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Managerial Finance
Do consolidation and foreign ownership affect bank risk taking in an emerging

economy? An empirical investigation
Mona A. ElBannan,
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MF
41,9
Do consolidation and foreign
ownership affect bank risk
taking in an emerging economy?
874 An empirical investigation
Received 15 December 2013
Revised 17 June 2015 Mona A. ElBannan
Accepted 20 June 2015 Department of Accounting and Finance,
German University in Cairo, Cairo, Egypt
Abstract
Purpose – The purpose of this paper is to examine the effect of bank consolidation and foreign
ownership on bank risk taking in the Egyptian banking sector.
Design/methodology/approach – Following prior studies (e.g. Yeyati and Micco, 2007; Barry
et al., 2011), this study uses pooled Ordinary Least Squares regression models under two main analyses
to test the relation between concentration and foreign ownership on one hand and bank risk-taking
behavior on the other hand, where observations are pooled across banks and years for the 2000-2011
period. The reform plan was launched in 2004 and resulted in various restructuring activities in the
banking system. Thus, to control for the effect of implementing the financial sector reform plan
on bank insolvency and credit risk, this study includes a reform dummy variable (RFM ) for the
post-reform period in models testing the association between consolidation, foreign ownership and
bank risk. Therefore, this categorical variable identifies whether bank risk is related to the reform
activities that have been observed during the post-restructuring period, 2005-2011. Moreover, to
accommodate the possibility that effects of bank concentration and foreign ownership on bank risk
differ due to the implementation of the reform plan, the author create two interaction terms: one
uses the product of the reform dummy variable and concentration measures, while the other uses
the product of the reform dummy and foreign ownership variables to capture interactions. These
interaction terms and the dummy variable provide ample room to capture the effect of bank
concentration and foreign ownership on bank risks during the post-reform period.
Findings – This study provides empirical evidence that bank concentration is associated with low
insolvency risk and credit risk as measured by loan loss provisions (LLP) in the post-reform period.
These results are consistent with the “concentration-stability” view, suggesting that concentration of
the banking sector will enhance stability. Moreover, evidence shows that while a higher presence of
foreign banks reduces bank credit risk in the post-reform period, it appears to increase insolvency risk.
These results are robust to using alternative measures. These findings imply that regulators in
emerging countries should support foreign investments in banks to transfer better managerial skills
and systems. However, government-owned banks are found to be more prone to insolvency and credit
risks; thus, their ownership should not be encouraged. Finally, policy makers should reinforce bank
consolidation, be prudent in determining the capital adequacy ratio (CAR) and monitor intensively less
profitable, well-capitalized and small-sized banks.
Practical implications – Consolidation of the banking sector decreases insolvency risk and credit
risk, as measured by LLP in the post-reform period. This study proposes that bank supervisors
implement prudent polices in determining the bank CAR, and monitor intensively less profitable, well-
capitalized and smaller banks, as they have incentives to increase risk. In addition, regulators should
encourage foreign investment in the banking sector and facilitate their operations in Egypt.
Social implications – Bank supervisors should intensely monitor banks with high-CARs that exceed
mandatory requirements because they may be more likely to engage in more risk-taking activities.
Managerial Finance
Vol. 41 No. 9, 2015
Originality/value – It provides empirical evidence from a country-specific, emerging market
pp. 874-907 perspective, in which restructuring events affect the national economy. Egypt, similar to other emerging
© Emerald Group Publishing Limited
0307-4358
countries in Africa, pursues an institutionally based (bank-based) system of corporate governance, where
DOI 10.1108/MF-12-2013-0342 banks are the primary sources of finance for firms. Therefore, restructuring banks and other financial
institutions and supervising their operations ensure the soundness and stability of these institutions, Bank risk
which represent the nerve of emerging economies. Because emerging countries tend to share common
characteristics and economic conditions, and the reform of their financial systems is significant for taking in an
economic development, the Egyptian banking reform and restructuring program should be of interest to emerging
other emerging countries to capitalize on this experiment. While international studies on these economy
relationships are mostly cross-country or focus on US banks, firm-specific studies are scant. Furthermore,
the findings of this study should be of interest to Egyptian regulators, bank supervisors and policy
makers studying the implications of bank reforms. 875
Keywords Foreign ownership, Banking, Bank risk taking, Consolidation, Z-score
Paper type Research paper
1. Introduction
In developing countries, banks represent the nerve of the financial system and
dominate financial markets. Therefore, developing countries in particular should pay
greater attention to their banking sectors due to the importance of these sectors’ role in
providing finance, ensuring safety for depositors and enhancing economic growth.
