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The Sources of ProductivityGrowth in Turkish Banksby Ownership: The InitialResponses of Public, Private,and Foreign Banks toLiberalizationIhsan Isik a & Doğan Uysal b
a Department of Accounting and Finance , RohrerCollege of Business, Rowan University and EconomicResearch Forum , Doki, Cairo, Egyptb Department of Economics, Faculty of Economics andAdministrative Sciences , Selçuk University , Konya,TurkeyPublished online: 25 Jan 2007.
To cite this article: Ihsan Isik & Doğan Uysal (2006) The Sources of Productivity Growthin Turkish Banks by Ownership: The Initial Responses of Public, Private, and ForeignBanks to Liberalization, Turkish Studies, 7:3, 365-403, DOI: 10.1080/14683840600891059
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Turkish StudiesVol. 7, No. 3, 365–403, September 2006
ISSN 1468-3849 Print/1743-9663 Online/06/030365-39 © 2006 Taylor & FrancisDOI: 10.1080/14683840600891059
The Sources of Productivity Growth in Turkish Banks by Ownership: The Initial Responses of Public, Private, and Foreign Banks to Liberalization
IHSAN ISIK* & DO
[GBREVE]
AN UYSAL**
*Department of Accounting and Finance, Rohrer College of Business, Rowan University and Economic Research Forum, Doki, Cairo, Egypt, **Department of Economics, Faculty of Economics and Administrative Sciences, Selçuk University, Konya, Turkey
Taylor and Francis LtdFTUR_A_189028.sgm10.1080/14683840600891059Turkish Studies1468-3849 (print)/1743-9663 (online)Original Article2006Taylor & Francis73000000September [email protected]
A
BSTRACT
Banks depending on their ownership type may demonstrate different responsesto the changing operational environment. The Turkish financial system has undergone signif-icant legal, structural and operational changes as a result of financial liberalization launchedin the early 1980s. This paper investigates the sources of initial productivity changes inpublic, private and foreign banks as financial repression is phased out of the Turkish financialsystem. According to the non-parametric Malmquist indexes, the results show that publiclyowned banks realized the slowest productivity growth and foreign banks experienced the fast-est after liberalization. Most of the productivity growth at public banks has come from chang-ing scale, while private (domestic or foreign) banks have seen more productivity growth fromincreasing technical efficiency. Apparently, the productivity growth observed in Turkishbanks during the liberal period mostly results from banks coming closer to the existing tech-nological frontier (increased efficiency). However, the progress of the technological frontierduring the period, representing the most efficient deployment of resources possible, was notas impressive. This implies that the source of productivity growth in Turkish banks is mainly“imitation”—the efforts of the inefficient banks to catch up with the best-practice banks—rather than “innovation”—the outward shifts of the production frontier by leading banks.
Introduction
Measurement and understanding of
X
-efficiency has become a very popular avenuein applied economics and finance in recent years. Empirical evidence to date indicatesthat resource waste in banking resulting from operating off the best-practice frontier(
X
-inefficiency) far exceeds the production costs resulting from either operating at anincorrect scale (scale inefficiency) or having a non-optimal mix of service and productlines (scope inefficiency).
1
In fact, due to radical changes taking place in bankingindustries all over the world, the importance of
X
-efficiency in banking has become
Correspondence Address:
Ihsan Isik, William G. Rohrer College of Business, Rowan University, 201Mullica Hill Road, Glassboro, NJ 08028, USA. Email: [email protected]
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more critical in recent years. Price and product liberalization, technological innova-tion, and fierce competition from new financial institutions coming from internal orexternal markets induce banks of all origins to give increasing emphasis on costcontrol and resource management. Efficient and productive use of resources is vitalfor modern banks to assure success in the new environment, because those unable todo so will more likely be driven out of the market or acquired by the best-practicebanks.
2
The Turkish banking system has undergone fundamental changes as a result ofthe financial reforms implemented throughout the 1980s. The abolition of directedcredit policies, liberalization of deposit and loan interest rates, liberal exchange ratepolicies, relaxation of entry barriers, introduction of new financial markets, institu-tions and services, and adoption of international best standard banking regula-tions—among other measures—were the main attributes of the Turkish financialsector in the 1980s. These reforms have fostered competition in the financialservices industry and accelerated the integration of the Turkish economy in theworld. In pursuit of complementing the relevant literature, this paper is to study thesources of productivity and efficiency developments in banking by
ownership
,drawing particularly on the initial post-liberalization experience of public, private,and foreign banks operating in Turkey. Such types of ownership are widespread inmany non-EU and non-US banking markets. Since the primary purpose is to exam-ine the relationship between ownership structure and productivity growth, it wascarried out in the context of the Turkish banking system, which has a rich mix ofownership forms—public, private, and foreign.
Earlier studies mostly subscribe to the Farrell School of
X
-efficiency in that theyonly quantify and report the performance scores of banking groups during liberal-ization with little effort to uncover the underlying reasons behind the efficiency andproductivity developments. In addition, earlier studies mostly used limited numberof years in their analyses, which may be inadequate (according to Berger andHumphrey
3
), if one wants to capture the long-term benefits of liberalization. Only afew new studies began to examine the association between organizational form andbank performance during times of liberalization.
4
In the spirit of Leibenstein,
5
this study explores the interactions between thechanges in the regulatory, market, and firm characteristics of the financial institu-tions in Turkey. Earlier, Zaim
6
and Isik and Hassan
7
examined the performance ofTurkish banks in the deregulated environment and found that Turkish banksperformed better in the new environment. However, both studies either used alimited number of years or focused exclusively on the performance of the
whole
sector with little or no reference to the impact of liberalization on different bankforms. Unlike the earlier studies, this paper investigates the
sources
of productivitygrowth and efficiency increase during the liberal environment by ownership andsize. Using the Malmquist index and ten year series of data (1981–90), it tries toexplain the developments in the productivity and efficiency of Turkish banks withthe changes in their operating environment (financial liberalization), variations intheir sizes (small X large), and differences in their ownership and organizational
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structures (domestic X foreign/public X private). Like the prior studies, this paperexcludes the post-1980s period where there have been constant financial disruptionsin the Turkish economy (such as in 1994, 1997–98, 2000, and 2001), which coulddistort the true relationships between the factors under study. In chaotic times, thesecurity and size of a commercial bank becomes extremely important for depositorsand borrowers. Thus, such a business environment presents significant advantagesto state-owned banks at the expense of private and foreign banks, as these banks areinvariably large institutions that enjoy implicit and explicit guarantees from thegovernment. In addition, privatization of some public banks and intensity of failuresamong private banks in the 1990s substantially reduce the number of observations ineach ownership form, which hampers the measurement of productivity scores in thefirst stage and robustness of correlates of productivity in the second stage.
Reflecting the changes in the nature of banking in recent years, this paper opts anew approach and uses two alternative models for measuring the productivitygrowth of banks: (1) the
traditional banking approach
, where banks accept depositsand transform them into an array of interest earning services by using labor andcapital, and (2) the
non-traditional
banking approach
, where banks accept depositsand turn them into a mix of fee generating and interest earning services by utilizinglabor and capital inputs. It is
hypothesized
that the ownership type or organizationalform that produces stronger incentives to control inputs and/or boost outputs willhave more efficient and productive operations.
8
Economic theory suggests thatpublicly owned firms should perform less efficiently and less profitably than privatefirms. Private ownership of the means of production is the single credible form forhigher productive efficiency. The cardinal goal of a successful private firm is tomaximize shareholder value, which is closely connected to the efficient use ofresources, whereas the goals of public firms are various, conflicting, and rarelyrelated to the efficient use of resources—such as to maximize employment, promoteregional development, and reward loyalists.
9
Also, state enterprises are not understrong market discipline, as they are not put out of business if they fail to earn apositive return on their funds. Moreover, public staff usually exerts less effortbecause they do not have ownership incentives.
10
An in-depth study of different groups of banks is very important for policy andresearch concerns, especially in the new competitive environment. As in virtually allemerging markets, banks are the dominant financial institution in Turkey. Bankscontrol most of the financial flows and possess 75 percent of the total assets of thefinancial system, and non-bank financial institutions are one way or another affiliatedto banks. Detecting the extents and sources of inefficiency (waste of resources) ineach organizational form is the first step for policy makers toward tackling theircurrent and future problems and improving their performance. Empirical evidenceindicates that inefficient banks are more likely to fail than efficient ones.
11
Thus, thestudy of bank productivity and efficiency has strong implications for the successes orfailures of banks and health of the economy at large. Also, the results will be relevantfor the public authorities that face resistance from the status quo against the relax-ation of entry barriers and privatization of public enterprises. Evidence indicates that
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inefficiencies of state-owned institutions in many countries only became apparentwhen they were forced to compete with newly arriving domestic and foreign institu-tions.
12
Hence, the period of the study of the authors of this article that correspondsto the period of economic liberalization in Turkey is a perfect setting for examiningperformance differences of various ownership forms.
Our results show that according to the Malmquist productivity compositions,Turkish banks on average became more productive over the period. Publicly ownedbanks saw the slowest productivity growth and foreign banks saw the fastest. Mostof the productivity growth at public banks came from changing scale, while private(domestic or foreign) banks saw more productivity growth from increasing technicalefficiency. Apparently, the productivity growth observed in Turkish banks duringthe liberal period mostly results from banks coming closer to the existing technolog-ical frontier (increased efficiency). However, the progress of the technological fron-tier during the period, representing the most efficient deployment of resourcespossible, was not as impressive. This implies that the source of productivity growthin Turkish banks is mainly “imitation”—the efforts of the inefficient banks to catchup with the best-practice banks—rather than “innovation”—the outward shifts ofthe production frontier by leading banks.
The rest of the paper is structured as follows. The second section summarizes theevolution of Turkish banking. The third section discusses the literature, while thefourth section introduces the methodology, empirical setting and data. The fifthsection presents empirical results and the sixth and final section concludes.
Institutional Background of the Turkish Banking Sector
Banking markets in emerging economies, which carry the typical features ofoligopolistic markets, differ considerably from those in industrialized economies.For instance, in emerging countries, financial institutions are limited in number andtype, thus competition is relatively weak; financial markets are underdeveloped,thus market participants are not many and sophisticated; asymmetric informationproblems are substantial, thus transaction costs are high; regulations are inadequateand often used for other purposes than the soundness and safety of financialsystem.
13
Berger and Hannan report that the US banks operating in more concen-trated markets tend to have significantly low cost efficiency.
14
Clearly, developingmarkets are highly concentrated when compared to developed markets. While thethree-bank concentration ratio is 0.19 for the US and 0.22 for Japan, it is 0.44 forTurkey, 0.65 for Egypt, 0.69 for Peru, 0.74 for Pakistan, and 0.87 for Uruguay.
15
As the
quiet life theory
suggests, it is likely that banks of concentrated markets areless motivated to operate productively, as such banks lack market discipline of stiffcompetition. The inexistence of developed money and capital markets also presentscomfort for banks of emerging countries, as “disintermediation” from depositorsand borrowers has not yet threatened their businesses as it has in developedmarkets. Besides, state interventions and protections are more frequent and stateand private banks operate side by side in emerging economies. Hence, studies from
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different regulatory and market environments may shed light on the impact of thesedifferences on bank performance.
Whether the set of financial reforms launched in the 1980s to enhance competi-tion in the financial markets have achieved their targets calls for a closer scrutinyover the changes in banking over time. Table 1 displays a number of descriptivestatistics of Turkish banks both industry-wise and group-wise. It appears that thesector has enjoyed an impressive rate of growth during the liberal era, with assetsincreasing from $18.631 billion (31 percent of GNP) in 1980 to $55.604 billion(43.3 percent of GNP) in 1990. Public and private banks coexist in Turkey’s mixedeconomic system. While the average number of state banks (nine) during the periodis far less than that of both private (21) and foreign banks (13), the state occupiesalmost half of the banking industry in terms of assets. There are no legal restrictionson the scope of banking for the three ownership modes; thus, they can, in principle,operate and compete for funds and loan opportunities in all markets. The definingfeature of the Turkish banking industry in the 1980s is actually the record number offoreign bank entries into the system (net 24 entries between 1980 and 1990, includ-ing the development and investment bank entries). Despite their small market share,the impact of foreign banks on Turkish banking has been remarkable due to the newconcepts and practices they have introduced.
16
The evolution of the Turkish banking sector into the current different ownershipforms (public, private, and foreign) dates back to the 19th century. In the Ottomansociety, foreigners or minorities in Istanbul conducted all banking activities. A
Table 1.
Selected Indicators of Turkish Banking System
Indicators 1980 1990 1994 1999 2000
Total Assets ($US mn) $18,631 $58,171 $52,672 $133,533 $155,237Total Assets (% of GNP) 31.4% 43.3% 52.3% 71.4% 79.6%
Number of Banks
43 66 67 81 79Public banks 12 8 6 12 15Private banks 24 25 29 31 28Foreign banks 4 23 20 19 18Other banks 3 10 12 19 18
Share in Sector (% of assets) 100% 100% 100% 100% 100%Public banks 44.1 44.6 40.1 40.5 42.7Private banks 44.2 43.2 48.2 49.5 47.4Foreign banks 2.8 3.5 3.6 5.2 5.5Other banks 8.9 8.7 8.1 4.8 4.4
Number of Employees
125,312 154,089 139,046 173,988 170,401Public banks 59,765 80,825 74,462 87,987 90,086Private banks 58,779 68,145 59,161 76,386 70,954Foreign banks 1,842 3,012 3,256 4,185 3,805Other banks 3,109 2,107 2,167 5,430 5,556
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Table 1.
