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Procedia Economics and Finance 3 (2012) 549 – 554

Emerging Market Queries in Finance and Business

Corporate governance and bank performance in the Romanian

banking sector
Gheorghe Chitana,*
a
Academy of Economic Studies, Bucharest 010961, Romania

Abstract

The present study examines how, in the period 2004-2011, the regulatory framework for minimum capital requirements, the
loan classification and provisioning for specific credit risk, the liquidity and the insurance of deposits and specific
banking development. Mainly, the results
indicate that the influence on bank performance is different from that on bank development and the need for more stringent
requirements in terms of equity and the establishment of provisions related to the debtors probability of default in order to
limit the risk and to improve financial performance.

© 2012 The©Authors.
2012 Published
Published byby Elsevier
Elsevier Ltd. access
Ltd. Open Selection
underand peer-review
CC BY-NC-ND under responsibility of the
license. Emerging
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Selection and Queries
peer review in Finance of
under responsibility and Business
Emerging localQueries
Markets organization
in Finance and Business local organization.

Keywords: external governance; bank performance; risk governance; risk management; Romanian banking system

1. Introduction

Within the framework of financial system deregulation, the financial crisis restores the attention to necessity
for improving the corporate governance in order to ensure financial stability. The study examines at the level of
the Romanian banking system the relationship between bank regulation, banking industry-specific variables and
national gross domestic product and bank development and performance, being inspired by Barth et al., 2004. It

* Corresponding author. Tel.: 00 40 726 762 030

E-mail address: [email protected].

2212-6716 © 2012 The Authors. Published by Elsevier Ltd. Open access under CC BY-NC-ND license.
Selection and peer review under responsibility of Emerging Markets Queries in Finance and Business local organization.
doi:10.1016/S2212-5671(12)00194-3
550 Gheorghe Chitan / Procedia Economics and Finance 3 (2012) 549 – 554

shows that the influence of regulations on capital adequacy and guarantees existence, unlike those regulations
regarding the setting of provisions, is positive over the bank performance and negative over banking
intermediation. Also, increasing borrowing helps to improve financial performance, but has a negative
influence on the bank development.
The study completes the analysis regarding the influence of internal corporative governance done by
Stefanescu, 2011, and shorter papers examining external governance over long period of time (e.g. Barth et al.,
2004 who conducted the study only for one point in time), including rules for liquidity and other characteristics
of regulatory variables and various prudential indicators.
The remainder of the paper is organized as follows. Section 2 reviews the literature and hypotheses
development. Section 3 describes the data and the variables. Section 4 describes the methodology and provides
the empirical results. Section 5 concludes.

2.

Corporate governance of an entity involved and is influenced by a series of relationships, manifested both
within the organization and also from external environment. Parties interested in the good functioning of an
entity, namely its shareholders, its management, its stakeholders, undertake and take steps in the field of risk
management in order to ensure adaptability to the business environment and business continuity, their failure
leading to manifestation of the governance risk.
Diamond, 1984 said that in the banking industry, regulators are one of the main stakeholders, yet their
objectives may clash with those of the other stakeholders. Laeven and Levine, 2009, found that other capital
regulations are positively related to risk-taking. These findings confirm the agency problem between the
regulators which follows the financial stability and to reduce risks and bank shareholders who want to
maximize investment value. Barth et al., 2004, when making a study over 107 countries, has found that the
stringency of capital regulations is positively correlated with bank development without a significant influence
over the net interest margin, and also that generous deposit insurance schemes are strongly and negatively
associated with bank stability. They also have not found a strong relationship between loan classification
stringency and provisioning stringency with bank development or performance. Related to bank performance,
expressed by before tax profit to total assets, before tax operating profit to total assets and overhead cost to
operating revenue, Barth et al., 2007, have found that annual real growth rate of GDP and equity to total assets
ratio have a positive influence while deposit to total assets ratio have a negative one. Merton, 1977 shows that
regulations influence the risk-taking incentives founding that deposit insurance intensifies the ability and
incentives of stockholders to increase risk. Influence of the banking regulatory framework is widely debated,
including Eisenbeis and Kaufman, 2008 who examined the implications that alternative regulatory structures
may have for resolving failed banking institutions in the EU, Naceur and Kandil, 2009 who investigated the
effects of capital regulations on cost of intermediation and profitability of the banking sector in Egypt,
Angkinand, 2009 who analysed the relationship between banking regulation and the output cost of banking
crises, Kilinc and Neyapti, 2012 who analyzed the welfare implications of bank regulation and supervision,
Demirgüç-Kunt et al., 2008 who studied whether better banking supervision and regulation is associated with
sounder banks, etc.
As Barth et al., 2006 was referring to strengthening capital standards, is considered that strengthening the
prudential regulation is important for improving bank efficiency, reducing corruption in lending and lowering
the fragility of the banking system in general.
Based on these findings and theory predicts may define the following hypothesis:

