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Loan and Income Diversification Strategies and Performances of Turkish

Banks

Yetkin ÇINAR, Ph.D.Yetkin ÇINAR, Ph.D.

Asst. Prof.Asst. Prof.,, Faculty of Political Sciences, Faculty of Political Sciences, Ankara University, Ankara University, TurkeyTurkeyPost-Doctoral Researcher, HSE, MoscowPost-Doctoral Researcher, HSE, Moscow

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Introduction

Recent Trends and Structural Characteristics in Recent Trends and Structural Characteristics in Turkish Banking SectorTurkish Banking Sector

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Recent Trends and Structural Characteristics of Turkish Banking Sector

Structural Chracteristics of Turkish Banking SectorStructural Chracteristics of Turkish Banking Sector

Number of BanksNumber of BranchesTotal Assets$Share of 10 largest banks by Total Assets (%)Share of Foreign Equity$Deposits$Loans$Non-Performing Loans (Net)$Shareholders’ Equity$ROA

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Recent Financial Crisis and TBS

After overcoming the impacts of the 2001 crisis, i.e., After overcoming the impacts of the 2001 crisis, i.e., between the years 2003 and 20between the years 2003 and 2012;12;

Turkish Banking Sector showed a rapid growth performanceTurkish Banking Sector showed a rapid growth performance, , except from except from the effects of global crisis in 2008 and fluctuations in 2005 and 2006the effects of global crisis in 2008 and fluctuations in 2005 and 2006..

RRapid growth in the banking sector raiseapid growth in the banking sector raise foreign fund entry but, incurred foreign fund entry but, incurred lower profit margins.lower profit margins.

FFaced with a more competitive environment, banks had to account for loan aced with a more competitive environment, banks had to account for loan losses while increasing their loan supply to become more profitable.losses while increasing their loan supply to become more profitable...

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What is the Role of Diversification?& Its relationships between

Performance and Risk

Diversification and Performance of Banks – Previous StudiesDiversification and Performance of Banks – Previous Studies

Possible Relations between Performance, Risk and Possible Relations between Performance, Risk and DiversificationDiversification

The Objective and The Scope of The Objective and The Scope of This This ResearchResearch

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Diversification and Performance of Banks – Previous Studies

Acharya et.al. (2006), Meyer & Yeager (2001), Stiroh & Rumble (2006), Mercieca et al. (2007), Hayden et al. (2007), Kamp et al. (2007), Baele et al. (2007), Berger et al. (2010),

Tabak et al. (2011).…analyze thanalyze the relationship between diversification and e relationship between diversification and

performance…. in Italy, Germany, Brasil, EU-15, US Canada, performance…. in Italy, Germany, Brasil, EU-15, US Canada, China …China …

However, tHowever, the empirical findings assert that diversification of he empirical findings assert that diversification of bankbank’s’s assets or incomes is not guaranteed to produce superior assets or incomes is not guaranteed to produce superior

performance and/or greater safety for banksperformance and/or greater safety for banks

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The Objective and The Scope of Research

n the effects of loan and income diversification the effects of loan and income diversification strategies on the performance strategies on the performance (and risk) (and risk) of Turkish of Turkish

banksbanks

n over the period 2005–2011, which includes the over the period 2005–2011, which includes the fluctuations in 2006 and 2008-2009 fluctuations in 2006 and 2008-2009 global financial global financial

crisis.crisis.

This paper empirically analyzesThis paper empirically analyzes;;

Our Sample

n In Turkish banking sector, there are 45 banks, 32 of them are commercial banks.

n They consist of 3 state-owned, 11 private (Turkish), 17 foreign banks in terms of ownership characteristics and one of them is under the control of Savings Deposit Insurance Fund.

n 20 commercial banks can be taken into account in 7 years: 2005-2011. However, they represent %95 of total assets in Turkish Banking Sector.

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Methodology & Application

Diversification Measure and Its “Related” and Diversification Measure and Its “Related” and “Unrelated” Components: Entropy Models“Unrelated” Components: Entropy Models

Relationships between bank returns, risk and Relationships between bank returns, risk and diversification: Panel Data Analysesdiversification: Panel Data Analyses

Diversification Measure and Its “Related” and “Unrelated” Components: Entropy Models

n In this paper, diversification is measured by Entropy methodology (Shannon, 1948; Palepu, 1985), so as to distinguish the total diversification into related and unrelated components.

n Entropy indices distinguishes between diversification within groups which consist of highly-related components and diversification across these groups.