(
Continued)
Indicators 1980 1990 1994 1999 2000
Number of Employees
125,312 154,089 139,046 173,988 170,401Public banks 59,765 80,825 74,462 87,987 90,086Private banks 58,779 68,145 59,161 76,386 70,954Foreign banks 1,842 3,012 3,256 4,185 3,805Other banks 3,109 2,107 2,167 5,430 5,556
Number of Branches
5,954 6,560 6,087 7,691 7,837Public banks 2,469 2,975 2,909 3,579 3,907Private banks 3,374 3,455 3,054 3,960 3,783Foreign banks 105 113 105 121 117Other banks 6 17 19 31 30
Return on Equity (%)
40.2 36 33.5
−
14.9
−
68.4Public banks 29.4 33.4
−
1.2 48.2
−
18.6Private banks 56.3 41.9 52.9 65.2 11.5Foreign banks 122.0 46.2 151.3 124.2 10.1Other banks 45.9 19.1
−
34.5 57.7 29.0
Equity to Total Assets (%)
5.5 10.1 8.5 5.9 7.3Public banks 7.1 8.2 5.9 4.1 3.1Private banks 3.3 11.5 10.6 12.9 14.0Foreign banks 4.8 11.1 19.6 12.6 9.6Other banks 8.8 13.2 4.8 18.9 24.4
Loans to Total Assets (%)
53.7 47.0 39.0 30.1 32.8Public banks 57.4 47.6 37.6 24.3 25.8Private banks 44.3 43.0 37.9 33.5 37.7Foreign banks 32.9 48.2 23.8 16.5 17.1Other banks 88.9 63.4 58.8 65.6 68.1
Off-balance sheets to Total Assets
1.88 1.97 1.04 1.01Public banks 1.53 1.48 0.32 0.33Private banks 2.18 2.35 1.23 1.41Foreign banks 1.97 2.65 2.51 2.17Other banks 1.95 1.93 0.42 0.52
Number of On-Line Branches
6,938 7,523
Number of ATMs
3,209 4,023 9,939 11,991
Number of POS
16,135 188,957 299,950
Credit Card Use (in thousands)
1,564 10,045 13,408
Bank Card Use (in thousands)
10,469 24,107 29,560
Credit Card Volume ($US mn)
1,273 12,410 16,413
Source
: Banks Association of Turkey, BDDK and own calculations. The ownership forms aredefined as follows: (1) public banks are the banks that are owned predominantly by the Turkishtaxpayers and voters; (2) private banks are the banks whose more than 50% of shares are ownedby the Turkish residents; (3) foreign banks are the banks whose more than 50% of shares areowned by the residents of foreign countries; and (4) other banks refer to development andinvestment banks (excluded from the analysis because of their different nature of business).
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national movement as a reaction to the increasing role and power of foreigners inbanking eventually led to the foundation of several national banks in Istanbul andAnatolia between the years 1908 and 1923. The foundation of the Republic of Turkeyin 1923 led to fundamental modernization and westernization efforts in many areas,including banking. At the time, domestic banks were mostly local and too small tofinance the newly developing economy. Thus, the state took the responsibility tosupport the main sectors of the economy (such as agriculture, housing, small busi-ness, marine, mining, and textile) by establishing several public banks. As a result ofpositive developments in the private sector, expansion of international cooperation,and transition to a multi-party political regime, “etatism” has gradually weakened inTurkey. At present, state banks operate as any other commercial bank, financing bothprivate and public projects. In the late 1970s, there was a rapid growth of privatebanks controlled by industrial behemoths. Due to lack of capital markets, industrialfirms had no option but to open or acquire banks to meet their funding needs, as statebanks were primarily dedicated to funding public investments.
In 1983, following the three years of military rule, a new government rich withinternationally experienced bureaucrats and technocrats came into power. Comple-menting the January 1980 New Economic Policy, this team designed a series ofliberalization and deregulation packages coined as the “December 1983 and January1984 Decisions.” The main theme of the reforms was to augment the efficiency andproductivity of the financial system by fostering competition among economicunits. A strategic switch to an export-oriented economy accelerated the openingprocess of a once closed economy to the world. By 1989, the process of capitalaccount liberalization was complete, as capital flows were fully liberalized in theexternal accounts. Parallel to this trend, most directed credit programs and preferen-tial rates were eliminated contributing to more efficient allocation of resources inTurkey. Prior to liberalization, only 25 percent of the total credit was free fromgovernment control.
17
Privatization of the state economic enterprises was alsowithin the priorities of the consecutive Turgut Özal governments in the 1980s.
Parallel to these liberal policies, new types of financial institutions and instru-ments were allowed, and a record number of foreign and domestic institutionsentered the market. Interest and foreign exchange rates were freed. Starting from1984, residents and non-residents were permitted to hold foreign exchange (FX)deposits, which boosted the volume of transactions and, consequently, profitabilityof banks, such that the level of FX deposits started to surpass the level of TurkishLira (TL) deposits in the sector. Special finance houses, doing business according toIslamic banking principles, were permitted to be a part of the Turkish bankingsystem from 1984. The first sale of government securities via periodic auctionsstarted in 1985. The Istanbul Stock Exchange (ISE) and Interbank Money Marketwere formed in 1986. Open Market operations started and banks began to be auditedby independent auditors in 1987. Turkey joined the SWIFT and Foreign Exchange,and Foreign Banknote Markets were established in 1989.
18
This new era has led to marked increases in bank outputs by providing them withopportunities to trade in asset-backed securities, foreign currencies, mutual fund
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shares, corporate bonds, commercial papers, and treasury securities, as well as tounderwrite various money and capital market securities, establish and managemutual funds, and provide financial consultation. The use of new financial methods,such as leasing, forfeiting, and factoring, has also promoted market development.Turkish banks, large or small, showed increasing interest in doing business abroadand engaging in international markets dealing with extensive off-balance sheetactivities such as swaps and forward agreements. Banks have put increasingemphasis on service quality because consumer banking became the fastest growingsectors of their business. Such concern is possibly a reflection of the heightenedcompetition among Turkish banks. In a competitive environment, banks are underconstant pressure to develop high quality services in order to better satisfy clientneeds (IGEME). The abolishment of interest rate ceilings, reductions in the reserveand liquidity requirements, financial taxes, restrictions on foreign exchangeoperations, as well as barriers on entry and exit have indeed provided a more liberaland contestable financial environment.
19
Within this new environment, banks inten-sively concentrated on computerization and automation projects to increase thespeed, quality, and efficiency of banking services.
20
Another response by Turkish banks to the heightened pressures of the newenvironment was to shut down or downsize unprofitable branches. Like in otherliberalization episodes, such as in the US experience, after the interest rate ceilingswere lifted, a competitive scramble outburst among banks to attract scarce depositsin the market. As depicted in Figure 1.1, this intense competition caused fundingcosts of banks to soar, reaching about 80 percent of the total bank costs at times inthe 1980s for all groups of banks. This sudden jump in interest costs severely weak-ened financial conditions of some small banks and newly formed banker housesbetween 1982 and 1983, a period dubbed as “banker crisis era.” Turkish banks tookrapid measures to tackle increased funding costs. First, they established “friendshippact” among each other to control running interest expenses. Despite this overtcollusion, the share of interest expenses in total costs was still far greater in the post-liberalization era than what they were in the pre-liberalization era. Second, banksadopted restructuring policies to curb the increasing banking costs by trimming theirmost variable input factor—labor. In parallel to the “branching mania” in the 1970s,over-employment had exacerbated in the sector in the pre-liberalization era.However, downsizing efforts induced by competitive pressures resulted in a notablereduction in the number of employees per bank in the sector (from 3,303 in 1980 to2,444 in 1990). As Figure 1.2 indicates, large layoffs, coupled with extensive branchclosures, tremendously reduced the fraction of labor expense in the total costs of alltypes of banks, taking it from about 45 percent by the end of the 1970s to less than15 percent by the end of the 1980s.
Figure 1.
Developments in interest and labor expenses of public, private, and foreign banks.
Apparently, funding costs of Turkish banks have more than doubled in the post-liberalization environment, which abruptly halted the free ride of a guaranteed spreadbetween asset yields and liability costs. However, increased funding costs andfollowing survival threats have disciplined banks in resource management, assuggested by substantial downsizing and automation efforts during the era. These
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Productivity Growth in Turkish Banks
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cursory observations suggest that financial reforms fostered incentives to controlcosts and boost revenues for Turkish banks, both of which are essential steps towardsa more productive and efficient banking sector. Yet how and to what extent thecounteractive developments of the new era affected the productivity, technology, andefficiency of different forms of Turkish banks are subject to empirical testing.
Literature Review
In essence, all
X
-efficiency models either explicitly or implicitly draw upon theseminal work of Farrell,
21
who provided the initial framework for measuring theconcept of the efficiency frontier and the distance of the sample units from the esti-mated frontier. However, Leibenstein
22
was the pioneering spirit in explaining thecauses and effects of inefficient behavior observed in decision-making units. Buttonand Weyman-Jones
23
view Farrel and Leibenstein of representing two different“schools of thought” in the economic theories underlying
X
-efficiency. While the
Figure 1.1 Interest Expense/Total Cost
20%
40%
60%
80%
70 75 80 85 90State Private Foreign
Figure 1.2 Labor Expense/Total Cost
5%
15%
25%
35%
45%
70 75 80 85 90
State Private Foreign
Figure 1. Developments in interest and labor expenses of public, private, and foreign banks.
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Farrell School
is essentially concerned with satisfactory measurement of productiveefficiency and the issue of how it can be computed in practice, the
LeibensteinSchool
is primarily concerned with explaining why firms might not be achievingmaximal efficiency in their productive decisions and behaviors. In their critique andreview of
X
-efficiency studies, Button and Weyman-Jones caution that “the majoritywere preoccupied with
measurement
(as in the Farrel approach), rather than
expla-nation
(in the Leibenstein tradition).”According to Leibenstein, the basic proposition of
X-efficiency theory
is thatmarket structure aspects are critical in determining the optimal behavior of firms inproduction of services and goods.
24
The degree of competitiveness in a firm’smarket, the extent to which it is formed as a part of public sector bureaucracy, andthe nature of the regulatory regime under which a firm operates are among theprimary factors that may explain the variations in
X
-efficiency. Also, as the
quiet lifetheory
suggests, the lower the intensity of environmental pressures, the lower is theeffort expended by managers to derive the maximal output from a given amount ofinputs. Moreover, the extent to which a firm has the right organizational structure orownership form that presents the necessary managerial skills and incentives to adaptto rapid changes in the operating environment and the extent to which a firm hasinternational outlet for its idle resources or access to new technology are otherpossible sources of variations in
X
-efficiency among different groups of banks.The economic theory (e.g. agency cost theory and public choice theory) generally
posits that public firms operate less efficiently and productively than their privatepeers.
25
Managers of public firms usually exert less effort to be productive becausethey do not have ownership incentives. In contrast, managers of private firms areoften given stock options as an incentive to maximize shareholder wealth, which isclosely related to productive use of firm resources.
26
Thus, in a rent-seeking society,public managers who are not shareholders may be inclined to pursue other goals thatare irrelevant to efficiency and productivity such as selling favors, employing loyal-ists, enhancing personal power, or augmenting the influence of ruling politicians.
27
In addition, if managers of private firms fail to deliver enough returns to owners’funds, they are put out of office; thus, the livelihoods of private managers depend onthe efficiency of their performance.
28
However, since the shares of public firms arenot traded in financial markets, public managers are not subject to strong ownershipcontrol, market discipline, and takeover threats. Unconditional access to capital maybe another source of weak market discipline and inefficiency for public firms,because their access to funding is generally unrelated to profitability and valuecreation,29 whereas private firms face relatively harder budget constraints, becausethey are cut out of capital markets unless they have positive net present valueprojects that will create value for creditors and owners. Finally, most public firmsare monopolies, and monopolies are seldom as productive as firms bound tocompete.
One artifact of financial liberalization observed around the globe after the 1980sis the increasing internationalization of financial institutions. The theories thatattempt to explain the international expansion of banks (comparative advantage
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Productivity Growth in Turkish Banks 375
theory, industrial organization theory, and eclectic theory, among others) implicitlyor explicitly suggest that foreign firms expand to other markets to utilize economiesof scale and comparative cost advantages arising from their superior operationalefficiency, operating strategies, organizational structures, and support from homegovernments.30 If such advantages exist, foreign banks are expected to operate moreproductively and efficiently than their domestic counterparts. Thus, domestic bankswill be forced to improve their operational performance if they are to survive in anopen market.31 Foreign banks therefore may provide significant competitive pres-sure that will improve the quality of domestic bank management. Hence, regulatorsof some developing countries relaxed entry barriers for foreign banks in the hopethat this sort of competition would bring improvements in bank performance.32 As amatter of fact, in a rapidly changing financial world, there is no faster and easierway to introduce advances in risk management, communications technology,contract enforcing, and distribution of financial services to the local market than towelcome foreign banks as full players.33
Empirical evidence so far has provided mixed results about the effect of owner-ship on bank performance. Bhattacharyya et al. found publicly owned banks to havebeen more efficient than privately owned banks.34 Altunbas et al. examined the link-age between bank ownership and efficiency in the context of German bankingmarket.35 Their results also suggest that public sector banks are more efficient thantheir private sector counterparts. In contrast, Isik and Hassan report that privatebanks generally dominate public banks in terms of efficiency in Turkey.36 However,in some instances, they find that public banks exhibit somewhat better performancethan private banks, particularly in terms of allocative efficiency. As compared toprivate banks, public banks generally face less expensive input prices, especially inlabor. Banking business is primarily based on credibility and security, because bankdeposits are not fully insured and bank equity may not be sufficient to perform asafety cushion function in times of crisis. Public banks enjoy strong support fromthe state in the form of implicit and explicit guaranty for their liabilities, makingthem attractive to risk-averse clients. Since it is very difficult for private banks toreplicate such level of security, they may have to pay high default premiums whileraising funds from the markets.