As a part of the Egyptian economic reform program, in 2004, the government
launched financial sector reform, which intended to bring banks into conformity with
the Basel Committee requirements. The first phase of this reform plan was
implemented over the 2004-2008 period and aimed to privatize and consolidate the
banking sector, restructure state-owned banks, address non-performing loans and
strengthen the supervisory role of the Central Bank of Egypt (CBE, 2010, p. 82). To
achieve the first objective of the reform plan, banks were required to raise their capital
adequacy ratios (CAR). Accordingly, several small banks with inadequate capital ratios
were unable to increase their capital and had to merge with larger banks.
As a consequence of this reform plan, the Egyptian banking sector witnessed a wave of
mergers and acquisitions during the 2005-2008 period. The primary motivation behind the
consolidation of the banking industry was to create a more stable, less-fragmented
banking sector that was better able to compete locally and internationally. During
2004-2009, the number of banks operating in Egypt decreased from 57 banks at the
beginning of the period in 2004 to 39 banks at the end of 2008 (CBE, 2010), a decrease of
almost 32 percent in the number of banks operating in Egypt. The government also
embarked on an ambitious privatization program whereby government banks reduced
their stake in private firms and joint ventures. This divestiture of the shareholdings of
state-owned banks in private and joint venture banks was directed toward foreign buyers
in most cases[1].
The purpose of the study is to examine whether bank risk taking is associated with
consolidation and foreign ownership in the Egyptian banking setting. The underlying
premise is that a more concentrated banking sector in which foreign banks are allowed
to compete with local banks should improve the performance, soundness and stability
of the financial system. Because the reform plan results in restructuring events, these
significant events should be considered when examining the relationships between
bank concentration, foreign ownership and bank risk. Hence, the purpose of this study
is to examine the effects of consolidation and foreign ownership on banks’ risk-taking
behavior while controlling for the effect of the reform plan that took place within the
sample period. Specifically, the study aims to examine the following question: Do bank
risk profiles differ with bank concentration and foreign ownership?
This study contributes to the debate on the relation between concentration, foreign
ownership and bank risk in several important ways. It provides empirical evidence
MF from a country-specific, emerging market perspective, in which restructuring events
41,9 affect the national economy. Examining this relationship in Egypt is of much interest,
as the Egyptian banking sector has undergone many restructuring activities and
experienced consolidation, privatization and the entry of foreign owners over the past
decade. That is, this study is motivated by these events in the banking sector and aims
to test their consequences on bank risk taking. Egypt, similar to other emerging
876 countries in Africa, pursues an institutionally based (bank-based) system of corporate
governance, where banks are the primary sources of finance for firms. Therefore,
restructuring banks and other financial institutions and supervising their operations
ensure the soundness and stability (Rwegasira, 2000) of these institutions, which
represent the nerve of emerging economies. The main characteristics of emerging
countries, for example, the domination of bank financing, inefficient capital markets,
undeveloped legal markets, high debt-equity ratios, concentrated ownership and the
lack of economic and political stability, have been discussed amply in the literature (e.g.
Rwegasira, 2000; Ahunwan, 2002). Because emerging countries tend to share common
characteristics and economic conditions, and the reform of their financial systems is
significant for economic development, the Egyptian banking reform and restructuring
program should be of interest to other emerging countries to capitalize on this
experiment. While international studies on these relationships are mostly cross-country
or focus on US banks (e.g. Bourgain et al., 2012; Angkinand and Wihlborg, 2010),
firm-specific studies are scant. Furthermore, the findings of this study should be of
interest to Egyptian regulators, bank supervisors and policy makers studying the
implications of bank reforms. Most studies examine the association between either
foreign ownership or consolidation and bank risk taking, except for De Nicolo
and Loukoianova (2007), who use cross-country analysis, and Beck (2008), who tests
the effect of these variables on bank crisis. However, the aim of this study is to examine
the effect of both foreign ownership and consolidation on bank risk taking, where the
relative importance of both factors can be observed.
The remainder of this paper is structured as follows. Section 2 reviews the relevant
literature leading to the hypothesis development. Section 3 describes the sample and
research methodology. Section 4 presents the empirical results. Finally, Section 5
concludes the paper.