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Formally;n Let the amount of exposure of bank b at time t to each sector / product (or the amount of each

type of earning) i denoted as Xibt, where (i = 1…m).

n Then, relative amount of the exposure / earnings in total amount of loan exposure / earnings will be;

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n The total diversification (TD) of this bank, at the given point of time is measured by this equation, by the entropy measure:

ibt

m

iibtbt PPTD

1ln.

1

m

iibt

ibtibt

X

XP

1

The Meaning of Entropy;

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n If TD is near to 0 then it means the loan portfolio of the bank is highly concentrated (low diversified or highly focused).

n On the other side, if relative exposures very close to each other, then TD takes higher values; at the extreme point if they are equally distributed, then TD takes its highest value (perfect diversification).

Calculation of the Components of Diversification;

IF there is, m type of loans / earnings in n group, where m > n. Then in any jth group the diversification of is measured by; “Within Group Diversification” or “Related Entropy” measure

AGD: Across Groups or Unrelated Diversification (AGD)

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j

n

j

j

PPAGD

1ln.

1

AGDTWGDTD

j

ibtji

jibtj

PPWGD

1ln. j

n

jj PWETWGD .

1

It’s been shown that;It’s been shown that;

Relationships between bank returns, risk and diversification: Panel Data Analysesn This paper’s aim is to show empirically that the

relationship between diversification strategy and a bank’s performance (profitability and risk) depends on the degree or type of diversity;

q diversification in interest and non-interest incomes, q industrial, q borrowersq diversification with respect to financial products and q related versus unrelated diversification.

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Measures calculated from Diversification Strategies: Independent

Variables

Diversification Strategies -1: Loan Diversification in terms of Financial Products

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Loan Diversification in

terms of Financial Products

(Borrowers)

Gr. (A): Consumer Loans

- Housing ,

- Vehicle,

- Consumer,

- Credit Cards,

- Other

-Gr. (B): Commercial - Business Loans;

- Vehicle

- Corporate Credit Cards

- Other

Diversification Strategies -2: Loan Diversification in Industries (Sectors)

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Loan

Diversification in

Industries

(Sectors)

Gr. (A): Agricultural sector;- Farming and raising livestock, - Forestry, - Fishing Gr. (B): Manufacturing sector;- Mining - Production - Electric, gas and water Gr. (C): The Construction sector (in a single item) Gr. (D): Wholesale and retail trade;- Hotel, food and beverage services, - Transportation and telecommunication, - Financial institutions, - Real estate and rental services, - Self-employement services, - Education services, - Health and social services in the Services sector Gr. (E): Other sectors which are not classified above (in a single item)

Diversification Strategies -3: Income Diversification – Interest vs. non-Interest Revenues

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Income

Diversification w.r.t.

interest and non-interest

revenues

Gr. (A): Interest based revenues; revenues from;- borrowers (loans)- banks- financial market operations- treasury bonds and issues- other Gr. (B): Non-Interest based revenues;revenues from;- dividends- Fees and Commissionsrevenues from- dividends- Fees and Commissions

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Performance Measures: Dependent Variables

and Control Factors

Panel Data Analyses: Performance and Risk Measuresn In panels, performance of the banks is evaluated in

two dimensions:

q Profitability: Return On Assets (ROA) of banksq Loan Risk: Measured in terms of ln (NPL / Assets)

Consistency (Stability): The standart deviation and the differences between actual data and trend values of the mean values of performance measures (ROA and ROE) are also calculated and used in a Linear regressions.

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Panel Data Analyses: Control FactorsIn this study different control variables are used.

These are the banks’;

nSize: In order to observe whether size of the bank is important in the relationship between diversification and risk or return, we control for size by using a variable measured by Assets in the regressions.

nOwnership Structure: In order to test whether ownership structure of the banks affects the results, the ownership dummies are used, i.e. state-owned, private (Turkish) or foreign-owned banks.

nMacroeconomic Factors: In order the capture the crisis and fluctuation period effects, time dummy is used which reflects the changes in the years 2008 - 2010 and 2006.