In the banking markets of the developed world, domestic banks were found to bemore efficient than foreign banks.37 The proposed reason in these papers is thatforeign banks had to finance their rapid market expansion relying predominantly onpurchased funds, which are relatively unstable and more expensive, rather than oncore funds, which are relatively stable and less expensive. Peek et al., however,explain this observation with another conjecture.38 Foreign banks entered the USmarket basically acquiring domestic banks. Thus, the relatively low efficiency offoreign banks may be attributed to the lower efficiency and performance of theacquired domestic banks. On the contrary, in the banking systems of emergingmarkets, foreign banks were found to be more efficient than domestic banks. Forinstance, Bhattacharya et al.,39 Srivastava for Indian banks,40 Hasan and Marton forHungarian banks,41 and Isik and Hassan for Turkish banks42 report that foreign
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376 I. Isik & D. Uysal
banks are more cost efficient than their domestic peers. Claessens et al. state thatforeign banks are also more profitable than their domestic peers.43 Leigthner andLovell44 and Leaven45 also indicate that as compared to domestic banks, foreignbanks demonstrate greater efficiency in the Thai banking system. A recent paper bySturm and Williams finds foreign banks more efficient than domestic banks inAustralia.46 However, they also add that superior efficiency does not result insuperior profits for foreign banks, because domestic banks in Australia have usedsize as a barrier to entry to new entrants.
As Berger and Humphrey stated, the conventional expectation, which holds thatderegulation always improves efficiency and productivity, may not be true giventhat in some cases deregulation led to a reduction in measured performance ratherthan an improvement.47 Unlike in Norway,48 Taiwan,49 Thailand,50 Korea,51 andIndia,52 the consequences of deregulation were negative in Spain53 and the UnitedStates.54 A desire to expand market share in Spain and a competitive scramble topay higher deposit interest rates in the United States are the main arguments of therelevant literature about these unexpected outcomes.55 As it seems, this issue is stillunresolved and requires further studies and analyses from other country episodes.Further, the great majority of earlier studies of financial liberalization have focusedon its impact on the performance of the entire banking industry rather than differentownership forms.
In order to assess the effects of liberalization, Zaim compared the operational effi-ciency of the Turkish banking sector at two points in time: in 1981 (assumed to representthe pre-liberalization era) and in 1990 (assumed to represent the post-liberalizationera).56 His two year efficiency results provided some initial evidence about the positiveimpact of liberalization on Turkish bank performance. Using the traditional Structure–Conduct–Performance (SCP) paradigm, Denizer looked at the impact of financialreforms on the competitiveness of Turkish banking system.57 His results suggest thatwhile the impact of reforms on the competition level of the industry was generallypositive, the impact of new entries on competition, especially in the retail-bankingsegment, was rather limited. The reason is that most of the new entries were verysmall institutions that opted to specialize in trade finance and wholesale corporatefinance.58
As a matter of fact, although related, efficiency and productivity concepts refer todifferent aspects of bank performance. Comparing efficiency scores across years orbanks tells only part of the story, because changes in distance function values fromone year to another could be either due to (1) movements of banks within input/output space or (2) technological change, i.e. shift of the production frontier overtime.59 Efficiency by itself could be a misleading measure of the performance of anindustry, especially for one experiencing a major environmental change, such thatefficiency of industry may decrease while its productivity increases if the degree oftechnical progress achieved by frontier banks (technological change—innovation)outweighs the efforts of inefficient banks to catch up with frontier banks (efficiencyincrease—catching up effect).60 Therefore, the trend in annual efficiency scores maynot accurately reflect the true impact of liberalization when the benchmark frontiers,
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Productivity Growth in Turkish Banks 377
against which efficiency scores are computed, are subject to change because oftechnical advances or de novo entries to the system.61
Methodology, Empirical Setting and Data
Researchers employ two different performance indices in practice, the stochasticTornqvist index62 or the non-stochastic Malmquist index,63 to measure productivitychange in economic units. Stochastic approaches attribute deviations from the fron-tier to both purely random shocks and inefficiency, whereas non-stochasticapproaches attribute all deviations from the frontier to inefficiency. Like Berg et al.,64
Grifell-Tatje and Lovell,65 Gilbert and Wilson,66 Leightner and Lovell,67 Wheelockand Wilson,68 Cummins et al.,69 Mukherjee et al.,70 and Darrat et al.,71 among others,this study chooses the Malmquist index to calculate productivity growth.72 Bankingtechnology is under the influence of several external and internal factors such asinnovation (technical advances), shocks (financial crises), developments in themarket structure (consolidation), and changes in the regulatory treatment of banksover time (liberalization), etc. If technology is changing over time, there will be shiftsin the best-practice technical frontier. The Malmquist index allows us to distinguishbetween shifts in the frontier (technology change, TECCH) and improvements inefficiency relative to the frontier (efficiency change, EFFCH), both of which are twomutually exclusive and exhaustive sources of total factor productivity change,TFPCH. It is also possible to decompose efficiency change into its distinct compo-nents with the Malmquist index: changes in management practices (pure efficiencychange, PEFFCH) and changes in production scales (scale change, SCH). Ideally,this treatment improves analytical efforts while tracing the underlying sources ofproductivity developments.
To understand the measurement of the Malmquist index as well as its decomposition,consider the following. Nt banks employ p inputs to produce q outputs for each timeperiod t = 1, 2,…, T. Transformation of the vector of inputs, xt ∈ , into the vectorof outputs, yt ∈ , during the production process is represented by the function: Ft:Ft = {(x, y): x can produce y at time t}, which is simply the production possibilitiesset, the set of all feasible combinations of inputs and outputs, at time t.73 By formingthe upper boundary (frontier) of Ft, the best-practices in the sample define the efficientproduction technology (frontier) at time t. Assume that xt and yt represent the observedinput and output vectors of a bank at time t, respectively. The Shephard output distancefunction relative to the technology existing at time t is defined as: dt (xt, yt) = inf {φ:(xt, yt/φ) ∈ Ft}, which gives a normalized measure of the distance from the locationof a bank in the input/output space to the production frontier at time t in the hyper-plane, where inputs are held fixed.74 Thus, the distance of a combination of xt and ytto the frontier can be as low as zero and as high as one if measured relative to thecontemporaneous technology (i.e. 0 ≤ dt (xt, yt) ≤ 1), but it can be higher than one ifmeasured relative to the technology of another period (i.e. 0 ≤ dt + 1 (xt, yt) [≤ or >] 1).Figure 2. Measurement of the Malmquist total factor productivity change (TFPCH) index.Figure 2 illustrates these concepts. First, assume a simple case with single-input/single-output and a constant returns to scale (CRS) technology, which shifted
Rp+
Rq+
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378 I. Isik & D. Uysal
upward from Ft (CRSt) to Ft + 1 (CRSt + 1) between two periods due to innovation.Assume that in year t, a bank was observed at point b, whereas in year t + 1, it wasobserved at point d. In this multi-period setting, there are two corresponding bench-mark banks for both observations. The first year observation, b, can be comparedwith either the efficient point, h, on its contemporaneous frontier Ft or the efficientpoint, j, on the next year frontier Ft + 1. Likewise, the second year observation d canbe assessed with respect to either the efficient point, n, on its contemporaneousfrontier Ft + 1 or the efficient point, l, on the previous year frontier Ft. Whenmeasured relative to their contemporaneous frontiers, both observations representfeasible but technically inefficient production points, because they are interior tothe frontiers.
Rather than arbitrary selection of the technology of period t or t + 1 as the bench-mark, like Berg et al.,75 Fare et al.,76 Ray,77 Wheelock and Wilson,78 and Mukherjeeet al.,79 the authors of this article calculate the Malmquist index, M, as the geometricmean of two Malmquist productivity indexes (M1 × M2)
0.5 (Equation 1). Here, M1represents the Malmquist index obtained relative to Ft frontier, whereas M2 representsthe Malmquist index calculated relative to Ft + 1 frontier. Equation 1 computes M with
Md x y
d x y
d x y
d x ytc
t t
tc
t t
tc
t t
tc
t t
=
×
+ +
+
+ + +
( , )
( , )
( , )
( , )( )
.
1 1
1
1 1 1
0 5
1
� ��������
���� ��� ���
�� �����
���� ������
�� �����
����� � �
�� � � � �
� �� ���� � � �����
Figure 2. Measurement of the Malmquist total factor productivity change (TFPCH) index.
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Productivity Growth in Turkish Banks 379
reference to the CRS frontiers (c denotes a CRS technology). In terms of inputdistances on the x-axis in Figure 1, M is equal to the following:
. Hence,M can attain a value greater than, equal to, or less than 1 depending on whether thebank i experiences productivity growth, stagnation, or productivity decline, respec-tively, between periods t and t + 1. Assuming that technology is one of CRS, Fareet al. rewrites Equation 1 in such a way that one could determine the sources of the
productivity change, M = TFPCH = (EFFCH × TECCH).80
In Equation 2, M is simply the product of efficiency change (EFFCH)—howmuch closer a bank gets to the efficient frontier (catching up or falling behind)—andtechnological change (TECCH)—how much the benchmark production frontiershifts at each bank’s observed input mix (innovation or shock). When one relaxesthe CRS assumption and adopts the variable returns to scale (VRS) assumption, onegets ft (VRSt) and ft + 1 (VRSt + 1) frontiers for t and t + 1 periods, respectively, inFigure 2. Through these VRS frontiers, one can decompose the CRS efficiencychange index in Equation 2 further into its pure technical efficiency change(PEFFCH) and scale change (SCH) components. In sum, M = TECCH × EFFCHand EFFCH = PEFFCH × SCH. Thus, the Malmquist index takes the followinggeneralized form: M = TECCH × PEFFCH × SCH.81 The M and its sub-componentsall take a value greater than 1 in case of improvement, 1 in case of no change, or lessthan 1 in case of deterioration. The superscripts c and v in Equation 3 denote thatdistance functions are measured with reference to the CRS and VRS frontiers,respectively.
With banking firms’ financial intermediation function evolving and broadeningthrough more off-balance sheet activities, “traditional” bank efficiency and perfor-mance measures may no longer provide an accurate assessment of a bank’s condi-tion.82 Off-balance sheet activities involve trading financial instruments andgenerating income from fees and loan sales, activities that affect bank profits but donot appear on bank balance sheets. These non-traditional activities represent apotential source of more dependable income and an effective innovation to dampenthe volatility in interest income. The nominal volume of off-balance sheet businessbegan to swamp the asset base and owners’ equity at most banks. For instance, the
{[(| | / | |) / (| | / | |)][(| | / | |) / (| | / | |)]} .y b y h y d y l y b y j y d y nt t t t t t t t+ + + +1 1 1 10 5
Md x y
d x y
d x y
d x y
d x y
d x ytc
t t
tc
t t
tc
t t
tc
t t
tc
t t
tc
t t
= × ×
+ + +
+ + +
+ +
+( , )
( , )
( , )
( , )
( , )
( , )( )
.
1 1 1
1 1 1
1 1
1
0 5
2
Md x y
d x y
d x y
d x y
d x y
d x y
d x y d x y
tv
t t
tv
t t
tv
t t
tv
t t
tv
t t
tv
t t
tc
t t tv
t t
= × ×
×
+ + +
+ + +
+ +
+
+ + +
( , )
( , )
( , )
( , )
( , )
( , )
( , ) ( ,
.
1 1 1
1 1 1
1 1
1
0 5
1 1 1 ++ + + +
+ + + + + +
1 1 1 1
1 1 1 1 1 1
0 5
3) ( , ) ( , )
( , ) ( , ) ( , ) ( , )( )
.d x y d x y
d x y d x y d x y d x ytc
t t tv
t t
tv
t t tc
t t tv
t t tc
t t
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380 I. Isik & D. Uysal
income from these items as a percentage of assets has nearly doubled since 1979 forthe US banks. One implication is that regardless of their origins, banks are rapidlymoving away from traditional banking business (collecting deposits and makingloans). In recent years, Turkish banks, like their counterparts elsewhere, moved theirbusiness aggressively off-balance sheet to generate extra earnings and controlincreasing costs.
In recent years, while the share of loans in total assets of the Turkish bankingsector has declined sharply, the level of off-balance sheets began to exceed the levelof on-balance sheets in the sector by at least two fold.83 More strikingly, the degreeof transformation was not uniform across different ownership forms. Foreign anddomestic private banks have become more non-traditional than domestic publicbanks as they were more active in arbitrage and off-balance sheet activities. Forinstance, in nominal terms, the ratio of off-balance sheets to on-balance sheets in1990 was 1.53 for state banks, 2.18 for private banks, and 1.97 for foreign banks.Therefore, the exclusion of off-balance sheet items may considerably understate theperformance measures of more active private banks (domestic or foreign) in thesetypes of activities. While preparing the empirical setting, thus, the most importantissue is to decide on banking technology: what factors of production (inputs) dobanks employ to produce financial services and products (outputs)? Like Aly et al.,84
Elyasiani and Mehdian,85 Bhattacharyya, Lovell and Sahay,86 Berger and Mester,87
Wheelock and Wilson,88 Mukherjee, Ray and Miller,89 Kumbhakar et al.,90 amongothers, this study adopts the so-called intermediation approach91 in order to definebank inputs and outputs.92
In order to understand and account for the impact of non-traditional activities onbank performance measures, the authors of this article model Turkish banks as multi-product firms in two alternative ways. Model 1 is a traditional banking approach, inwhich banks use three input factors: (1) labor [Labor], the number of full-timeemployees on the payroll, (2) capital [Capital], the book value of premises and fixedassets, and (3) banking funds [Funds], the sum of the TL and FX demand and timedeposits and non-deposit funds, while producing a vector of three bank outputs: (1)short-term loans [ST Loans], (2) long-term loans [LT Loans]: the loans with less thanand more than a year maturity, respectively, (3) other earning assets [OEA]: loans tospecial sectors, inter-bank funds sold and investment securities (treasury and othersecurities). Model 2 is a non-traditional banking approach, in which banks utilize theabove three input factors (1) labor, (2) capital, and (3) funds, to generate an array offour bank outputs: (1) short-term loans, (2) long-term loans, and (3) other earningassets as well as (4) off-balance sheet activities [OFF-B/S]: guarantees and warran-ties (letters of guarantee, bank acceptance, letters of credit, guaranteed pre-financing,endorsements, and others), commitments, foreign exchange and interest rate transac-tions, as well as other off-balance sheet activities. All variables except for the inputfactor labor are measured in millions of US dollars. Model 2 aims to proxy the newbank activities that are mostly fee-based with off-balance sheet activities, which arerisk-adjusted using Basle Accord risk weights to provide conformity with on-balancesheet items. Data used in this study originate from the several issues of the Banks
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Productivity Growth in Turkish Banks 381
Association of Turkey (BAT), which houses all forms of banks in Turkey asmembers. The sample includes the universe of domestic and foreign banks that oper-ated between 1981 and 1990. Altogether, the authors of this article have a total of 439bank observations, of which 97 come from domestic public banks, 210 come fromdomestic private banks, and 132 come from foreign private banks.
