Market entry, privatization and bank performance in transition

Abstract

This paper examines how market entry and privatization have affected the margins and marginal costs of banks in the post-communist transition. We estimate bank revenue and cost functions, allowing the estimated parameters to change over time. In the first sub-period (1995-98), we find that privatized banks earned higher margins than other banks, while foreign start-ups had lower marginal costs. In the third sub-period (2002-2004), foreign banks remained low marginal cost service providers, while privatized domestic banks had the widest margins. Subtracting marginal costs from margins to calculate mark-ups, an indication of demand for services, shows that initially privatized banks had the largest mark-ups. However, by the third sub-period, differences among private banks diminished. In comparison to private banks, state banks persistently under-performed in controlling costs and attracting demand. Our evidence therefore indicates that foreign bank entry promoted lower costs and that privatization and market entry encouraged more demand for services. © 2006 The Authors Journal compilation 2006 The European Bank for Reconstruction and Development.