2. Literature review and hypothesis development

2.1 Bank concentration and bank risk-taking behavior
A number of motives behind the consolidation of the banking sector are mentioned in
the literature, and, in fact, these motives for consolidation are the main causes of merger
and acquisition activities[2]. Further, studies suggest that the consolidation will
directly increase market power and change systemic risk due to the change in the
individual risks of banks (Berger et al., 1999).
Consolidation of the banking industry has ramifications for banks’ profitability,
stability and fragility. Concentration increases bank size and reduces competition
within the banking sector; thus, concentration may affect the risk-taking behavior of
banks through its effect on size and competitive behavior. Many scholars examine the
relation between size, performance and risk. Boyd and Runkle (1993) find in US bank
holding companies that larger banks have smaller capital ratios and volatility of
asset returns. Demstez and Strahan (1997) argue that while larger banks are well
diversified, they are more highly leveraged and have lower capital ratios and riskier
lending portfolios. In a cross-country study of US, Japanese and European banks,
De Nicolo (2000) finds a positive relation between bank size and insolvency risk, Bank risk
suggesting that consolidation increases bank insolvency risk. Cetorelli et al. (2007) taking in an
argue that large banks are less transparent, use sophisticated financial instruments
and have lower managerial efficiency, less effective internal corporate control and
emerging
increased operational risk. In a more recent study, De Haan and Pohosyan (2012) use economy
a sample of US banks over the 2004-2009 period and find empirical evidence that
large banks have lower earnings volatility compared to small banks, whereas this 877
relation decreases with high-market concentration[3].
Another strand of literature examines the relation between competition and bank
risk-taking behavior, where various studies use bank concentration ratios to proxy for
competition in the banking industry. This literature suggests that the link between
concentration, bank risk taking and financial stability is ambiguous (Boyd and
De Nicolo, 2005), and mixed results are reported according to the measures used for
competition and bank risk.
The studies that test the relation between concentration and bank risk may be
classified into two main groups. The first group supports the “concentration-stability”
view and argues that concentration of the banking sector will enhance stability, as a
negative relation between concentration and risk-taking behavior is found (e.g. Salas
and Saurina, 2003; Jiménez et al., 2007; Liu et al., 2012), while the second group supports
the notion of “competition-stability,” that is, competition will support stability, as a
negative relation between competition and bank risk is found (e.g. De Nicolo et al., 2004;
Boyd et al., 2006; Koetter and Poghosyan, 2009).
Proponents of the “concentration-stability” view argue that a highly (less)
concentrated banking sector with high (low) market power and low (high) competitive
pressures will tend to increase (decrease) profits and increase (reduce) the franchise
value, which encourages bank managers to decrease (increase) their risk taking[4].
In line with these arguments, Konishi and Yasuda (2004) find empirical evidence that a
decline of franchise value increases bank risk. Similarly, Salas and Saurina (2003) and
Jiménez et al. (2007) show in a sample of Spanish banks that liberalization increases
competition, reduces market power and decreases charter value, which leads to high
exposure to bank risk. Furthermore, Boot and Thakor (2000) argue that capital market
competition reduces relationship lending, which is defined as the close ties between a
firm and the financial institution. In a more recent study, Liu et al. (2012) use a sample
of four Southeast Asian countries and find that competition does not increase bank
risk-taking behavior, while concentration is inversely related to bank risk, as more
concentrated banking systems are less susceptible to systemic failure. Similarly,
Beck et al. (2006) argue that high competition is associated with greater banking system
fragility and leads to financial crisis. However, Martinez-Miera and Repullo (2010)
argue that the relation between competition and bank risk is a U-shaped relationship,
as more competition leads to lower loan rates, which consequently leads to lower
probabilities of loan default and, therefore, less risky banks; however, lower loan rates
reduce bank revenues and cause banks to be more risky.