Demirguc-Kunt and Detragiache use the event of interest rate deregulation as themajor criteria to determine the start of deregulation in their panel data of 53 coun-tries while studying the association between banking crisis and deregulation.93
Given the fact that freeing interest rates was not complete until the end of 1986, thisstudy considers the year 1986 as the full-fledged starting year of liberalization.According to Denizer94 and Yulek,95 it is more plausible to take 1986 as the start ofthe financial liberalization, as it was in 1986 that most of the financial markets andinstruments became available. Accordingly, the authors of this article divide theentire study period (1981–90) into two distinct periods: Period 1 for 1981–86 (pre-liberalization) and Period 2 for 1986–90, (post-liberalization).96 The measurementof productivity growth necessitates existence of at least two years. Thus, 1996serves as the ending year for Period 1 and basis year for Period 2. Accordingly, thesample statistics of the bank variables and Malmquist productivity change measuresare summarized and analyzed based on this two-stage division of the full studyperiod. Moreover, in a performance analysis, the firms should be relatively homoge-neous and subject to similar market and regulatory conditions. Thus, this studyexcludes development and investment (non-depository) banks and instead focuseson only commercial (depository) banks. Unlike the latter, the former group canengage in trading and leasing real goods while they cannot collect deposits from thepublic. Thus, non-depository banks do not possess large brick and mortar branchingnetworks requiring large workforce, which substantially differentiates those banks’production technology from that of commercial banks.97
Table 2 presents the summary statistics of average inputs and outputs for publicbanks (Panel 1, P1), private banks, (P2) and foreign banks (P3) for the two sub-periods—Period 1 and Period 2—and for the entire study period (Pooled). The resultssuggest that the volume of bank inputs and outputs has expanded greatly over time,probably owing to the fast growing Turkish economy and accompanying increaseddemand for banking services. It is expressive to note that the average volume ofshort-term loans is at least four times greater than that of long-term loans in the newera. Obviously, in case of high and volatile inflation, bank loan portfolios becomeskewed to short-term working capital loans, probably resulting from defensive poli-cies by banks against the heightened interest rate risk within the new environment.This issue adversely affects the level of long-term investments in the economy andincreases the chance of default among borrowing firms, as they have to borrow short-term funds to finance their long-term projects. It is also noteworthy that the volumeof off-balance sheet activities exceeds the total of short- and long-term loans by atleast two fold. This stresses the significance of these outputs for Turkish banks in thenew era and underscores the potential bias they could create unless accounted forwhile modeling bank production process.
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382 I. Isik & D. UysalTa
ble
2.Sa
mpl
e St
atis
tics
for
Out
puts
and
Inp
uts
of P
ublic
, Pri
vate
and
For
eign
Ban
ks (
$US
Mill
ions
)
P1: D
omes
tic P
ublic
Ban
ksP2
: Dom
estic
Pri
vate
Ban
ksP3
: For
eign
Pri
vate
Ban
ks
#M
ean
SD#
Mea
nSD
#M
ean
SD
BA
NK
OU
TPU
TS
ST L
oans
Peri
od 1
919
8.24
190.
2819
183.
2333
1.54
1021
.36
34.7
1Pe
riod
28
412.
8240
1.12
2427
6.10
404.
7919
28.0
239
.33
Pool
ed9
284.
0727
4.61
2122
0.38
360.
8413
24.0
236
.56
LT
Loa
nsPe
riod
142
.34
70.8
853
.22
142.
908.
7620
.68
Peri
od 2
86.3
310
6.17
35.9
211
4.67
3.90
12.4
2Po
oled
59.9
384
.99
46.3
013
1.61
6.81
17.3
7
OE
APe
riod
139
4.46
765.
1148
.69
121.
473.
097.
10Pe
riod
293
5.74
1,47
1.46
105.
3615
8.74
9.98
15.2
3Po
oled
610.
971,
047.
6571
.36
136.
385.
8510
.35
OF
F-B
/SPe
riod
132
5.39
291.
3633
5.20
533.
1751
.80
90.6
4Pe
riod
254
7.27
653.
8241
1.85
508.
6557
.64
79.6
4Po
oled
502.
8958
1.33
396.
5251
3.56
56.4
781
.84
BA
NK
IN
PUT
SL
abor
Peri
od 1
97,
437.
7610
,933
.86
93,
183.
295,
431.
199
287.
1755
6.49
Peri
od 2
89,
668.
0013
,268
.55
82,
871.
424,
866.
138
151.
6432
7.44
Pool
ed9
8,32
9.86
11,8
67.7
49
3,05
8.54
5,20
5.16
923
2.96
464.
87
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Productivity Growth in Turkish Banks 383Ta
ble
2.(C
onti
nued
)
P1: D
omes
tic P
ublic
Ban
ksP2
: Dom
estic
Pri
vate
Ban
ksP3
: For
eign
Pri
vate
Ban
ks
#M
ean
SD#
Mea
nSD
#M
ean
SD
Cap
ital
Peri
od 1
25.9
228
.52
16.3
426
.08
1.58
2.07
Peri
od 2
110.
5611
8.99
33.3
351
.72
1.37
2.68
Pool
ed59
.78
64.7
123
.13
36.3
41.
492.
31
Fun
dsPe
riod
182
8.04
1,22
5.70
471.
4586
6.91
61.9
796
.20
Peri
od 2
1,89
4.12
2,32
7.62
654.
481,
044.
0755
.88
76.7
2Po
oled
1,25
4.47
1,66
6.47
544.
6793
7.77
59.5
388
.41
Per
iod
1 sp
ans
1981
thro
ugh
1986
, Per
iod
2 sp
ans
1986
thro
ugh
1990
, and
Poo
led
is f
or th
e en
tire
peri
od. L
abor
is m
easu
red
in te
rms
of n
umbe
rof
em
ploy
ees
on p
ayro
ll by
the
end
of th
e re
spec
tive
year
. Tab
le 2
rep
orts
sam
ple
stat
istic
s of
ban
k ou
tput
s an
d in
puts
for
dif
fere
nt b
anki
ng f
orm
sin
the
sam
ple.
Out
puts
: (1)
sho
rt-t
erm
loan
s, S
T lo
ans,
and
(2)
long
-ter
m lo
ans,
LT
loan
s: th
e lo
ans
with
less
than
and
mor
e th
an a
yea
r m
atur
ity,
resp
ectiv
ely;
(3)
ris
k-ad
just
ed o
ff-b
alan
ce s
heet
ite
ms,
OFF
-B/S
: gu
aran
tees
and
war
rant
ies
(let
ters
of
guar
ante
e, b
ank
acce
ptan
ce,
lette
rs o
fcr
edit,
gua
rant
eed
pre-
fina
ncin
g, e
ndor
sem
ents
and
oth
ers)
, co
mm
itmen
ts,
fore
ign
exch
ange
and
int
eres
t ra
te t
rans
actio
ns a
s w
ell
as o
ther
off
-ba
lanc
e sh
eet a
ctiv
ities
; (4)
oth
er e
arni
ng a
sset
s, O
EA
: loa
ns to
spe
cial
sec
tors
, loa
ns s
old
in in
ter-
bank
mar
ket a
nd in
vest
men
t sec
urity
por
tfol
ios
(tre
asur
y bi
lls,
gove
rnm
ent
bond
s an
d ot
her
secu
ritie
s).
Inpu
ts:
(1)
labo
r: t
he q
uant
ity o
f la
bor
by t
he n
umbe
r of
ful
l-tim
e em
ploy
ees
on t
hepa
yrol
l; (2
) ca
pita
l: th
e bo
ok v
alue
of
prem
ises
and
fix
ed a
sset
s; (
3) f
unds
: the
sum
of
depo
sit (
dem
and
and
time)
and
non
-dep
osit
fund
s as
of
the
end
of th
e re
spec
tive
year
. OFF
-B/S
act
iviti
es o
f T
urki
sh b
anks
bec
ame
avai
labl
e to
the
publ
ic b
egin
ning
fro
m 1
986.
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384 I. Isik & D. Uysal
Empirical Results and Analysis
Table 3 reports the standard deviations and geometric means of the Malmquist indexalong with its components averaged over the entire period. The purpose is toprovide a quick glance at the central tendency of productivity change among public,private, and foreign banks in the post-liberalization era. The results according to twoalternative models—“traditional” Model 1 and “non-traditional” Model 2—suggestthat all types of banks have benefited from the more liberal environment in Turkey.More formally, according to Model 1 (and Model 2), the average results for variousownership forms are as follows. Average productivity growth is 1.2 percent (2.9percent) for public banks, 3.9 percent (9.5 percent) for private banks, and 14.2percent (17 percent) for foreign banks.98 Average technical progress is −6.2 percent(−7.2 percent) for public banks, −7.1 percent (−1.7 percent) for private banks, and −0.4 percent (9.3 percent) for foreign banks. Average efficiency change is 7.9 percent
Table 3. The Sources of Productivity Growth (TFPCH) for Public, Private and Foreign Banks in Turkey
(1) Malmquist
index(2) Technical
change(3) Efficiency
change
(4) Pure efficiency
change(5) Scale change
(TFPCH) = (2)*(3)
(TECCH) = (1)/(3)
(EFFCH) = (4)*(5)
(PEFFCH) = (3)/(5)
(SCH) = (3)/(4)
P1: MODEL 1Public Banks 1.012 (0.242) 0.938 (0.272) 1.079 (0.274) 1.022 (0.219) 1.055 (0.188)Private Banks 1.039 (0.402) 0.929 (0.283) 1.118 (0.481) 1.089 (0.411) 1.027 (0.235)Foreign Banks 1.142 (3.489) 0.996 (0.290) 1.146 (2.907) 1.060 (1.941) 1.082 (0.627)
P2: MODEL 2Public Banks 1.029 (0.189) 0.928 (0.175) 1.109 (0.235) 0.983 (0.131) 1.128 (0.219)Private Banks 1.095 (0.370) 0.983 (0.361) 1.114 (0.437) 1.084 (0.341) 1.027 (0.230)Foreign Banks 1.170 (0.555) 1.093 (0.410) 1.071 (0.334) 1.040 (0.283) 1.030 (0.151)
The annual geometric means of the Malmquist index (TFPCH) and its components are summa-rized in the table with standard errors in parentheses. Banks are modeled as multi-product firmsin Models 1 and 2. Model 1 assumes that banks are engaged mostly in traditional banking,accepting deposits and making loans, whereas Model 2 assumes that banks embrace increas-ingly non-traditional activities in the new environment, thus they transform bank inputs notonly to traditional commercial loans but also to extensive amount of non-traditional off-balance sheet items such as swaps and forwards. Accordingly, in Model 1, bank produce 3outputs from 3 inputs, where outputs are (1) short-term loans, (2) long-term loans (3), otherearning assets, and inputs are (1) number of employees, (2) physical capital, and (3) sum ofdeposit and non-deposit funds. In Model 2, employing inputs 1, 2 and 3, bank produce 4outputs, off-balance sheet activities in addition to the 3 outputs in Model 1. While Model 1results are based on data from 1981–90, Model 2 results are based on data from 1986–90 asbanks in Turkey began to report their contingencies and commitments since 1986.
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Productivity Growth in Turkish Banks 385
(10.9 percent) for public banks, 11.8 percent (11.4 percent) for private banks, and14.6 percent (7.1 percent) for foreign banks.
The results from Model 2 indicate that accounting for off-balance sheet serviceshelped domestic and foreign private banks more than public banks in terms ofproductivity, maybe because of the fact that the former two forms are more engagedin these activities. The decomposition of efficiency change into its constituentsreveals the following: according to Model 1 (and Model 2), average pure efficiencychange is 2.2 percent (−1.7 percent) for public banks, 8.9 percent (8.4 percent) forprivate banks, and 6.0 percent (4.0 percent) for foreign banks. Average scale effi-ciency change is 5.5 percent (2.19 percent) for public banks, 2.7 percent (2.7percent) for private banks, and 8.2 percent (3.0 percent) for foreign banks. Theseresults suggest that the main source of efficiency increases in domestic and foreignprivate banks is better management practices rather than improved scales. However,scale improvements seem to be the major source of efficiency increase in publicbanks.
The causal analysis above based on aggregates attribute the productivity growthto efficiency change rather than technical progress for different forms of banksoperating in Turkey. To investigate further the main sources of productivity growthin different ownership forms, the authors of this article correlate the Malmquistproductivity scores with its components using the pooled data from 1982–90. Theresults from Table 4 reinforce the prior findings. For all forms of banks, the produc-tivity change (TFPCH) index is associated more with the efficiency change index(the CRS EFFCH or the VRS PEFFCH) than with any other index, confirming thesuperiority of efficiency improvements in leading productivity changes in Turkishbanks. However, the degree of association between TFPCH and EFFCH (PEFFCH)is more outstanding in domestic, 0.765 (0.812), and foreign private banks, 0.727(0.771), than in domestic public banks, 0.503 (0.523). The coefficients of correlationbetween EFFCH and PEFFCH versus between EFFCH and SCH are 0.712 × 0.604for public banks, 0.840 × 0.401 for private banks, and 0.896 × 0.302 for foreignbanks. These correlation results support the dominant role of resource managementimprovements (PEFFCH) in fueling efficiency increases (EFFCH) in Turkishbanks.99 The great majority of these relations are also statistically significantaccording to the t-statistics.
