Bank Ownership and Credit Supply during the Financial Crisis: Evidence from Russia Zuzana Fungáčová# Bank of Finland Risto Herrala Bank of Finland Laurent Weill* University of Strasbourg and EM Strasbourg Business School The recent financial crisis has provoked major economic troubles. A key channel of transmission has been the contraction of credit supply by banks. This contraction was primarily caused by the reduction of transactions on the interbank markets, but also by the reluctance of banks to lend in troubled times. In other words, banks were less able but also less willing to lend. This problem is of particular importance in emerging countries as the low development of financial markets gives banks a fundamental role in the financing of the economy. These countries are also characterized by the significant market share of state-controlled banks and foreign-owned banks and the presence of these banks can influence credit supply in crises times. Our aim in this paper is to examine how bank ownership influences credit supply in troubled times. Our research is motivated by the fact that bank ownership can influence lending behavior of banks for two main reasons. # Bank of Finland Institute for Economies in Transition (BOFIT), Snellmaninaukio, PO Box 160, FI-00101 Helsinki, Finland. Email: zuzana.fungacova@bof.fi Bank of Finland Institute for Economies in Transition (BOFIT), Snellmaninaukio, PO Box 160, FI-00101 Helsinki, Finland. Email: risto.herrala@bof.fi * Institut d’Etudes Politiques, Université de Strasbourg, 47 avenue de la Forêt Noire, 67082 Strasbourg Cedex, France. Email : laurent.weill@unistra.fr 1 First, foreign banks can have a different lending behavior than domestic banks in case of economic difficulties of the host country. In the literature this pattern is described as a possible “lack of loyalty” of foreign banks (Weill, 2003). According to this argument, domestic banks would be committed to the domestic economy, whereas foreign banks would neglect the host country by reducing credit more than domestic banks in downturn times. However, the empirical literature comparing the lending behavior of domestic and foreign banks in emerging markets in the 1990s does not support this view. For Latin America during the 1990s, Peek and Rosengren (2000) and Dages, Goldberg and Kinney (2000) find that domestic and foreign banks adopt the same lending behavior during crisis periods. In their analysis of the role of foreign banks in the lending channel in emerging countries, Arena, Reinhart and Vazquez (2007) study the evolution of lending and do not find any significant differences between foreign and domestic banks. Second, in order to support the economy during the crises, state-controlled banks can decide to reduce credit supply less than privately-owned banks. The reason is the different objective function of state-controlled banks which can include the stabilization of the economy. Private banks, on the other hand, only aim at private benefits. Moreover, the principal of statecontrolled banks, the government, might be willing to limit the fall of credit in troubled times to enhance its chances of reelection or to avoid potential political troubles. Literature provides evidence showing that state-owned banks can have different lending behavior than private banks. Dinc (2005) observes that lending of state-owned banks is correlated with the electoral cycle in a cross-country study. These banks enhance their lending in election years in comparison to private banks, in line with the view of a different objective function for both types of banks. In a cross-country analysis, Micco and Panizza (2006) investigate the role of the business cycle in the comparative lending behavior of state-owned and private banks. They find that the lending of state-owned banks is less sensitive to macroeconomic shocks than the one of private banks, which is in line with the idea that stateowned banks consider macroeconomic stabilization in their objective function. In a related vein, Jia (2009) analyzes the relationship between ownership and the prudential behavior of banks in China by comparing state-owned and joint-equity banks. He observes that state-owned banks are less prudent in lending. This finding suggests that state-owned banks would then reduce lending less than other banks in crisis times. 