Political connection and bank performance

This is a short post about a curious, but interesting, paper I recently read. Titled The dark side of political connection: Exchange easy loans for the political career of bank CEOs, and written by Chen, Hasan, Lin and Yen (CHLY thereafter), the paper demonstrates that banks with political connections underperformed ‘independent’ ones during the crisis.

This probably won’t come as a surprise to many of you. A quick read through Calomiris and Haber’s Fragile by Design shows the critical and disastrous influence of politics on banking and economic performance. Still, the paper is worth a look as it provides further empirical evidence.

CHLY define ‘government banks’ as banks with at least 20% state ownership. They then subdivide this group into two: those with CEOs that served as politicians are called ‘political banks’ and the other ones are ‘non-political banks’. A first comment: I believe their sample underestimate political connections. They probably only pick banks that have the strongest connections. There are non-state-owned banks whose CEOs used to be or have subsequently become politicians, or have been to school with current government officials and have very close links with them. Their sample doesn’t capture such cases. Weirdly, their sample seems to exclude countries such as the US, UK or Germany. No reason is provided.

Based on this admittedly limited dataset, they analyse the evolution of the asset quality, as well as a number of performance indicators (return on equity and assets, cost/income…), of those banks during the crisis. They find that

Political banks significantly approve more low-quality loans than non-political banks, such that they are confronted with a higher ratio of nonperforming loans to gross loans during the crisis. This ratio indicates that politically connected banks become increasingly inefficient and pursue a more risky lending behavior. Further, these lower quality loans cause significant underperformance as measured by the return on assets, return on equities, net interest income to total assets, and the cost to income ratio during the crisis years.

CHLY also find that institutional framework, low corruption, strong governance, and institutional ownership mitigate the impact of political connection on the agency problem. ‘Non-political government banks’ also seem to be partly protected from most of the bad effects that plague ‘political banks’.

Moreover, they find that politically-connected CEOs grant more low quality loans for their own benefit, and that many of those CEOs (almost 30%) were offered political jobs after the crisis. They conclude that

the politically connected CEOs, who have poor operating performance, are less likely to be penalized by the bank or politics. They even have a bright future political career after the crisis. This evidence is consistent with our political connection hypothesis that these CEOs use their power and influence to relax lending standards and reap private benefits.

And some people still question the conclusions of the Public Choice school… Worse, many others want to nationalise the money creation framework (see Positive Money), falsely believing in a fully independent central bank that would always act for the greater good. Others want to nationalise the whole banking system, as if this recipe had never been tried before. Go figure.