An analysis based on averages is very susceptible to extreme observations.100
However, an analysis based on numbers (or percentages) of banks is less sensitive tosuch outliers. To see this, assume that a banking industry is made up of only fourbanks, banks 1, 2, 3, and 4, whose productivity change scores are 0.7, 0.8, 0.9 and1.8, respectively. These scores indicate that while banks 1, 2, and 3 suffered produc-tivity loss, bank 4 registered an extreme productivity growth. The results based onaverage would suggest that banking industry experienced 5 percent productivitygain as the average of these four scores is 1.05. The results based on percentages(numbers) would correctly suggest that 75 percent of banks in this industry experi-enced productivity fall, while only 25 percent recorded productivity rise. Thus, thedevelopments in the productivity of public (Table 5), private (Table 6), and foreign
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386 I. Isik & D. Uysal
Table 4. The Pearson Correlation Coefficients (r) among the Malmquist Indices for Public, Private and Foreign Banks
Productivity Change
(TFPCH)
Technological Change
(TECCH)
Efficiency Change
(EFFCH)
Pure Efficiency Change
(PEFFCH)
Scale Change (SCH)
Public BanksTFPCH 1.000TECCH 0.278a 1.000EFFCH 0.503a −0.607a 1.000PEFFCH 0.523a −0.360a 0.712a 1.000SCH 0.113 −0.494a 0.604a −0.111 1.000Private BanksTFPCH 1.000TECCH 0.139b 1.000EFFCH 0.765a −0.467a 1.000PEFFCH 0.812a −0.184a 0.840a 1.000SCH 0.012 −0.588a 0.401a −0.142b 1.000Foreign BanksTFPCH 1.000TECCH 0.242b 1.000EFFCH 0.727a −0.458a 1.000PEFFCH 0.771a −0.233a 0.896a 1.000SCH −0.022 −0.503a 0.302a −0.145b 1.000IndustryTFPCH 1.000TECCH 0.177a 1.000EFFCH 0.728a −0.480a 1.000PEFFCH 0.770a −0.219a 0.831a 1.000SCH 0.029 −0.545a 0.423a −0.134b 1.000
Pearson correlation coefficients among the indices are based on the pooled data for the entireperiod. Five performance indices, (1) TFPCH, total factor productivity change, and fourcomponents [(2) TECCH, technical change, (3) EFFCH, efficiency change, (3) PEFFCH,pure efficiency change and (5) SCH, scale change] are correlated with each other to detect thedegree of their association and in turn to determine the sources of productivity and efficiencygains in different ownership types. As known, the correlation coefficient attains a valuebetween −1 (perfectly negative association) and +1 (perfectly positive association). The closerthe coefficient to −1 or +1 is, the stronger the association between the two variables is. Thenull hypothesis is that the Pearson correlation between the two indices is 0; i.e. there is nostatistically significant association between the two. a, b and c indicate 1%, 5% and 10%significance levels, respectively, for the Pearson coefficients (r) using the t-statistics with n
observations = .
r n
r
−
−
2
1 2
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Productivity Growth in Turkish Banks 387
banks (Table 7) based on percentages between 1981 and 1990 are analyzed next. Inorder to detect whether there is a shift in bank productivity over time, the results arepresented for the two sub-periods, Period 1 and Period 2, as well as for the entireperiod. For each group, what percent of banks owes their productivity growth (loss)to an efficiency increase (decrease) and what percent owes it to a technical progress(regress) is reported. What percent of banks owes its efficiency increase (decrease)to a pure efficiency increase (decrease) and what percent owes it to a scale effi-ciency increase (decrease) is also reported.
Table 5 highlights the sources of productivity growth (loss) and efficiencyincrease (decrease) for public banks in detail. For example, between 1981 and 1990,the banks that saw productivity growth mostly due to an efficiency increase make up29 percent of all public banks, while the ones that saw the productivity growthmostly due to technical progress make up 20 percent. Stated differently, of the banksthat experienced productivity growth, 60 percent (29/49) owed it mostly to an effi-ciency increase, while 40 percent owe it mostly to a technical progress. The produc-tivity loss in public banks in the 1980s, on the other hand, can be mostly attributedto a technical regress (72 percent) rather than an efficiency decrease (28 percent).Confirming earlier results, the major source of efficiency increase in public banks isscale-related. Between 1981 and 1990, the public banks that recorded an efficiencyimprovement owed it mostly to a scale efficiency increase (68 percent) rather than apure technical efficiency increase (32 percent). However, the role of scale efficiencyincrease in driving efficiency is much profound in Period 2. Sixty-four percent ofpublic banks recorded an efficiency increase during this period. Of those, 81 percentowed it to scale efficiency increase, 19 percent owed it to pure technical efficiencyincrease. Briefly, in the 1980s, one half of public banks experienced productivitygain, mostly due to an efficiency increase, which mainly stemmed from scaleimprovements. The roles of poor management practices and scale problems indriving efficiency decreases in public banks are comparable.
Table 6 dwells on the sources of productivity changes for private banks. BothModel 1 and 2 statistics suggest that the engine of productivity growth observedafter liberalization in private banks is predominantly efficiency increase rather thantechnical progress. Although this point is true for both Period 1 and 2, it is moreindicative for Period 2. The average percent of private banks that recorded produc-tivity growth mainly due to efficiency increase rose from 27 percent to 53 percentbetween the two periods. Stated differently, of the private banks that recordedproductivity growth in Period 2 (Period 1), 83 percent (68 percent) owed it to anefficiency increase, and 17 percent (32 percent) owed it to a technical progress.Accounting for non-traditional bank services increases the percent of banks thatowed the productivity growth mainly to technical progress by 13 percent (11 percentin Model 1 and 24 percent in Model 2). In Period 1, 61 percent of private banksincurred productivity loss, of which 49 percent (30/61) was due to efficiencydecrease and 51 percent (31/61) due to technical regress, whereas in Period 2, thepercent of private banks that incurred productivity loss dropped to 36 percent, ofwhich 56 percent (20/36) was due to efficiency decrease and 44 percent (16/36) due
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388 I. Isik & D. UysalTa
ble
5.M
ain
Sour
ces
of P
rodu
ctiv
ity a
nd E
ffici
ency
Cha
nges
in D
omes
tic P
ublic
Ban
ks in
Tur
key
Prod
uctiv
ity G
RO
WT
H
mai
nly
b/c
of:
Prod
uctiv
ity L
OSS
mai
nly
b/c
of:
Eff
icie
ncy
INC
RE
ASE
m
ainl
y b/
c of
:
Eff
icie
ncy
DE
CR
EA
SE m
ainl
y b/
c of
:
Peri
od#
Eff
. Inc
r.T
ech.
Pro
gres
sE
ff. D
ecr.
Tec
h. R
egre
ssN
O
Prod
. ∆PT
E I
ncr.
SE I
ncr.
PTE
Dec
r.SE
Dec
.N
O
Eff
. ∆
P1: M
odel
119
81–
––
––
––
––
––
1982
911
%11
%22
%56
%0%
44%
0%22
%0%
33%
1983
922
%44
%11
%22
%0%
22%
0%11
%22
%44
%19
849
11%
22%
11%
56%
0%11
%33
%0%
22%
33%
1985
911
%33
%11
%33
%11
%11
%11
%22
%11
%44
%19
869
44%
0%0%
56%
0%22
%33
%11
%11
%22
%19
879
44%
33%
22%
0%0%
22%
44%
22%
11%
0%19
888
25%
0%25
%50
%0%
0%75
%13
%13
%0%
1989
838
%25
%25
%13
%0%
13%
38%
0%38
%13
%19
908
50%
13%
0%38
%0%
13%
50%
25%
13%
0%
Mea
nPe
riod
120
%22
%11
%44
%2%
22%
16%
13%
13%
36%
Per
iod
239
%18
%18
%25
%0%
12%
52%
15%
18%
3%Po
oled
29%
20%
14%
36%
1%18
%32
%14
%16
%21
%
P2: M
odel
219
86–
––
––
––
––
––
1987
950
%25
%25
%0%
0%13
%50
%13
%25
%0%
1988
875
%0%
25%
0%0%
25%
50%
13%
13%
0%
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Productivity Growth in Turkish Banks 389Ta
ble
5.(C
onti
nued
)
Prod
uctiv
ity G
RO
WT
H
mai
nly
b/c
of:
Prod
uctiv
ity L
OSS
mai
nly
b/c
of:
Eff
icie
ncy
INC
RE
ASE
m
ainl
y b/
c of
:
Eff
icie
ncy
DE
CR
EA
SE m
ainl
y b/
c of
:
Peri
od#
Eff
. Inc
r.T
ech.
Pro
gres
sE
ff. D
ecr.
Tec
h. R
egre
ssN
O
Prod
. ∆PT
E I
ncr.
SE I
ncr.
PTE
Dec
r.SE
Dec
.N
O
Eff
. ∆
1989
863
%0%
0%38
%0%
25%
63%
13%
0%0%
1990
850
%0%
0%50
%0%
13%
75%
13%
0%0%
Mea
nP
erio
d 2
59%
6%13
%22
%0%
19%
59%
13%
9%0%
Tab
le 5
rep
orts
the
maj
or s
ourc
es o
f de
velo
pmen
ts in
the
prod
uctiv
ity a
nd e
ffic
ienc
y of
dom
esti
c pu
blic
ban
ks in
Tur
key.
Def
initi
on o
f th
e so
urce
sis
as
follo
ws:
Pro
duct
ivity
GR
OW
TH
bec
ause
of
Tec
hnol
ogic
al P
rogr
ess:
TFP
CH
>1,
and
TE
CC
H>
(1
and
EFF
CH
); P
rodu
ctiv
ity G
RO
WT
Hbe
caus
e of
Eff
icie
ncy
Incr
ease
: TFP
CH
>1,
and
EFF
CH
> (
1 an
d T
EC
CH
); P
rodu
ctiv
ity L
OSS
bec
ause
of
Tec
hnol
ogic
al R
egre
ss: T
FPC
H<
1 an
dT
EC
CH
< (
1 an
d E
FFC
H);
Pro
duct
ivity
LO
SS b
ecau
se o
f E
ffic
ienc
y D
ecre
ase:
TFP
CH
<1,
and
EFF
CH
< (
1 an
d T
EC
CH
); E
ffic
ienc
y IN
CR
EA
SEbe
caus
e of
PT
E I
ncre
ase:
EFF
CH
>1,
and
PE
FFC
H>
(1
and
SCH
), E
ffic
ienc
y IN
CR
EA
SE b
ecau
se o
f SE
Inc
reas
e: E
FFC
H>
1, a
nd S
CH
> (
1 an
dPE
FFC
H);
Eff
icie
ncy
DE
CR
EA
SE b
ecau
se o
f PT
E D
ecre
ase:
EFF
CH
<1
and
PEFF
CH
< (
1 an
d SC
H),
Eff
icie
ncy
DE
CR
EA
SE b
ecau
se o
f SE
Dec
reas
e: E
FFC
H<
1, a
nd S
CH
< (
1 an
d PE
FFC
H).
Per
iod
1 sp
ans
1981
thro
ugh
1986
, Per
iod
2 sp
ans
1986
thro
ugh
1990
, and
Poo
led
is f
or th
een
tire
peri
od.
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390 I. Isik & D. UysalTa
ble
6.M
ain
Sour
ces
of P
rodu
ctiv
ity a
nd E
ffici
ency
Cha
nges
in D
omes
tic P
riva
te B
anks
in T
urke
y
Prod
uctiv
ity G
RO
WT
H
mai
nly
b/c
of:
Prod
uctiv
ity L
OSS
m
ainl
y b/
c of
:E
ffic
ienc
y IN
CR
EA
SE
mai
nly
b/c
of:
Eff
icie
ncy
DE
CR
EA
SE
mai
nly
b/c
of:
Peri
od#
Eff
. Inc
r.T
ech.
Pr
ogre
ssE
ff.
Dec
r.T
ech.
R
egre
ssN
O
Prod
. ∆PT
E I
ncr.
SE I
ncr.
PTE
D
ecr.
SE
Dec
.N
O
Eff
. ∆
P1: M
odel
119
81–
––
––
––
––
––
1982
2020
%20
%30
%30
%0%
25%
20%
40%
5%10
%19
8319
16%
11%
42%
32%
0%37
%0%
26%
26%
11%
1984
1811
%11
%56
%22
%0%
6%22
%61
%11
%0%
1985
1844
%22
%11
%22
%0%
67%
6%6%
22%
0%19
8621
43%
0%10
%48
%0%
33%
48%
14%
0%5%
1987
2317
%35
%35
%13
%0%
17%
9%4%
65%
4%19
8823
43%
0%13
%43
%0%
22%
57%
13%
4%4%
1989
2467
%4%
29%
0%0%
29%
42%
25%
4%0%
1990
2483
%4%
4%8%
0%38
%58
%4%
0%0%
Mea
nPe
riod
127
%13
%30
%31
%0%
33%
19%
29%
13%
5%P
erio
d 2
53%
11%
20%
16%
0%26
%41
%12
%18
%2%
Pool
ed38
%12
%25
%24
%0%
30%
29%
22%
15%
4%
P2: M
odel
219
86–
––
––
––
––
––
1987
234%
61%
35%
0%0%
4%4%
9%74
%9%
1988
2330
%0%
4%65
%0%
35%
48%
9%4%
4%
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Productivity Growth in Turkish Banks 391Ta
ble
6.(C
onti
nued
)
Prod
uctiv
ity G
RO
WT
H
mai
nly
b/c
of:
Prod
uctiv
ity L
OSS
m
ainl
y b/
c of
:E
ffic
ienc
y IN
CR
EA
SE
mai
nly
b/c
of:
Eff
icie
ncy
DE
CR
EA
SE
mai
nly
b/c
of:
Peri
od#
Eff
. Inc
r.T
ech.
