile, Colombia, Costa Rica,
Paraguay, Peru, Uruguay and Venezuela except for
M2/GDP in which Peru and Venezuela were excluded
due to data availability.
5
Literature Review

• Economists have largely disagreed on the role of
  financial development and economic growth.
• Increased numbers of financial institutions and
  financial instruments help reduce information
  costs in the economy (Rioja and Valev, 2004).
• Many other studies find a positive relationship
  between finance and growth (King and Levine
  (1993a, b, c), Roubini and Sala-i-Martin (1992),
  Pagano (1993), Jayaratne and Strahan (1996),
  Levine (1997a, 1998), Arestis and Demetriades
  (1997), Rajan and Zingales (1998), Lindh (2000),
  Levine et al. (2000) among others.

6
Literature Review

• Thus, if finance is to explain economic growth,
  we need theories that describe how financial
  development influences resource allocation
  decisions in ways that foster productivity
  growth...
• Levine, 2004 p. 6

7
Literature Review

• Recent studies address how financial development
  affects economic growth through greater
  productivity (economic).
• Particularly, Levine et al. (2000), Arestis et
  al. (2002) and Arestis et al. (2006) argue that
  financial development affects economic growth
  through productivity growth.
• There are various studies which suggest that
  financial development may enhance greater
  economic productivity and contribute to a more
  efficient allocation of capital.

8
Motivation

• Latin American financial systems are highly bank-
  based.
• Extensive literature on the relationship between
  financial deepening and economic growth.
• No literature focusing on the microeconomic
  relationship financial deepening and banking
  productivity and/or vice-versa.
• Financial deepening forms the broad environment
  in which banks operate.

9
Data

• Data obtained from Bankscope and the IFS from the
  IMF.
• Study includes 9 Latin American countries
  Argentina, Brazil, Chile, Colombia, Costa Rica,
  Paraguay, Peru, Uruguay and Venezuela.
• Observations 973
• Years 2000 - 2006

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Methodology
GMM Panel Data endogenous variables (TFP, PCR)
exogenous variables macro variables
TFP TOTAL FACTOR PRODUCTIVITY PCR CREDIT TO
THE PRIVATE SECTOR /GDP CPI CONSUMER PRICE
INDEX TRADE SUM OF EXPORTS IMPORTS / GDP GOV
TOTAL GOVERNMENT EXPENDITURE / GDP XRATE
AVERAGE ANNUAL EXCHANGE RATE GDP per capita
GROSS DOMESTIC PRODUCT per capita
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TFP or the Malmquist Index

• The Malmquist Productivity Index is a distance
  function which measures the degree of
  productivity using a multi input and multi output
  approach.
• Created by the Swedish statistician Malmquist in
  1953, it was first proposed by Caves,
  Christensen, and Diewert (1982).
• It has since been further developed by Fare
  (1998), Fare et al. (1994) among others.

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TFP or the Malmquist Index
Where M is the Malmquist Productivity Index D is
the distance function made up of inputs and
outputs. A value of M gt1 implies an increase of
productivity A value of M1 means no change in
productivity and M lt1 is a reduction in
productivity. The distance function is the DEA
input-oriented approach. x inputs (interest
rate expenses, personnel expenses and other
operating expenses) y outputs (loans and other
earning assets)
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TFP or the Malmquist Index

• MI(TFP) TEC
  TC
• Where MI represents the Malmquist Index (TFP-
  Total Factor Productivity), TEC is the technical
  efficiency change and TC is the technological
  change.
• The technical efficiency change relates to how
  close firms are operating in relation to the best
  practice frontier.
• On the other hand, technical change refers to
  the shift in the best practice frontier.

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Empirical Results
Figure 3 TFP, TC and TEC average annual geometric
average in Latin America ()
TFP, TC and TEC are the geometrical averages for
the corresponding years in Latin America. The
Latin American average includes the countries in
study Argentina, Brazil, Chile, Colombia,
Costa Rica, Paraguay, Peru, Uruguay and Venezuela.
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Empirical Results
Table 1 GMM dynamic panel data, TFP as the
dependent variable
TFP (a) TFP (b) TFP (c)
TFP lagged(t-1) .061 -.059 -.019
PCR 1.133 1.488
PCR lagged(t-1) 1.56 -.845
PCR lagged(t-2) .832 .228
CPI .032 .031 .043
TRADE -.34 .267 -.082
GOV -2.618 -2.857 -2.647
XRATE -.036 -.095 -.058
GDP per capita -.059 -.039 -.184
Cte. 1.481 1.128 2.511
AR(1) p-value AR(2) p-value Hansen J test p-value Observations Year dummies -2.04 (0.042) 1.22 (0.224) 25.89  (0.359) 973 Yes -1.58 (0.113) -0.19 (0.853) 28.31 (0.166) 513 Yes -1.87 (0.062) -0.03 (0.977) 19.48 (0.427) 973 Yes
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Empirical Results
Table 2 GMM dynamic panel data, PCR as the
dependent variable
PCR (d) PCR (e) PCR (f)
PCR lagged(t-1) .463 .986  .835
TFP .016 .008
TFP lagged(t-1) -.011  -.015
TFP lagged(t-2) -.024 -.005
CPI -.005 -.004 -.006
TRADE .286 .22 .223
GOV .683 .21 .301
XRATE -.001 -.009  -.006
GDP per capita .095 .11 .117
Cte. -.8   -.902 -.951
AR(1) p-value AR(2) p-value Hansen J test p-value Observations Year dummies -2.6 (0.009) -2.02 (0.043) 44.96 (0.006) 973 Yes -1.44 (0.150) -1.15 (0.251) 36.91 (0.024) 513 Yes -1.05 (0.293) -1.02 (0.310) 22.57 (0.257) 513 Yes
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Results

• The main findings indicate there is a strong
  positive relationship between TFP and PCR and
  vice-versa (model f).
• CPI is positive and significant when explaining
  banking sector productivity but negative and
  significant when explaining financial deepening.
• TRADE, is positive and significant when
  explaining financial deepening.
• Government expenditure is negative and
  significant with TFP, implying that greater
  government expenditure decreases banking
  productivity.

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Other results

• XRATE variable is negatively and significantly
  related TFP.
• GDP per capita is positively and significantly
  related with PCR.

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Conclusions 1/2

• The above results are in general supportive of a
  positive relationship between financial deepening
  and banking productivity.
• This finding suggests that a channel through
  which the beneficial effects of financial
  deepening find their way through the economy is
  the banking system.

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Conclusions 2/2

• Evidence of reverse causality between financial
  deepening and banking productivity.
• The finding of reverse causality may indicate the
  existence of a virtuous cycle between financial
  deepening and banking productivity where one
  facilitates the other.

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Policy Implications

• Policy oriented measures in the region should
  take in consideration the positive causality
  between financial deepening and banking
  productivity and try to increase the level of
  credit to the private sector as a stimulant of
  economic growth.