Influence of external corporate governance on bank performance is different from that on bank
development.
 Gheorghe Chitan / Procedia Economics and Finance 3 (2012) 549 – 554 551

3. Data and variables

To capture the influence of external corporate governance over the Romanian banking system are used as
dependent variables - bank development (BD) and variable for bank performance, the return on assets (ROA)
and return on equity (ROE). To capture the external governance are used variables which express rules in force
at the end of each sub-period within the observation panel on capital adequacy, loans classification,
provisioning specific credit risk, liquidity of banks and deposit insurance for whose creation was followed the
methodology used by Barth et al., 2004. Considering the regulatory framework of the Romanian banking sector,
were included, in addition to other studies, a variable relating to liquidity and additional questions relating to
large exposures and the operational risk for regulatory capital, validation of internal rules for loans
classification and other features than those related to fiscal issues for provisioning framework and issues on
guaranteeing loans and also the trend to cover deposits along with banking intermediation for the guaranteeing
framework. These are dummy variables which take on values of 1 or 0, 1 indicating the presence of that
attribute and 0 indicating the absence of that attribute. These values are given based on questions regarding the
existence or nonexistence of each variable subcomponents.
Also, within the study were considered variables to express monitoring indicators for the prudence of the
banking sector and nominal gross domestic product (NGDP) in order to capture the influence of
macroeconomic conditions. Quarterly data were collected from on the website of the National Bank of Romania
(www.bnr.ro) from 2004:Q4 to 2011:Q4. Definition of variables, design methodology and their statistics is
presented in Table 1. Regarding performance variables, ROE has recorded the most significant variations due to
declining profitability and increasing capital requirements. Out of regulatory variables, standard deviation (SD)
indicates that capital and liquidity regulations have recorded the most significant variations the rest suffering
moderate variations. Mean leverage and liquidity indicates o good framing within the regulatory requirements.

Table 1. Variables, definitions and descriptive statistics.

Variable Definition Mean SD

(%) ROA Quarterly net profit to total assets at average value. 0.598 0.61
(%) ROE Quarterly net profit to equity at average value 5.291 5.763
Bank development Loans to private sector to nominal gross domestic product 1.299 0.430
Capital regulatory Capital regulatory index adds one for an affirmative answer to each of the 4.655 1.518
following questions: (1) Large exposure is defined and its limits are set?; (2)
Before minimum capital adequacy is determined, market value of loan losses
not realized in accounting books is deducted from the book value of capital?;
(3) Is subordinated debt allowable as part of capital?; (4) Is subordinated debt
required as part of capital?; (5) Does the minimum capital required vary as a
function of an individual bank's credit risk?; (6) Does the minimum capital
required vary as a function of an individual bank's market risk?; (7) Does the
minimum capital required vary as a function of an individual bank's
operational risk?
Guaranty regulatory Guaranty regulatory index adds one for an affirmative answer to each of the 2.827 0.384
following questions: (1) Deposits from credit institutions are guaranteed? (2)
The coverage has grown along with banking intermediation?; (3) there is the
possibility that state to guarantee the loans to small and medium enterprises
and to individuals?

