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Caution urged in call for more privatisation within the European banking sector

New research has questioned the increasing pressure for more privatisation within the European banking sector.

According to Portsmouth researchers, government ownership is not associated with an increase in savings banks’ risk behaviour.

Following the global financial crisis of the late 2000s, the ownership structure and the associated risk taking of savings banks has come under greater scrutiny for their ability to absorb systemic shocks.

Current theoretical research suggests that government-owned banks have increased risk-taking behaviour thanks to the protectionism in the form of guarantees. However, according to researchers from the University of Portsmouth, government ownership is not associated with an increase in savings banks’ risk behaviour.

Following an analysis of data from 721 savings banks in seven European countries over a 16-year period from 2000 to 2015, the Portsmouth researchers found that in the majority of countries, Government owned banks have a lower risk profile. The risk was measured through a Z-score, which captures the probability of default of a country’s banking system. Z-score compares the buffer of a country’s banking system (capitalisation and returns) with the volatility of those returns.

Lead author of the study, Dr Yaseen Ghulam, a Senior Lecturer in Economics, said: “Our findings do not support the general perception in relation to excessive risk taking by government owned saving banks due to government guarantees. These guarantees are understood to be one of the major factors in encouraging management to increase risk by lending to less credit worthy borrowers. Not only that, management could also invest in risky securities due to job security.

“The finding that financial shocks render government ownership insignificant in explaining the risk taking behaviour of savings banks during financial crisis period is very interesting and warrants further investigation.”

The data was analysed across three different times frames over the 16-year period (2000 – 2007, 2008 – 2010 and 2011 – 2015) to measure the effect of the financial crisis. While the same positive relationship between fully and partly government-owned banks and their respective Z-scores were found for the periods before and after the financial crash, it could not be confirmed for the crisis period from 2008 to 2010.

Dr Ghulam said: “The contrary findings compared to general perception could be as a result of the Z score inability to approximate risk taking behaviour of the banks and that the financial shocks that European savings banks had to suffer cannot be expressed through just simple and widely used accounting ratios. Additionally, not all financial entities of the different countries were influenced in similar ways during crisis period. Commercial banks could get affected differently compared to saving and cooperative banks in particular in distressed market conditions.”

Dr Ghulam further said: “These results indicate that the relationship between government ownership and Z-score is robust for a normal market condition but seems to break down when the market is distressed. If Z-scores are used as a risk proxy due to their popularity among academics and regulators then we could conclude that managers of government owned banks did not increase the risk during the crisis period and hence, the case for the privatisation of these banks is debatable.”

The study, ‘Government ownership and risk taking among European savings banks’ is published in the Journal of Banking Regulation.

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