Abstract

Purpose – The purpose of this paper is to investigate the relationship between the quality of property rights institutions (PRIs) and bank financial performance in an empirical study of 136 countries over the period 1999-2006. Design/methodology/approach – The quality of PRIs and financial accounting-based measures of bank performance are obtained from the Economic Freedom of the World Project (Gwartney et al., 2006), the Polity IV Project, the World Bank data indicators database, and the International Monetary Fund. Several multiple regression analyses are conducted to test the study hypotheses. Findings – The results reveal that the quality of legal structure and security of PRIs positively (negatively) affects both bank cost efficiency (inefficiency) and profitability. The presence of a quality political structure negatively (positively) affects bank cost efficiency (inefficiency). The quality of political structure has no direct impact on bank profitability. The impact of PRIs on bank cost efficiency is more evident in the upper middle and high income group of countries than in the low and lower middle income group of countries. An appropriate level of PRI quality is essential to achieve both competition and development. Practical implications – The paper highlights policy implications for international policy makers, regulators, and the management of banks who are interested in banking sector development across countries. Originality/value – The study investigates the fundamental importance of PRI quality in its effect on the banking sector and extends the largely US-focused literature to a broader international setting.

Highlights

  • The banking industry plays a central role in the international allocation of financial resources and economic growth (Rajan and Zingales, 1998)

  • This paper investigates the impact of property rights institutions (PRIs) quality on the cost efficiency and profitability of banks across 136 countries over the period 1999 to 2006

  • We find that the quality of the legal structure and security of property rights institutions positively affects bank cost efficiency and profitability, consistent with our predictions

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Summary

Introduction

The banking industry plays a central role in the international allocation of financial resources and economic growth (Rajan and Zingales, 1998). Gwartney et al (2006) find that countries with quality PRIs enjoy faster economic growth through their enhanced ability to attract private investment. These studies are built largely on the institutional theories which highlight the importance of quality institutions in financial and economic development (North, 1981). Other empirical studies focus on the influence of some form of PRI quality on access to external capital (Rajan and Zingales, 1998), firm valuation and earnings quality (La Porta et al, 2002a; Leuz et al, 2003), firm growth (Beck et al, 2005), operating cost savings (Ben Naceur and Omran, 2011), and firm profitability (Verriest et al, 2008). The use of composite indices to represent governance indicators in these studies makes it difficult to isolate the impact of individual institutions on bank performance and to compare their relative importance

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