Faculty Scholarship 1994 - Present

Market Entry, Financial Liberalization and Operational Performance: Evidence from the Turkish Financial Sector

Established banks have a decided advantage over de novo banks in their greater experience, greater size, and well-established reputations (Rose, 1977). New banks may not reap returns on their investments sufficiently in their early times due to inadequate volume of transactions to minimize production costs and inefficiencies. As Mester (1996) suggests, high set-up costs for de novo banks result especially from the time needed to establish customer relationships. It may take several years for a de novo bank to form its "optimal" customer portfolio as a result of asymmetric information problems associated with a new market (Rose, 1977; Brislin and Santomero, 1991). Therefore, it is possible that banking technology inherits learning by doing, suggesting that as banks grow older, they could manage their operations better and become more efficient. As a matter of fact, the best practice banks are more likely to survive than inefficient banks. Evidently, majorities of failures are usually observed among newly establsihed banks (DeYoung, 2003). Hence, as compared to established banks, de novo banks are expected to demonstrate lower efficiency upon inception due to scale and experience problems. However, one should note that the pace of learning is faster in the early years. As new banks move along the learning curve, they become able to produce more output per input since they experience a gigantic improvement in their outputs although their inputs do not change much. This could happen as a result of consuming possible economies of scale and eliminating asymmetric information problems related to the new market. Thus, one can expect that new banks would experience substantial productivity and efficiency gains in their early years than in their later years. Turkish financial system has gone through a major structural change as a result of the financial liberalization program launched in the early 1980s. The relaxation of regulatory barriers, which has purported to enhance banking competition, attracted a significant number of domestic and foreign banks into the Turkish financial system. De novo banks, which have joined the system in the post-deregulation era, constituted half of the banking industry by 1996. The purpose of this study is to examine the post-entry performance of de novo banks in Turkey as they age. Empirical evidence indicates that the initial performance of a de novo bank is strongly related to its experience, financial strength, relations and contacts of its founders and quality of its managers (Selby, 1981). Like any business start-ups in other sectors, most de novo banks incur initial losses as a result of substantial asymmetric information problems and high operational costs. Yet, no study has investigated the post-entry performance of Turkish de novo banks to see whether these institutions were able to compete effectively with established banks in terms of efficiency and productivity. Our study should interest both bank regulators and investors. Until they can operate efficiently, de novo banks will neither earn a satisfactory rate of return nor be a strong rival for establsihed banks. In advanced countries such as in the US, regulators require de novo banks to have enough intial capital to offset three years worth of losses and low earnings. Bank regualators in Turkey and elsewhere can benefit from our findings while making decisions regarding entry restrictions and conditions, i.e., whether de novo entry should be made easier or more difficult. Our results try to show whether de novo banks underperform established banks and if so, how many years of close scrutiny will be needed for de novo banks to ensure a comparable performance.