Contrary to this “concentration-stability” view, many studies have adopted the
opposite view supporting the notion of “competition-stability” because there is
empirical evidence that competition reinforces stability. In a cross-country analysis,
De Nicolo et al. (2004) test the relation between consolidation and bank risk taking
for the 1995-2000 period using three- and five-firm concentration ratios as a standard
measure of consolidation and the Z-index to measure bank risk, and they argue
that highly concentrated banking systems show higher levels of systemic risk than
MF less-concentrated systems, suggesting more bank fragility. Analogously, Boyd and
41,9 De Nicolo (2005) argue that less competition and a more concentrated banking industry
will allow banks to charge high interest rates, which will affect the lending market
by decreasing borrowers’ profits, pushing firms to take more risks and, hence,
increasing fragility and bank crisis. Similarly, Koetter and Poghosyan (2009) use a
sample of German banks for the period from 1994 to 2004 and find empirical evidence
878 that market power will increase corporate risks, as banks will engage in risky projects
and will be unable to repay bank loans exposing banks to bank distress. In a similar
manner, for a large sample of banks in developed countries, Berger et al. (2009) find that
banks with high market power (measured by the Lerner index of bank competition and
Herfindahl-Hirschman deposit and loan indices as proxies for bank concentration) have
less overall risk, as measured by the Z-index; however, these banks have high loan
risk, as measured by the ratio of non-performing loans. In line with the concentration-
fragility view, Uhde and Heimeshoff (2009) find evidence that banking concentration
(measured by three- and five-concentration ratios) has a negative impact on banks’
financial soundness (proxied by the Z-score) in the European Union in the period from
1997 to 2005. Similarly, Boyd et al. (2006) provide empirical evidence of a positive and
significant relationship between banking concentration and the probability of failure.
From the above discussion, it is evident that the relationship between concentration
and bank risk, although significant, remains mixed and needs to be examined within the
context of the Egyptian banking sector following the period of consolidation that took
place from 2004 to 2008. Under its reform plan, the Egyptian government aimed to
consolidate the Egyptian banking sector and to create new, strong entities that are
suitable for external and internal competition (CBE, 2010). This raises the question of
whether the reform plan was successful in consolidating the banking sector, creating
strong entities and reducing banks’ risk-taking behavior. The underlying theory is that
less competition in highly concentrated markets will increase banks’ franchise value and
mitigate bank risk-taking behavior in order for banks to avoid losing their high franchise
value. In contrast, high competition in less-concentrated markets will reduce banks’
franchise value, and thus, they will increase their risk, leading to financial instability
( Jiménez et al., 2007). Therefore, I hypothesize that the consolidation of Egyptian banks
would have favorable effect on mitigating the risk-taking behavior of banks:
H1. Concentration in the banking sector is negatively associated with bank risk
taking.
2.2 Ownership structure and bank risk-taking behavior

The entry of foreign banks and the increase of foreign shares in the banking sector
motivate many scholars to study the effect of foreign ownership on the performance
and the risk-taking behavior of banks[5]. Many studies argue that the ownership
structure of banks is a significant determinant of bank risk-taking behavior and
performance (e.g. Demirgüç-Kunt et al., 1998; Barth et al., 2004; Yeyati and Micco, 2007;
Angkinand and Wihlborg, 2010)[6].
The entry of foreign banks implies benefits and costs for the banking sector and,
ultimately, for the whole economy. These advantages and disadvantages of foreign
ownership are extensively examined in the literature[7]. Regarding the benefits of foreign
ownership in banks, prior studies suggest that foreign bank entry will diversify risk
(Berger et al., 2005) and increase the efficiency of the banking sector due to increased
competition, which reduces costs and enhances profits (Claessens et al., 1998). Foreign
ownership increases the supply of credit, as these banks have better access to capital Bank risk
markets, and improves the allocation of this credit to domestic firms, which strengthens taking in an
the financial system (Giannetti and Ongena, 2009). Moreover, Levine (1996) suggests that
foreign banks improve the quality and availability of financial services due to high
emerging
competition, introduce better skills and technology, enhance banks’ supervisory and legal economy
framework, and enhance the access to international capital markets. In particular,
foreign banks will offer many services to multinational firms that are not provided 879
locally and provide information technologies to the developing countries, which help
these countries better manage quantitative information (Berger et al., 2005). Further,
Choi and Hasan (2005) argue that foreign banks transfer knowledge and superior
technology to local banks, conduct business with more expertise relative to local
banks and drive management to adapt more transparent, competitive and efficient
operating strategies. In line with these arguments, many other studies support the
positive effect of foreign banks and their favorable effect on the operations of domestic
banks (Claessens et al., 2001).
However, the preceding benefits are not without costs. For instance, foreign
banks will have difficulty managing from a distance and coping with different
economic and regulatory environments (Berger et al., 2005). The presence of foreign
banks exerts competitive pressure on domestic banks and decreases their franchise
value and eventually forces them to increase their risk to confront this competition
(Hellmann et al., 2000). In addition to the costs to domestic banks, local entrepreneurs
and the government will also be negatively affected. Local entrepreneurs may obtain
fewer services, as foreign banks will focus on multinational firms, and the
government control of the economy will be reduced (Stiglitz, 1993).