Table 1. (Continued)
552 Gheorghe Chitan / Procedia Economics and Finance 3 (2012) 549 – 554

Variable Definition Mean SD

Classify regulatory Classify regulatory index adds one for an affirmative answer to each of the 4.862 0.351
following questions: (1) Does the internal rules/norms for determining
financial performance for both individuals and legal persons are validated by
the regulatory authority?; (2) If a customer has multiple loans and one loan is
classified as non-performing, are the other loans automatically classified as
non-performing?; (3) Is there a forward looking estimate of the probability of
default?; Does the loan classification criteria and, where take into account (4)
the number of days a loan is in arrears?; (5) financial performance?; (6)
initiation of legal proceedings?
Provision regulatory Provision regulatory index adds one for an affirmative answer to each of the 2.172 0.384
following questions: (1) Are the provisions general established for credit risk
are deducted from taxable income?; (2) There is a different provisioning
coefficient applied for individuals debtors exposed to currency risk?; (3) In
determining the base for calculus, is considered the entire exposure, regardless
the collaterals for a loan classified as "loss", where legal proceedings have
been initiated or where at least one amount of respective credit recorded a debt
service over 90 days?; (4) There are provisions set based on probability of
default?
Liquidity regulatory Liquidity regulatory index adds one for an affirmative answer to each of the 2.275 0.454
following questions: (1) There is defined and monitored high liquidity risk?;
(2) The minimum level of liquidity is at least level 1?; (3) The liquidity
indicator is maintained for all maturity bands?; (4) The liquidity indicator is
calculated separately for operations in euro and operations in lei?; (5) The
liquidity indicator is also calculated for the maturity bands over 12 months?
(%) Leverage Level 1 equity to assets total at the medium value. 7.974 0.693
(%) Loans to Loans to customers (gross value) / Deposits from customers (gross value). 1.041 0.184
deposits
(%) Overdue claims Overdue and doubtful receivables to total assets (net value). 0.667 0.625
Liquidity ratio Effective liquidity to necessary liquidity 2.060 0.505
NGDP Nominal gross domestic product (bill. lei) 110.482 33.919

4. Methodology and results

To perform the study it is used multivariate regression and Ordinary Least Squares (OLS) as the method of
estimation. The specific model estimated is as follows:

Pt t t Pt

where P is the performance variable; B is banking industry-specific variables; I is external governance

variables; NGDP is nominal gross domestic and
Definitions of variables are provided in Table 1.
Table 2 reports the results from regressions of ROA, ROE and BD. The regression specification reported in
Column 3 only includes variables with more intense influence on lending (capital regulatory, guaranty
regulatory, leverage and loans to deposits). Column 4 additionally includes others variables increasing the
number of regressors resulting in low degrees of freedom. As many of our explanatory variables turn out to be
insignificant in most specifications, as a further robustness check of the results, it was employed a forward and
 Gheorghe Chitan / Procedia Economics and Finance 3 (2012) 549 – 554 553

backward stepwise regression approach to obtain a more parsimonious model. It was used a 10% significance
level cutoff for exclusion of variables from the model.
The results show that the coefficient on capital regulatory is negative and significant related to ROA
(inconsistent with Barth et al., 2004) and ROE and positive and significant related to BD (similar to Barth et al.,
2004). This can be explained by the possible inclusion of subordinated loans into equity, by not deducting from
equity the losses from loans unrecorded in accounting and also not setting for establishment of differentiated
capital according to risk for each exposure, leading to availability of funds, to increase of exposure and a more
relaxing risk approach. On the other hand, immobilizations of capital to cover the credit risk reduce the lending
and potential payout.

Table 2. Return on assets (ROA), return on equity (ROE) and bank development (BD) regressions. t-Statistics are reported in parentheses.
The Durbin-Watson test or, in case of indecision, the Breusch-Godfrey test with 2 lags is used for testing autocorrelation of errors,
respectively White test for testing heteroscedasticity. *, **, and *** indicate significance at the 10%, 5%, and 1% levels, respectively.