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Panel Data Analyses: FormulationsRelationship between banks’s return and diversification measures is investigated by running two type of regressions:

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bttj jbtjbtbtbtbt OwnTDZTWGDAGDTDbt

ROA 3210

bttj jbtjbtbtbtbt OwnTDZTWGDAGDTDbt

ROA 11312110

Panel Data Analyses: FormulationsRelationship between banks’s risk and diversification measures is investigated by running the following regressions:

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bttj jbtjbtbtbtbt OwnTDZTWGDAGDTDbt

NPL 3210

btbtbtbt ZTWGDAGDTDbt

NPL 1312110

bttbtbtj jbtj ROANPLOwnTD 111

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Summary of Results

Diversification (sector means) Patterns vs. ROADiversification (sector means) Patterns vs. ROA

Diversification ComponentsDiversification Components

Diversification TrendsAll diversification measures are normalized with the ln (m), where m stands for number of loan type in the groups (they are different).When we compare them, we see that in years total (mean) sectoral diversification were raising.Income and product diversification have been falling in total terms.However we realize different patterns when we consider them w.r.t. their components. It is consistent with our assumption that components of diversification should also be taken into account in regressions.

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Main Results

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Diversification ComponentDiversification Component ROAROA RISKRISK

AGD – ProductAGD – Product N/Sig.N/Sig. N/Sig.N/Sig.

TWGD – ProductTWGD – Product N/Sig.N/Sig.

AGD (-1) – ProductAGD (-1) – Product N/Sig.N/Sig.

TWGD (-1) – ProductTWGD (-1) – Product N/Sig.N/Sig.

AGD – SectorAGD – Sector N/Sig.N/Sig.

TWGD – SectorTWGD – Sector N/Sig.N/Sig. N/Sig.N/Sig.

AGD (-1) – SectorAGD (-1) – Sector N/Sig.N/Sig. N/Sig.N/Sig.

TWGD (-1) – SectorTWGD (-1) – Sector N/Sig.N/Sig. N/Sig.N/Sig.

AGD – IncomeAGD – Income N/Sig.N/Sig.

TWGD – IncomeTWGD – Income N/Sig.N/Sig.

AGD (-1) – IncomeAGD (-1) – Income N/Sig.N/Sig. N/Sig.N/Sig.

TWGD (-1) – IncomeTWGD (-1) – Income N/Sig.N/Sig. N/Sig.N/Sig.

SUM

MARY of RESU

LTSSU

MM

ARY of RESULTS

Main Results -1n Results summarized in Table show that there is a

little evidence that diversification positively effects the returns and risks, increases ROA and reduces NPL. In total terms no significant effect is found. But when using its components some significant effects can be realized.

n For instance in total terms since there is no significant effect in total terms by means of product diversification; evidences are obtained in its components. However they are opposite. In terms of across groups diversification a negative effect on ROA is observed, while within group diversification has positive effects on ROA. This indicates that the total effect is neutralized.

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Main Results -2n The evidence about income diversification effects found in this

study means that if a bank’s exposures are to the individual consumers rather than corporate clients and the bank changes her decision and shifts to the corporate banking it has negative affects the risk of loan losses,

n But if it stands in the retail (consumer) banking and diversify in terms of products and shows the benefit of measuring diversification in distinguished terms.

n This result is also in consistent with the previous studies asserting that noninterest revenues have more crucial role in bank management in a more competitive environment. Fees and commissions are the in the innovative instruments of return in the new era of banking.

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Main Results -3n There is no substantial evidence about the effects

of sectoral diversification on performance. The only significant finding is that across group diversification reduces risk.

n It could be suggested that all sectors effected from economic conditions in a similar way.

n Therefore loan losses or returns gained from the sectors, especially within one group, are not differentiated. Only, if possible, across group diversification can give a benefit.

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Conclusion

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Conclusion

In conclusion, the main results show that; there are In conclusion, the main results show that; there are only little evidences that diversification increases only little evidences that diversification increases

ROA and reduces NPL, however they are found with ROA and reduces NPL, however they are found with respect to the components of diversification respect to the components of diversification

measures. measures.

Therefore it is shown in this study that when Therefore it is shown in this study that when investigating the effects of diversification using investigating the effects of diversification using

different different dimensions of this factor is more beneficial dimensions of this factor is more beneficial than using only total measures.than using only total measures.

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Thank You…Comments and Questions?