The relationship between foreign bank ownership and bank risk has been widely
studied. Laeven (1999) argues that foreign-owned banks take little risk relative to other
banks in the East-Asian region. Likewise, Demirgüç-Kunt et al. (1998) find that foreign
ownership reduces financial fragility and makes banks less prone to financial crisis.
Supporting this view, Barth et al. (2004) find that barriers to foreign bank entry are
positively associated with bank fragility. Choi and Hasan (2005) show that the extent of
the foreign ownership has a significant positive effect on bank return and a significant
negative effect on bank risk in Korea. Chou and Lin (2011) support the notion that
foreign banks are less risky in a sample of Taiwanese banks and provide evidence that
foreign institution ownership is associated with lower overdue loans and higher
regulatory capital.
On the contrary, the entry of foreign banks is associated with increase in risk, as found
by studies such as Unite and Sullivan (2003), who test this relation in the Philippine
banking market using the ratio of loan loss provisions (LLP) to measure risk. In a
cross-country study, Angkinand and Wihlborg (2010) reach a similar result and argue that
foreign ownership is associated with higher risk taking, as measured by the Z-score.
Similarly, in a sample of Latin American banks, Yeyati and Micco (2007) find that foreign
banks are riskier than domestic banks. In Russian banks, Fungáčová and Solanko (2008)
find evidence that foreign banks have higher insolvency risk than domestic banks during
the period from 1999 to 2007, suggesting that foreign-owned banks bear higher risks.
De Nicolo and Loukoianova (2007) posit that in non-industrialized countries, the risk
profiles of foreign banks are significantly higher than domestic banks, and this relation
depends on country- and firm-specific characteristics.
The relation between the foreign-owned banks and bank risk-taking behavior
is still controversial, although it is highly examined in the literature in cross-country
MF analysis and studies on individual countries. The results differ from one country
41,9 to another according to country- and firm-specific characteristics (De Nicolo and
Loukoianova (2007). This study aims to fill this gap in the literature by examining
the relationship between foreign ownership and bank risk taking in Egypt as an
emerging country. This should be of importance to policy makers and planners,
specifically given the implementation of the 2004 reform plan and entry of the foreign
880 banks. The foreign bank entry may have favorable effects on domestic banks
by increasing the competition in the host country ( Jeon et al., 2011) and therefore
increasing their efficiency. However, increased competition may reduce the profits and
charter value of domestic banks, increasing their risk and making them vulnerable
(Claessens et al., 2001). Furthermore, prior studies find evidence that foreign banks
achieve more favorable performance in developing countries than in developed

countries (e.g. Claessens et al., 2001; Bonin et al., 2005; Micco et al., 2007). This may refer
to the high technology, skills, financial services and other benefits transferred by the
foreign banks and will be of more interest to developing countries than to developed
countries. As a result, one could expect that the entry of foreign banks in a developing
country such as Egypt would be of high benefit for the Egyptian banking industry and
that the advantages of the foreign ownership will outweigh the disadvantages.
Therefore, a negative relation between the foreign ownership and bank risk-taking
behavior would be expected, and the following hypothesis is developed:
H2. Foreign bank ownership is negatively associated with bank risk taking.
3. Empirical analysis
3.1 Sample and data
The sample for the study includes all banks actively operating in Egypt and registered
with the Central Bank of Egypt (CBE) during the 2000-2011 period. To be included in
the sample, a bank must have data available in Bankscope and Kompass-Egypt[8].
Observations are pooled across banks and years, resulting in a sample of 576
bank-years from 48 banks over the 2000-2011 period. Estimates for this sample period
examine the relationship between consolidation and foreign ownership on one hand
and bank risk on the other hand.
Definitions of all variables used in the study are shown in Table I. Banks with
missing values for any of the study variables are omitted from the regression analysis.
Therefore, the number of observations in each model includes only the banks with
complete data for all the variables used in the model. The financial data are obtained
from the Bankscope database, ownership data are collected from the Kompass-Egypt
financial yearbook, and individual bank financial statements are used to double-check
some variables. The variables introduced in Table I are described below in more detail.