2 Our investigation of the impact of bank ownership on credit supply in troubled times provides two major contributions to the literature. First, we consider a case which perfectly suits our research question: Russia in the recent financial crisis. The magnitude of the economic troubles makes this event an optimal opportunity to analyze the evolution of credit supply depending on bank ownership. Russia is an important emerging country which is of particular interest for our investigation, as its banking industry consists of state-controlled, foreign-owned and domestic private banks. It is consequently the ideal country to analyze if foreign banks or state-owned banks behave differently in their lending during the crisis. We employ a rich dataset that includes quarterly data on all Russian banks, which allow us to analyze thoroughly the evolution of credit supply over the period from the first quarter of 2007 to the fourth quarter of 2009. Second, we introduce an original approach to estimate credit supply from bank level data. The major advantage is that we are able to separate credit supply from credit demand, without requiring detailed data from borrowers and lenders. Khwaja and Mian (2008) have proposed one method to disentangle both sides of the credit market, which is the key issue in this literature, but by using data on all participants of the credit market. The novel approach is based on the hypothesis first formalized by Holmström and Tirole (1997). Under this hypothesis credit supply constraints the borrower distribution because banks supply credit to the economically most viable borrowers up to a cutoff point determined by the return requirement set by their capital. We show that, under this hypothesis, credit supply can be estimated from the observed distribution of bank lending under relatively mild conditions. Credit supply can be uniquely identified as the maximum of the bank lending distribution, and estimated in parametric form by a stochastic frontier analysis. To allow inference about the effect of bank type on credit supply, we allow credit supply to depend on bank type, as well as bank capital and idiosyncratic factors. A similar approach has been employed previously by Chen and Wang (2008) for Taiwan and Herrala (2009) for Finland to estimate credit supply from borrower data. Stochastic frontier analysis has previously been widely applied in the banking literature to estimate bank efficiency (e.g. Karas, Schoors and Weill, 2010, for Russian banks). Our main conclusion is that bank ownership has exerted an impact on credit supply during the financial crisis. Whereas credit supply has overall diminished during the crisis, we observe 3 that this reduction was greater for foreign banks and lower for state-controlled banks relative to domestic private banks. Thus, we find support for the hypothesis of “lack of loyalty” of foreign banks, according to which these banks would have a stronger reduction of lending than domestic banks in troubled times. We also provide evidence in favor of the view according to which the objective function of state-owned banks would lead them to support the economy during economic downturns. The implications of our findings are that the privatization of the state-owned banks and the foreign bank entry might contribute to deterioration of the economic situation during economic downturns. This does not mean that these policies should be abandoned, as they can generate other benefits like efficiency gains for foreign bank entry (Karas, Schoors and Weill, 2010). References 1. Arena, M. Reinhart, C., Vazquez, F., 2007. The Lending Channel in Emerging Economies: Are Foreign Banks Different? IMF Working Paper n°7/48, March 2007. 2. Chen, N., Wang H.J., 2008. Demand and Supply Effects in Financial Crises. Southern Economic Journal 75, 1, 26-49. 3. Dages, B., Goldberg, L., Kinney, D., 2000. Foreign and Domestic Bank Participation in Emerging Markets: Lessons from Mexico and Argentina. Federal Reserve Bank of New York Economic Policy Review, 6, 3, 17-36. 4. Dinc, S., 2005. Politicians and Banks: Political Influences on Government-Owned Banks in Emerging Countries. Journal of Financial Economics 77, 453-479. 5. Herrala, R., 2009. Credit Crunch? An Empirical Test of Cyclical Credit Policy. Bank of Finland Research Discussion Papers 10/09. 6. Hölmstrom, B., Tirole, J., 1997. Financial Intermediation, Loanable Funds, and the Real Sector. Quarterly Journal of Economics 92, 3, 663-691. 7. Jia, C., 2009. The Effect of Ownership on the Prudential Behavior of Banks – The Case of China. Journal of Banking and Finance 33, 77-87. 8. Karas, A., Schoors, K., Weill, L., 2010. Are Private Banks More Efficient than Public Banks: Evidence from Russia. Economics of Transition 18, 1, 209-244. 9. Khwaja A., Mian, A., 2008. Tracing the Impact of Bank Liquidity Shocks: Evidence from an Emerging Market, American Economic Review 98, 4, 1413-1442. 10. Micco, A., Panizza, U., 2006. Bank Ownership and Lending Behavior. Economics Letters 93, 248-254. 11. Peek, J., Rosengren E., 2000. Implications of the Globalization of the Banking Sector: The Latin American Experience. 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