Pr
ogre
ssE
ff.
Dec
r.T
ech.
R
egre
ssN
O
Prod
. ∆PT
E I
ncr.
SE I
ncr.
PTE
D
ecr.
SE
Dec
.N
O
Eff
. ∆
1989
2446
%21
%29
%4%
0%13
%42
%38
%8%
0%19
9024
75%
13%
4%8%
0%33
%58
%4%
4%0%
Mea
nP
erio
d 2
39%
24%
18%
19%
0%21
%38
%15
%23
%3%
Tab
le 6
rep
orts
the
maj
or s
ourc
es o
f de
velo
pmen
ts i
n th
e pr
oduc
tivity
and
eff
icie
ncy
of d
omes
tic
priv
ate
bank
s in
Tur
key.
Def
initi
on o
f th
eso
urce
s is
as
follo
ws:
Pro
duct
ivity
GR
OW
TH
bec
ause
of
Tec
hnol
ogic
al P
rogr
ess:
TFP
CH
>1,
and
TE
CC
H>
(1
and
EFF
CH
); P
rodu
ctiv
ityG
RO
WT
H b
ecau
se o
f E
ffic
ienc
y In
crea
se:
TFP
CH
>1,
and
EFF
CH
> (
1 an
d T
EC
CH
); P
rodu
ctiv
ity L
OSS
bec
ause
of
Tec
hnol
ogic
al R
egre
ss:
TFP
CH
<1
and
TE
CC
H<
(1
and
EFF
CH
); P
rodu
ctiv
ity L
OSS
bec
ause
of
Eff
icie
ncy
Dec
reas
e: T
FPC
H<
1, a
nd E
FFC
H<
(1
and
TE
CC
H);
Eff
i-ci
ency
IN
CR
EA
SE b
ecau
se o
f PT
E I
ncre
ase:
EFF
CH
>1,
and
PE
FFC
H>
(1
and
SCH
), E
ffic
ienc
y IN
CR
EA
SE b
ecau
se o
f SE
Inc
reas
e: E
FFC
H>
1,an
d SC
H>
(1
and
PEFF
CH
); E
ffic
ienc
y D
EC
RE
ASE
bec
ause
of
PTE
Dec
reas
e: E
FFC
H<
1 an
d PE
FFC
H<
(1
and
SCH
), E
ffic
ienc
y D
EC
RE
ASE
beca
use
of S
E D
ecre
ase:
EFF
CH
<1,
and
SC
H<
(1
and
PEFF
CH
). P
erio
d 1
span
s 19
81 t
hrou
gh 1
986,
Per
iod
2 sp
ans
1986
thr
ough
199
0, a
ndP
oole
d is
for
the
entir
e pe
riod
.
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392 I. Isik & D. Uysal
to technical regress. Unlike in public banks, the major source of productivity loss inprivate banks mainly originates from efficiency decreases rather than technicalregress. Efficiency increases in private banks were mostly associated with increasesin pure technical efficiency in Period 1 and with improvements in scale efficiency inPeriod 2. Efficiency decreases were mostly related to pure efficiency decreases inPeriod 1 and scale efficiency decreases in Period 2. These results underscore theimportance of scale policies for Turkish banks, as scale changes have become themajor determinant of both efficiency increases and efficiency decreases in Turkishbanking.
Table 7 reveals interesting results for foreign banks. Foreign banks behaved liketheir domestic counterparts in Period 1. However, they departed broadly from theirpeers in Period 2. Unlike domestic banks (public or private), most of the foreignbanks owe their productivity growth mainly to technical progress rather than effi-ciency increase in Period 2. According to Model 1, 60 percent of foreign banks sawproductivity growth in Period 2. Of those, 65 percent owe it to technical progresswhile 35 percent owe it to efficiency increase. According to Model 2, 58 percent offoreign banks recorded productivity growth. Of those, 78 percent owe it to techni-cal progress while 22 percent owe it to efficiency increase. Expressively, account-ing for non-traditional banking activities raised the technical progress markedly inforeign banks. Most of the productivity loss is also due to technical regress inforeign banks. It seems that technical change is the dominant power drivingproductivity changes in those banks. Efficiency changes (increases or decreases) inforeign banks are related mostly to pure efficiency change rather than scaleefficiency change. This observation is also different from what the authors of thisarticle observed earlier for domestic public and private banks, whose efficiencychanges are mostly scale-related.
The above results indicate that although all types of banks saw productivitygrowth during the liberalization period, productivity grew more quickly at privateand foreign banks than at public banks. Also, the components of the productivitychange index presents interesting results. Although all forms of banks recordedsubstantial efficiency increases, except for foreign banks, they all experienced nota-ble technical regresses during the new era. This suggests that the major source ofproductivity gains in Turkish banking is efficiency change (imitation—increasedproximity of banks to the frontier) rather than technical progress (innovation—outward shifts in the benchmark frontier). In other words, the efficiency gapbetween the worst- and best-practice banks tended to narrow in the liberal environ-ment, which apparently fostered the average productivity of the industry.
In terms of operational efficiency, foreign banks strongly outperform domesticprivate and public banks in Turkey.101 The results above show that foreign banksdemonstrated the fastest productivity growth during the liberalization period. Thus,foreign banks seem to represent the best-practice banks in the industry, whoseactions are closely followed by domestic banks. In fact, foreign banks have been thepioneers of many new products and practices in the system, as they introducedcredit cards, leasing, factoring and forfeiting, and a market-oriented management
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Productivity Growth in Turkish Banks 393Ta
ble
7.M
ain
Sour
ces
of P
rodu
ctiv
ity a
nd E
ffici
ency
Cha
nges
in F
orei
gn P
riva
te B
anks
in T
urke
y
Prod
uctiv
ity G
RO
WT
H
mai
nly
b/c
of:
Prod
uctiv
ity L
OSS
mai
nly
b/c
of:
Eff
icie
ncy
INC
RE
ASE
mai
nly
b/c
of:
Eff
icie
ncy
DE
CR
EA
SE m
ainl
y b/
c of
:
Peri
od#
Eff
. Inc
r.T
ech.
Pro
gres
sE
ff. D
ecr.
Tec
h. R
egre
ssN
O
Prod
. ∆PT
E I
ncr.
SE I
ncr.
PTE
Dec
r.SE
Dec
.N
O
Eff
. ∆
P1: M
odel
119
81–
––
––
––
––
––
1982
633
%33
%33
%0%
0%17
%17
%17
%33
%17
%19
838
13%
13%
38%
38%
0%13
%13
%25
%25
%25
%19
8410
20%
10%
50%
20%
0%20
%0%
50%
0%30
%19
8513
46%
15%
15%
23%
0%38
%15
%23
%8%
15%
1986
1443
%7%
7%43
%0%
43%
21%
14%
0%21
%19
8717
18%
59%
6%18
%0%
35%
12%
12%
12%
24%
1988
1718
%24
%6%
53%
0%24
%24
%12
%6%
35%
1989
2025
%55
%15
%5%
0%15
%15
%25
%20
%25
%19
9021
24%
19%
10%
48%
0%14
%29
%24
%10
%24
%
Mea
nPe
riod
131
%16
%29
%25
%0%
26%
13%
26%
13%
22%
Per
iod
221
%39
%9%
31%
0%22
%20
%18
%12
%27
%Po
oled
27%
26%
20%
27%
0%24
%16
%22
%13
%24
%
P2: M
odel
219
86–
––
––
––
––
––
1987
1712
%76
%0%
12%
0%29
%12
%12
%18
%29
%19
8817
18%
24%
6%53
%0%
18%
29%
12%
0%41
%
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394 I. Isik & D. UysalTa
ble
7.(C
onti
nued
)
Prod
uctiv
ity G
RO
WT
H
mai
nly
b/c
of:
Prod
uctiv
ity L
OSS
mai
nly
b/c
of:
Eff
icie
ncy
INC
RE
ASE
mai
nly
b/c
of:
Eff
icie
ncy
DE
CR
EA
SE m
ainl
y b/
c of
:
Peri
od#
Eff
. Inc
r.T
ech.
Pro
gres
sE
ff. D
ecr.
Tec
h. R
egre
ssN
O
Prod
. ∆PT
E I
ncr.
SE I
ncr.
PTE
Dec
r.SE
Dec
.N
O
Eff
. ∆
1989
2010
%60
%10
%20
%0%
15%
15%
20%
15%
35%
1990
2114
%19
%14
%52
%0%
10%
24%
24%
10%
33%
Mea
nP
erio
d 2
13%
45%
8%34
%0%
18%
20%
17%
11%
35%
Tab
le 7
rep
orts
the
maj
or s
ourc
es o
f de
velo
pmen
ts in
the
prod
uctiv
ity a
nd e
ffic
ienc
y of
fore
ign
priv
ate
bank
s in
Tur
key.
Def
initi
on o
f th
e so
urce
sis
as
follo
ws:
Pro
duct
ivity
GR
OW
TH
bec
ause
of
Tec
hnol
ogic
al P
rogr
ess:
TFP
CH
>1,
and
TE
CC
H>
(1
and
EFF
CH
); P
rodu
ctiv
ity G
RO
WT
Hbe
caus
e of
Eff
icie
ncy
Incr
ease
: TFP
CH
>1,
and
EFF
CH
> (
1 an
d T
EC
CH
); P
rodu
ctiv
ity L
OSS
bec
ause
of
Tec
hnol
ogic
al R
egre
ss: T
FPC
H<
1 an
dT
EC
CH
< (
1 an
d E
FFC
H);
Pro
duct
ivity
LO
SS b
ecau
se o
f E
ffic
ienc
y D
ecre
ase:
TFP
CH
<1,
and
EFF
CH
< (
1 an
d T
EC
CH
); E
ffic
ienc
y IN
CR
EA
SEbe
caus
e of
PT
E I
ncre
ase:
EFF
CH
>1,
and
PE
FFC
H>
(1
and
SCH
), E
ffic
ienc
y IN
CR
EA
SE b
ecau
se o
f SE
Inc
reas
e: E
FFC
H>
1, a
nd S
CH
> (
1 an
dPE
FFC
H);
Eff
icie
ncy
DE
CR
EA
SE b
ecau
se o
f PT
E D
ecre
ase:
EFF
CH
<1
and
PEFF
CH
< (
1 an
d SC
H),
Eff
icie
ncy
DE
CR
EA
SE b
ecau
se o
f SE
Dec
reas
e: E
FFC
H<
1, a
nd S
CH
< (
1 an
d PE
FFC
H).
Per
iod
1 sp
ans
1981
thro
ugh
1986
, Per
iod
2 sp
ans
1986
thro
ugh
1990
, and
Poo
led
is f
or th
een
tire
peri
od.
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Productivity Growth in Turkish Banks 395
philosophy to the domestic market. Domestic banks responded to these changes byimitating foreign banks, such as by extending consumer credits and establishingATM networks, associating to the SWIFT system, and using online computersystems. Pehlivan and Kirkpatrick suggest that planning, marketing and recruitmentpolicies of domestic banks have been strongly affected by foreign banks.102 Forinstance, there were no marketing departments in the domestic banks until the entryof foreign banks. Once arrived, foreign banks first established marketing depart-ments and exercised the practice of modern marketing strategies. Domestic bankssoon followed the same path. Prior to that, a passive approach towards productdevelopment had evolved. In a weak competitive environment, domestic bankslikely had not felt any pressure to differentiate their services or develop new prod-ucts. As Turkish residents received managerial training in foreign banks and transferto domestic banks, modern techniques, skills, and concepts have been diffused tothe entire sector. As these transfers were mostly to private banks, they appear tohave benefited more from this diffusion than public banks.103
The superiority of efficiency change in driving productivity in Turkish bankscontradicts with the results of the US banks,104 Spanish banks,105 and Koreanbanks,106 where the productivity growth was found to be driven mostly by technicalprogress rather than efficiency increase. One possible explanation is that Turkishbanks are less experienced compared to their peers in those countries in adapting tothe conditions of the new environment and in assimilating the new technology. Iftechnology input faces learning curves, Turkish banks may need more time to takeadvantage of their technology investments. According to Akçao[GBREVE] lu, although finan-cial liberalization has the potential to foster innovation in banking, deficiencies thatcontinue to exist in the system may distort/hinder the production and/or diffusion offinancial innovation.107 To him, one such deficiency in Turkey is the lack of sophis-tication of market participants. This issue primarily explains the lack of demand forderivative securities in Turkey. For example, real firms are not very informed ofthese instruments and banks do not have knowledgeable and well-trained staff inmany new financial products. In addition, the lack of strong legal infrastructure toenforce financial contracts also inhibits the proliferation of new financial instru-ments. Thus, existing macro and micro problems, such as lack of necessary legal,social, and economic infrastructure; qualified workforce; and sophisticated clientelemay be inhibiting the full utilization of bank inputs and curbs financial innovation(shift of production frontier upward) in this emerging market.
Summary and Conclusion
Utilizing a non-parametric approach, this paper measures productivity changes forpublic, private, and foreign banks operating in Turkey over the initial post-deregula-tion period. This model helps us to isolate the contributions of the changes in tech-nology, efficiency, and scale to the changes in bank productivity. The resultsindicate that productivity grew notably at Turkish banks after the liberalizationperiod. The rate of productivity growth per year in the new era according to Model
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396 I. Isik & D. Uysal
1, a model that considers only traditional (interest earning) bank outputs, is 1.2percent for public banks, 3.9 percent for private banks and 14.2 percent for foreignbanks; whereas the rate of productivity growth per year according to Model 2, analternative model that considers both traditional (interest earning) and non-traditional (fee generating) off-balance sheet bank outputs, is 2.9 percent for publicbanks, 9.5 percent for private banks and 17.0 percent for foreign banks. These resultsunderline the importance of accounting for non-traditional services in measuringbank performance, especially in an era when banks of all origins embrace increas-ingly non-traditional and innovative ways to deliver banking services.