Variables ROA ROE BD BD

(1) (2) (3) (4)
Constant 0.963* (1.871) 19.275* (1.702) -0.565* (-1.742) 0.573 (1.055)
Capital regulatory -0.318*** (-6.908) -2.836*** (-6.182) 0.188*** (6.894) 0.277*** (5.840)
Provision regulatory 0.916*** (5.913) 9.502*** (5.919) -0.355** (-2.245)
Classify regulatory -4.369* (-1.858)
Liquidity regulatory -0.245* (-1.753)
* **
Guaranty regulatory -0.323 (-1.841) 0.349 (2.785) 0.278** (2.403)
NGDP (bill. lei) 0.721*** (2.484)
(%) Leverage 2.213** (2.484) 26.135** (2.819) -1.667*** (-2.897) -2.513*** (-4.391)
(%) Loans to deposits -38.506*** (-3.273) 2.931*** (4.153) 2.130** (2.842)
Liquidity ratio 0.830* (1.755)
(%) Overdue claims 0.389** (1.055)
F statistic 19.501*** 14.619*** 27.699*** 19.159***
R-squared 0.815 0.776 0.834 0.894
Durbin-Watson test (Breusch-Godfrey test) 1.885** 1.886** 2.001** 1.675 (3.117***)
White test 6.178* 9.595** 4.436* 9.362***

The coefficient on provision regulatory is positive and significant related to ROA and ROE (different to
Barth et al., 2004), not setting provisions based on the probability of default of the debtor, doubled by a failure
to apply a differentiated provision coefficient for those debtors exposed to the currency risk leading to
improvement in the bank performance. Also the establishment of provisions for the granted loans is negative
and significant related to BD, limiting the grow of exposure by decreasing the banking intermediation. The
coefficient on classify regulatory is negative and significant related to ROE (different to Barth et al., 2004), not
setting a criterion for the classification of loans with probability of default clients leading to the materialization
of risks, reduce profitability. Liquidity regulatory variable related to BD, is negative, setting liquidity index
higher than one for one year, limiting so the long-term lending from short-term resources. On the other hand,
liquidity ratio had a positive effect on BD due to failure to maintain its level for each maturity band within a
year and also by uncalculating this indicator for maturity bands over 12 months. The coefficient on guaranty
regulatory is negatively related to ROA and positively related to BD meaning that guaranty of deposits and for
certain loans allow a growth of lending under the reserve of a safety net for possible losses. The coefficient on
NGDP show that once it is increasing also the economical profitability will be improved ROA (similar to Barth
et al., 2004). The coefficient on (%) leverage is positive and significant related to ROA and ROE and negative
and significant related to BD, limiting the credits due to the necessity for equity to cover the assets leading to
554 Gheorghe Chitan / Procedia Economics and Finance 3 (2012) 549 – 554

reduction of bank intermediation and achieving safer return investments. The coefficient on (%) loans to
deposits is negative related to ROE and positive related to BD, the growth of lending intensifying the banking
interrelation but also the establishment of additional capital in order to cover the resources. The coefficient on
(%) overdue claims related to BD shows that the growth of banking interrelation is accompanied by a
worsening of the portfolio of receivables.
These findings lend support to hypothesis of study: Influence of external corporate governance on bank
performance is different from that on bank development.

5. Conclusion

This study examines how external corporate governance, namely prudential supervisory measures such as
capital requirements, classification of credits and provisioning specific credit risk, liquidity of banks and
deposit insurance affects the performance and development of the Romanian banking sector. The study
indicates that existence of regulatory guarantees and the availability of equity, backed by failure to deduct from
equity of the losses unregistered into accounting and also by not providing variable capital related to risk
exposure helped improving the bank development, and failure to establish the criteria for the provisioning
according to the probability of default of the debtors improved bank performance but resulted in potential
exposure to risk. Data limitations does not allow to be used the panel procedures to examine the influence of
internal and external governance to every credit institution. Remedies for improving the external governance
framework respectively the improvement of the quality of the equity and sizing them based on the exposure to
risks are in accordance with recent Basel III requirements.

Acknowledgements

This work was supported by the Academy of Economic Studies, Bucharest - IOSUD.

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