Positive developments in Turkish banks’ efficiency are also noteworthy. The rateof efficiency increase per year during the period is 7.9 percent for public banks, 11.8percent for private banks, and 14.6 percent for foreign banks as calculated usingModel 1 (improvements are generally much stronger with Model 2). The trend ofpositive developments in bank productivity and efficiency is more acute in the secondhalf of the liberalization period (Period 2). As the new reforms began to show theireffects on banks more in the maturity stage of liberalization, all types of banksapparently demonstrated better performance. However, technological improvementsin those banks are less than impressive, although incorporating off-balance sheetservices provides some signs of technical advance, especially in foreign banks.
Overall the authors’ results suggest that technology of domestic banks did notimprove notably over the initial post-liberalization period. This is contrary to theexpectations given the fact that Turkish banks made heavy investments in computer-ization and automation projects after liberalization. Apparently, this capital invest-ment did not pay off, at least in the short-term. Several factors could have playedsome role in this unexpected outcome. Following liberalization, banks started a raceto establish their own communication networks, information systems, and ATMs.However, these investments were driven mostly by prestige and reputation ratherthan the feasibility or profitability of these projects. Many banks lacked the requiredsophistication, transaction capacity or customer base to justify these investments.This eventually resulted in idle capacity in these banks. Evidently, because theywere experiencing increasing returns to scale, some banks with lack of transactionvolume began to share their technological devices and systems with others. Inaddition, these data processing and communication devices needed strong informa-tion management systems and information economics. It is clear that Turkish banksare still riding the learning curve and discovering how to best utilize these costlyhigh-tech investments.
The results also have important implications for ownership incentives. An openenvironment presents more opportunities to banks to make profits. As financialrepression fades in an economy, banks become freer in their operations. In a liberalenvironment, bank managers can set their interest rates in response to marketconditions, determine the optimum mix of their investment portfolios, decide onwhich industry to focus, and on which currency to store wealth, etc., all of whichshould result in more efficient operations. It appears that in Turkey private owner-ship is more adaptive to a new environment and better motivated to utilize emerging
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Productivity Growth in Turkish Banks 397
opportunities as they benefited the most from the relaxed regulations. Furthermore,state ownership—devoid of compensation and ownership incentives, profitorientation, and market discipline—seems slower at adapting to changing economicconditions and responding to the demands of the modern world.
Acknowledgements
The original version of this paper received the Best Occasional Paper Award fromthe Merrill Lynch Center for the Study of International Financial Services andMarkets, Hofstra University, Hempstead, NY, USA. The authors wish to thank thefollowing individuals for their insights for the first draft of this paper: M. KabirHassan, Iftekhar Hasan, George Papaioannou, Lokman Gündüz, Osman Kiliç, EminAkçao[GBREVE] lu, Larissa Kyj, Gülser and [IDOT ] lhan Meriç, Carol Welsh, Robert Pritchard, andChris Gadarowski. The usual caveat applies.
Notes
1. Specifically, Berger and Humphrey report that on average, the loss from X-inefficiency is about 20percent in terms of costs and 50 percent in terms of potential profits, while the loss from scale andscope inefficiencies account only for about 5 percent of the total bank costs in the United States.Allen Berger and David Humphrey, “The Dominance of Inefficiencies over Scale and Product MixEconomies in Banking,” Journal of Monetary Economics, Vol.28 (1991), pp.117–48.
2. Allen Berger and Loretta Mester, “Inside the Black Box: What Explains Differences in the Efficien-cies of Financial Institutions?” Journal of Banking and Finance, Vol.21 (1997), pp.895–947; DavidHumphrey and Lawrence Pulley, “Banks’ Responses to Deregulation: Profits, Technology, andEfficiency,” Journal of Money, Credit, and Banking, Vol.29 (1997), pp.73–93; Ihsan Isik and M.Kabir Hassan, “Cost and Profit Efficiency of the Turkish Banking Industry: An Empirical Investi-gation,” Financial Review, Vol.37 (2002), pp.257–80.
3. Allen Berger and David Humphrey, “Efficiency of Financial Institutions: International Survey andDirections for Future Research,” European Journal of Operational Research, Vol.98 (1997),pp.175–212.
4. As an example of savings versus commercial banks in Spain, see Emili Grifell-Tatje and C.A.Knox Lovell, “Deregulation and Productivity Decline: The Case of Spanish Savings Banks,”European Economic Review, Vol.40 (1997), pp.1281–1303; Amar Bhattacharya, C.A. KnoxLovell and P. Sahay, “The Impact of Liberalization on the Productive Efficiency of IndianCommercial Banks,” European Journal of Operational Research, Vol.98 (1997), pp.332–45, forforeign versus state and private banks in India; Jonathan Leightner and C.A. Knox Lovell, “TheImpact of Financial Liberalization on the Performance of Thai Banks,” Journal of Economics andBusiness, Vol.50 (1998), pp.115–31, for small banks versus large banks/foreign banks versusdomestic banks in Thailand; David. Wheelock and Paul Wilson, “Technical Progress, Inefficiency,and Productivity Change in U.S. Banking, 1984–1993,” Journal of Money, Credit, and Banking,Vol.31, No.2 (1999), pp.212–34, for small versus large banks in the United States.
5. Harvey Leibenstein, “Allocative Efficiency vs. X-efficiency,” American Economic Review, Vol.56(1966), pp.614–41; Harvey Leibenstein, “On the Basic Propositions of X-efficiency Theory,”American Economic Review, Vol.68 (1978), pp.328–32.
6. Osman Zaim, “The Effect of Financial Liberalization on the Efficiency of Turkish CommercialBanks,” Applied Financial Economics, Vol.5 (1995), pp.257–64.
7. Ihsan Isik and M. Kabir Hassan, “Financial Deregulation and Total Factor Productivity Change: AnEmpirical Study of Turkish Commercial Banks,” Journal of Banking and Finance, Vol.27 (2003),pp.1455–85.
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398 I. Isik & D. Uysal
8. Yener Altunbas, Lynne Evans and Philip Molyneux, “Bank Ownership and Efficiency,” Journal ofMoney, Credit and Banking, Vol.33 (2001), pp.926–54.
9. David Beim and Charles Calomiris, Emerging Financial Markets (New York: McGraw-Hill/Irwin,2001).
10. Maxim Boycko, Andrei Shleifer and Robert Vishny, “A Theory of Privatization,” The EconomicJournal, Vol.106 (1996), pp.309–19.
11. Richard Barr, Lawrence Seiford and Thomas Siems, “Forecasting Bank Failure: A Non-parametricApproach,” Recherches Economiques de Louvain, Vol.60 (1994), pp.411–29.
12. Juliet D’Souza and William Megginson, “The Financial and Operating Performance of PrivatizedFirms during the 1990s,” Journal of Finance, Vol.54 (1999), pp.1397–1438.
13. For example, reserve and liquidity requirements had been extensively used as a monetary policytool in Turkey until the mid-1980s. It is believed that the reserves that were kept at the Central Bankhave been used to finance the state’s budget deficits during this era. Emin Akçao[GBREVE] lu, FinancialInnovation in Turkish Banking, Capital Markets Board of Turkey, Publication No.127 (Ankara:Capital Markets Board of Turkey, 1998).
14. Allen Berger and Timothy Hannan, “The Efficiency Cost of Market Power in the Banking Industry:A Test of the Quiet Life and Related Hypotheses,” Review of Economics and Statistics, Vol.80(1998), pp.454–65.
15. Asli Demirguc-Kunt and Ross Levine, “Bank-Based and Market-Based Financial Systems: Cross-country Comparisons,” Working Paper, Development Research Group (Washington, DC: WorldBank, 1999).
16. Cevdet Denizer, “Foreign Entry in Turkey’s Banking Sector, 1980–97,” Working Paper (Washing-ton, DC: World Bank, 1999).
17. James Hanson and Craig Neal, “Interest Rate Policies in Selected Countries, 1970–82,” ResearchPaper (Washington, DC: World Bank, 1986).
18. In 1992, an electronic funds transfer system was installed for direct crediting in the banking system.The Turkish Interbank Clearing System was launched in 1992. During 1995, the Gold Exchangestarted to operate in Istanbul. During this period, the Banking and Insurance School was founded byT.C. Ziraat Bankasi to prepare Turkish bankers for a possible integration with the European Union.In addition, the DC Gardner Turkey and several other private training firms entered the market tomeet the increasing demand in the sector for learning new financial instruments and practices.These training programs for bank manpower were influential for boosting sector growth. Moreover,the introduction of new markets facilitated the control of liquidity and interest rate risks anddiversification of assets and liabilities. Banks became able to distribute clients’ portfolio risks to thebroader investment areas, as markets became more complete.
19. Zaim (1995); Isik and Hassan (2002).20. Turkish banks started to issue credit cards in August 1988. The number of credit cards in Turkey
increased from 1 million in 1992 to 13.6 million in March 2001, a growth rate that is much higherthan the EU average (Denizer, 1999). Advances in terms of technology infrastructure were remark-able in Turkish banking with a sharp increase in the number of ATMs, use of online bankingservices, use of Electronic Funds Transfer, and SWIFT systems. Banking services have alsoexpanded and bankcard and credit card use has increased rapidly.
21. Michael J. Farrell, “The Measurement of Productive Efficiency,” Journal of the Royal StatisticalSociety, Series A, Vol.120 (1957), pp.253–81.
22. Leibenstein (1966).23. Kenneth Button and Thomas Weyman-Jones, “Ownership Structure, Institutional Organization and
Measured X-efficiency,” American Economic Review, Vol.82 (1992), pp.439–45.24. Leibenstein (1978).25. William Megginson, Robert Nash and Matthias van Randerborgh, “The Financial and Operating
Performance of Newly Privatized Firms: An International Empirical Analysis,” Journal of Finance,Vol.49 (1994), pp.403–52; Boycko, Shleifer and Vishny (1996); Narjess Boubakri and Jean-ClaudeCosset, “The Financial and Operating Performance of Newly Privatized Firms: Evidence from
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Productivity Growth in Turkish Banks 399
Developing Countries,” Journal of Finance, Vol.53 (1998), pp.1081–110; D’Souza and Megginson(1999); Altunbas, Evans and Molyneux (2001); Beim and Calomiris (2001).
26. Michael Jensen and William Meckling, “Theory of the Firm: Managerial Behavior, Agency Costsand Ownership Structure,” Journal of Financial Economics, Vol.3 (1976), pp.305–60; EugeneFama and Michael Jensen, “Separations of Ownership and Control,” Journal of Law and Econom-ics, Vol.26 (1983), pp.301–26.
27. Anne Krueger, “The Political Economy of Rent Seeking Society,” American Economic Review,Vol.64, pp.291–303.
28. Michael Jensen, “Takeovers: Their Causes and Consequences,” Journal of Economic Perspectives,Vol.2 (1988), pp.21–48.
29. Anthony Boardman and Aidan Vining, “Ownership and Performance in Competitive Environ-ments: A Comparison of the Performance of Private, Mixed and State Owned Enterprises,” Journalof Law and Economics, Vol.32 (1989), pp.1–33.
30. Arvind Mahajan, Nanda Rangan and Asghar Zardkoohi, “Cost Structures in Multinational andDomestic Banking,” Journal of Banking and Finance, Vol.20 (1996), pp.238–306.
31. C. Edward Chang, Iftekhar Hasan and William Hunter, “Efficiency of Multinational Banks: AnEmpirical Investigation,” Applied Financial Economics, Vol.8 (1998), pp.1–8.
32. Aslı Demirgüç-Kunt and Ross Levine, “Financial Structures Across Countries: StylizedFacts,” Working Paper No.2143, Development Research Group (Washington, DC: World Bank,1999).
33. Edward Kane, “Capital Movements, Asset Values, and Banking Policy in Globalized Markets,”Working Paper No.6633, National Bureau of Economic Research (July 1998) Beim and Calomiris(2001). It should be noted that there are some factors that may reduce the value of comparative costadvantages for foreign banks such as the lack of exposure and training in lesser known markets, thelack of stringent monitoring of the bank by the senior management in the home country, amongothers. Chang, Hasan and Hunter (1998).
34. Bhattacharya, Lovell and Sahay (1997).35. Altunbas, Evans and Molyneux (2001).36. Isik and Hassan (2002).37. Iftekhar Hassan and William C. Hunter, “Efficiency of Japanese Multinational Banks in the
United States,” Research in Finance, Vol.14 (1996), pp.157–73; Mahajan, Rangan and Zardkoohi(1996); Chang, Hasan and Hunter (1998); Robert DeYoung and Daniel Nolle “Foreign-OwnedBanks in the US: Earning Market Share or Buying it?” Journal of Money, Credit, and Banking,Vol.28 (1996), pp.622–36; Allen N. Berger, Robert DeYoung, Hesna Genay and Gregory F.Udell, “Globalization of Financial Institutions: Evidence from Cross-border Banking Perfor-mance,” Brookings–Wharton Working Papers on Financial Services, Vol.3 (2000); MilindSathye, “X-efficiency in Australian Banking: An Empirical Investigation,” Journal of Bankingand Finance, Vol.25 (2001), pp.613–30.
38. Joe Peek, Eric Rosengren and Faith Kasirye, “The Poor Performance of Foreign Bank Subsidiar-ies: Were the Problems Acquired or Created?” Journal of Banking and Finance, Vol.23 (1999),pp.579–604.
39. Bhattacharya, Lovell and Sahay (1997).40. Pradeep Srivastava, Size, Efficiency and Financial Reforms in Indian Banking (Indian Council for
Research on International Economic Relations, New Delhi, India, 1999).41. Iftekhar Hasan and Katherin Marton. “Development and Efficiency of the Banking Sector in a
Transitional Economy: Hungarian Experience,” Journal of Banking and Finance (forthcoming).42. Isik and Hassan (2002).43. Stijn Classens, Asli Demirguc-Kunt and Harry Huizinga, “How Does Foreign Entry Affect
Domestic Banking Markets?” Journal of Banking and Finance, Vol.25 (2001), pp.891–911.44. Leightner and Lovell (1998).45. Luc Leaven, “The Efficiency of Thai Banking System,” Working Paper (Washington, DC: World
Bank, 1999).
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46. Jan-Egbert Sturm and Barry Williams, “Foreign Bank Entry, Deregulation and Bank Efficiency:Lessons from the Australian Experience,” Journal of Banking and Finance, Vol.28 (2004),pp.1775–99.
47. Berger and Humphrey (1997).48. Berg, Atle, Forsund and Jansen, “Malmquist Indices of Productivity Growth During the Deregula-
tion of Norwegian Banking, 1980–89,” Scandinavian Journal of Economics, Vol. 94, S211–S228.49. Jonshi Shyu, “Deregulation and Bank Operating Efficiency: An Empirical Study of Taiwan’s
Banks,” Journal of Emerging Markets, Vol.3, No.1 (1998), pp.27–46.50. Leightner and Lovell (1998).51. R. Alton Gilbert and Paul. Wilson, “Effects of Deregulation on the Productivity of Korean Banks,”
Journal of Economics and Business, Vol.50 (1998), pp.133–55; Jonathan Hao, William Hunter andWon Keun Yang, “Deregulation and Efficiency: The Case of Private Korean Banks,” Journal ofEconomics and Business, Vol.53 (2001), pp.237–54.
52. Bhattacharya, Lovell and Sahay (1997).53. Ana Lozano, “Efficiency and Technical Change for Spanish Banks,” Applied Financial Economics,
Vol.8 (1995), pp.289–300; Grifell-Tatje and Knox Lovell (1997); Subal Kumbhakar, Ana Lozana-Vivas, C.A. Knox Lovell and Iftekhar Hasan, “The Effects of Deregulation on the Performance ofFinancial Institutions: The Case of Spanish Savings Banks,” Journal of Money, Credit and Banking(forthcoming).
54. Hassan Aly, Richard Grabowski, Carl Pasurka and Nanda Rangan, “Technical, Scale and Alloca-tive Efficiencies in U.S. Banking: An Empirical Investigation,” Review of Economics and Statistics,Vol.72 (1990), pp.211–8; Humphrey and Pulley (1997); Wheelock and Wilson (1999); AllenBerger and Loretta Mester, “Explaining the Dramatic Changes in Performance of US Banks: Tech-nological Change, Deregulation and Dynamic Changes in Competition,” Journal of FinancialIntermediation, Vol.12 (2003), pp.57–95.
55. However, a recent study by Mukherjee et al. reported some signs of productivity gains in large USbanks after deregulation. Kankana Mukherjee, Subhash Ray and Stephen Miller, “ProductivityGrowth in Large US Commercial Banks: The Initial Post-deregulation Experience,” Journal of Bank-ing and Finance, Vol.25 (2001), pp.913–39. In addition, DeYoung et al. reported that the recentgeographical deregulation resulted in higher cost efficiency in the US banks. Robert DeYoung,Iftekhar Hasan and Bruce Kirchhoff, “The Impact of Out-of-State Entry on the Cost Efficiencies ofLocal Commercial Banks,” Journal of Economics and Business, Vol.50 (1998), pp.191–203.
56. Zaim (1995).57. Cedvet Denizer, “The Effects of Financial Liberalization and New Bank Entry on Market Structure
and Competition in Turkey,” Working Paper No.1839, World Bank Development Research Group,Washington D.C., USA, (November 1997).
58. As mentioned, this study differs from the earlier Turkish studies (Zaim, 1995; Isik and Hassan,2003) because the authors of this article look at the performance of Turkish banks in a dynamicsetting. Using a ten year time series and cross sectional data, the association between productivitygrowth and ownership structure during liberalization is focused on. Thus, in a way, this will be thefirst study that exclusively focuses on the productivity responses of different ownership forms toliberalization. In order to assess the long-term impacts of reforms correctly, a longer period of seriesdata is needed (Berger and Humphrey, 1997). With limited number of years, Zaim’s (1995) effi-ciency analysis mainly dwells on the industry level effects of liberalization, making his results intu-itive but not conclusive about the productivity aspects of liberalization for different ownershipforms. His study did not focus on the productivity development, efficiency change, scale change,and technical progress issues in the industry or sub-group levels, as his method did not allow theproduction frontier to shift over time. Isik and Hassan (2003) is a relevant study, however; the studyby the authors of this article is a more focused examination. They investigate the impact of thereforms on the whole industry without special emphases on ownership aspects in terms of theoryand implications. This study looks at the same issue from ownership per se.
59. Berg, Atle, Forsund and Jansen; Gilbert and Wilson (1998); Wheelock and Wilson (1999).
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Productivity Growth in Turkish Banks 401
60. In their paper, Wheelock and Wilson (1999) present an excellent discussion and geometric proof ofthis case.
61. Ibid.62. Leo Tornqvist, “The Bank of Finland’s Consumption Price Index,” Bank of Finland Monthly Bulle-
tin, Vol.10 (1936), pp.1–8.63. Sten Malmquist, “Index Numbers and Indifference Surfaces,” Trabajos de Estadistica, Vol.4
(1953), pp.209–42.64. Berg, Atle, Forsund and Jansen.65. Grifell-Tatje and Knox Lovell (1997).66. Gilbert and Wilson (1998).67. Leightner and Lovell (1998).68. Wheelock and Wilson (1999).69. J. David Cummins, Sharon Tennyson and Mary Weiss, “Consolidation and Efficiency in the US
Life Insurance Industry,” Journal of Banking and Finance, Vol.23 (1999), pp.325–57.70. Mukherjee, Ray and Miller (2001).71. Ali Darrat, Can Topuz and Tarik Yousef, “Assessing Bank Efficiency in an Emerging Market: The
Kuwaiti Experience in the 1990s,” Studies in Economics and Finance, Vol.21 (2003).72. Berger and Humphrey (1997) report that in the financial institutions literature, efficiency studies
employing non-parametric approaches outnumber efficiency studies using parametric approaches.Potential mistakes in the specification of a cost or revenue function as well as distributionalassumptions about the error term in parametric approaches could confound the inefficiency scoreswith specification error. The Malmquist index uses exclusively quantity information and thusdemands neither problematic price information nor a restrictive behavioral assumption in its calcu-lation. While this DEA-type index suffers from the lack of random error, in a multi-period settingthis issue is substantially alleviated. Kumbhakar, Lozana-Vivas, Lovell and Hasan (forthcoming).
73. Ft is assumed to satisfy certain conditions which make it possible to obtain meaningful outputdistance functions. See Ronald W. Shephard, The Theory of Cost and Production Functions(Princeton: Princeton University Press, 1970).
74. Shephard (1970).75. Berg, Atle, Forsund and Jansen.76. Rolf Fare, Shawna Grosskopf, Mary Norris and Zhongyang Zhang, “Productivity Growth, Techni-
cal Progress, and Efficiency Change in Industrialized Countries,” The American Economic Review,Vol.84, No.1 (March 1994), pp.66–83.
77. Subhash Ray, “Measurement and Decomposition of the Malmquist Productivity Index: A Paramet-ric Approach,” Working Paper (University of Connecticut, 1999).
78. Wheelock and Wilson (1999).79. Mukherjee, Ray and Miller (2001).80. Fare, Grosskoph, Norris and Zhang (1994).81. M is obtained utilizing the DEA, a linear programming. For further discussion, please see Wheelock
and Wilson (1999) and Mukherjee, Ray and Miller (2001).82. Thomas Siems and Jeffrey Clark, “Rethinking Bank Efficiency and Regulation: How Off-Balance-
Sheet Activities Make a Difference,” Financial Industry Studies, Federal Reserve Bank of Dallas(1997), pp.1–11; Berger and Mester (1997); Isik and Hassan (2002).
83. For instance, the loan to asset ratio has diminished strikingly from 54 percent in 1980 to 47 percentin 1990 and 30 percent in 1999. At the same time, the ratio of off-balance sheets to on-balancesheets was 1.95 in 1988, 1.88 in 1990, 1.97 in 1994 and 2.36 in 1996. This is partly due to increas-ingly profitable arbitrage activities, much of which revolve around the management and funding ofthe large government paper portfolios (1997 IMF staff report). On a $US basis, the real interestrates in the three to six month and six to nine month T-bills and government bonds were 9 percentand 27 percent, 43 percent in 1995 and 9 percent, 18 percent and 15 percent in 1996, respectively.As of the end of 1995, 82 percent of the banks’ securities portfolios consisted of public sectorsecurities such as treasury bills, government bonds, and revenue sharing certificates. The share of
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securities portfolio in total assets of the banking sector increased from 6 percent in 1980 to 11percent in 1990 and 17 percent in 1999 (Banks Association of Turkey (BAT)).
84. Aly, Grabowski, Pasurka and Rangan (1990).85. Elyas Elyasiani and Seyed Mehdian, “Productive Efficiency Performance of Minority and
Nonminority-Owned Banks: A Nonparametric Approach,” Journal of Banking and Finance,Vol.16 (1992), pp.933–48.
86. Bhattacharya, Lovell and Sahay (1997).87. Berger and Mester (1997).88. Wheelock and Wilson (1999).89. Mukherjee, Ray and Miller (2001).90. Kumbhakar, Lozana-Vivas, Lovell and Hasan (forthcoming).91. Calvin W. Sealey, Jr. and James Lindley, “Inputs, Outputs, and a Theory of Production and Cost at
Depository Financial Institutions,” Journal of Finance, Vol.32 (1977), pp.1251–66.92. As the format of the financial statements of Turkish banks has radically changed after 1980, this
study does not extend to the pre-1980 period. In addition, as the 1990s are mostly characterizedwith financial instabilities, raged inflation, and state interventions to seize ownership of weakbanks, this work does not extend to the post-1990 period either. As the new economic policy wasintroduced in January 1980 and a series of reforms followed soon after, the study period (1981–90)is an ideal time frame for tracing the initial impact of the reforms on Turkish banks. The denomina-tion of the variables in $US is chosen to eliminate the adverse impact of the inflation on the realmagnitudes given the real exchange policies pursued by Turkey.
93. Asli Demirguc-Kunt and Enrica Detragiache, “Financial Liberalization and Financial Fragility,”Working Paper No.1917, Development Research Group (Washington, DC: World Bank, 1998).
94. Denizer (1997).95. Murat Yulek, “Financial Liberalization and the Real Economy: The Turkish Experience,” Capital
Markets Board of Turkey, Publication Number 110 (Ankara: Capital Markets Board of Turkey, 1998).96. Denizer (1997) also uses 1986 as the basis year when analyzing the impact of liberalization on
market structure and competition of Turkish banks. After several decades of state interventions, thedetermination of interest rates in Turkey was eventually left to the market forces in July 1980,which opened a new era in Turkish banking called “July Banking.” However, stability concerns,which emerged especially after the 1983 “banker crisis,” resulted in re-regulation of interest ratesbetween 1983 and 1986.
97. Foreign banks operating in Turkey are subject to the same regulations as their domestic counter-parts. Public banks by their foundation decrees are expected to compete with private banks andoperate profitably. Nonetheless, it may be still questionable whether foreign and domestic commer-cial banks operating in Turkey posses the same banking technology. This is of critical concern,because only when foreign and domestic banks share the same technology can the data on thegroups be pooled, and the efficiency and productivity measures be estimated relative to a commonfrontier, combining both forms of banks into a pooled sample. Like Aly et al. (1990) and Elyasianiand Mehdian (1992), using parametric (ANOVA) and non-parametric (Mann–Whitney, Kruskal–Wallis and Kolmogorov–Smirnov) methods, the null hypothesis that domestic and foreign bankshave identical technologies was tested. The authors of this article failed to reject the null hypothe-sis, suggesting that it is appropriate to construct a common frontier by pooling the data. Thus, therest of the study continues with the results computed relative to common frontier. The test resultsare available upon request.
98.These averages are actually rates of productivity growth per year for each group. Thus, total produc-tivity growth between 1981 and 1990 according to Model 1 is 11 percent for public banks, 42percent for private banks, and 229 percent for foreign banks. According to Model 2, total productiv-ity growth between 1986 and 1990 is 12 percent for public banks, 43 percent for private banks, and88 percent for foreign banks. For the same period, total productivity growth with Model 1 is 13percent, 59 percent, and 89 percent. These results indicate that Turkish banks recorded significantlypositive productivity growth after liberalization.
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99. The technology change index (TECCH) is negatively correlated with all other indices except forTFPCH. It is interesting to observe that the efforts of the inefficient banks to catch up with the best-practice banks, either by improving their resource management skills or scales, do not result inupward shifts in the benchmark frontier. It may be that technical change stems from other sources.However, the positive relationship between the TFPCH and TECCH indices makes sense as theadvances in technology enable banks to generate more outputs given the same resources.
100. This issue is critical especially for small samples. Although the universe of Turkish banks isincluded in this study, sub-categorization reduces the number of observations. In addition, as can beseen from Table 3, the standard deviations of the Malmquist indices are relatively high, a potentialcase for the outlier problem.
101. Isik and Hassan (2002).102. Hatice Pehlivan and Colin Kirkpatrick, “The Impact of Transnational Bank on Developing
Countries’ Banking Sector: An Analysis of the Turkish Experience, 1980–89,” British Journal ofMiddle Eastern Studies, Vol.19 (1992), pp.186–201.
103. Erdogan Kumcu and Mehmet Karafakioglu, “The Marketing of Bank Services in Turkey,” Interna-tional Journal of Bank Marketing, Vol.3, No.2 (1985), pp.22–34; Erdogan Kumcu, “UniversalMarketing Myopia or Banks’ Rational Behavior? An Empirical Study of Bank Marketing inTurkey,” International Journal of Bank Marketing, Vol.3, No.1 (1985), pp.36–47; Akçao[GBREVE] lu(1998).
104. Mukherjee, Ray and Miller (2001).105. Grifell-Tatje and Knox Lovell (1997).106. Gilbert and Wilson (1998).107. Akçao[GBREVE] lu (1998).
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