3.1.1 Bank risk measures. This study employs three different risk measures as
dependent variables to proxy for bank risk taking, specifically, insolvency risk
and credit risk. Following prior literature, the insolvency risk, i.e., bank probability
of failure, is measured by the Z-score, an inverse measure of overall bank risk
(e.g. De Nicolo et al., 2004; Yeyati and Micco, 2007; De Nicolo and Loukoianova, 2007;
Fungáčová and Solanko, 2008; Angkinand and Wihlborg, 2010). The period average
Z-score is denoted as follows:
h i
Z i ¼ ROAAi þ EQ=TA i =sðROAAÞi
Variables Measures Source
Bank risk
taking in an
Dependent variable emerging
Z-score index Z-score Bank i’s average period return on assets Author-
plus average period capital asset ratio constructed economy
divided by the SD of asset returns
Loan loss provisions LLP Ratio of loan loss provisions to total loans Bankscope 881
Loan loss reserves LLR Ratio of loan loss reserves to total loans Bankscope
Explanatory variables
Three-bank assets CR-3 Ratio of the three largest bank’s assets Author-
concentration ratio over total banking sector assets. constructed
CR-3 ¼ 3 largest bank’s assets/total

Banking sector assets
Five-bank assets CR-5 Share of assets held by the five largest Author-
concentration ratio banks in the banking industry. constructed
CR-5 ¼ 5 largest bank’s assets/total
banking sector assets
Three-bank deposit CR3-D Share of deposits held by three largest Author-
concentration ratio banks in the banking industry. constructed
CR3-D ¼ 3 largest bank’s deposits/total
banking sector deposits
Herfindahl- HHI-A Sum of squared market shares in banking Author-
Hirschman index industry in terms of total assets constructed
Herfindahl- HHI-D Sum of squared market shares in banking Author-
Hirschman index industry based on total deposits constructed
Foreign ownership FORN% The percentage of shares owned by Kompass-Egypt
foreigners
FOR A dummy variable that takes the value of Kompass-Egypt
one if 50% or more of the bank shares are
owned by foreigners and zero otherwise
Bank-specific variables
Government GOV The percentage of shares owned by Kompass-Egypt
ownership government
Bank size SIZE Natural logarithm of bank total assets Bankscope
Liquidity LIQ Liquid assets divided by total assets Bankscope
Diversification DIV Non-interest income divided by operating Bankscope
income
Efficiency EFF Non-interest expenses divided by Bankscope
operating income
Bank lending LOAN Net loans divided by total assets Bankscope
Operating leverage FIXED Fixed assets divided by total assets Bankscope
Bank capitalization CAP Equity capital divided by total assets Bankscope
Bank profitability PROF Profits before taxes divided by total assets Bankscope
Bank reform RFM A dummy variable that takes the value of Author-
one for post-reform period (2005-2011) and constructed
zero for pre-reform periods (2000-2004)
Macroeconomic variables
GDP growth rate GDP Annual GDP growth rate CBE publications Table I.
Inflation CPI Consumer price index World Bank Variables definition
Note: The table presents the definition and measure for all the study variables and data source
MF where Zi is the period average Z-score for bank i, ROAAi is the period average return on
41,9 assets for bank i as a proxy for bank profitability, (EQ/TA)i is bank i ratio of period
average equity capital to total assets as a proxy for bank capitalization and σ (ROAA)i
is the standard deviation of bank asset returns as a proxy of volatility of bank returns.
Therefore, the Z-score components are profitability, capitalization and return volatility.
The Z-score ratio increases (decreases) with the increase (decrease) in profitability and
882 capitalization levels, and a decrease (increase) of the volatility of asset returns reflects
higher (lower) bank stability and soundness (instability and probability of failure).
Therefore, a high (low) Z-score means less (high) insolvency risk and risk taking. Due
to the unavailability of quarterly data for the financial variables used to calculate the
Z-score, annual data are used. I follow Berger et al. (2009) and use one observation per
bank for the Z-score measure while using 12 years of data to calculate this variable,
i.e., the ROAA and the equity-to-total-assets ratio for each bank is averaged over the
study period, and the standard deviation of the ROAA for each bank is calculated over
the 12 years. A positive relation is expected between concentration and foreign
ownership in the banking sector and the Z-score measure.
Following Liu et al. (2012), two additional risk measures are used to proxy for bank
credit risk; LLP and loan loss reserves (LLR)[9]. Prior literature uses non-performing
loans as a proxy for credit risk. However, the large number of missing non-performing
loan observations in the sample is prohibitively large. LLP is measured as the ratio of
LLP to total loans, and it shows the provisions or the funds actually used by banks to
cover losses of impaired loans (non-performing loans). LLR is the reserves determined
by banks to cover future expected losses, which may suggest higher bank risk
(Altunbas et al., 2007). High levels of LLP and LLR suggest an increase in bank credit
risk; therefore, a negative relationship is expected between bank concentration, bank
foreign ownership and bank credit risk as proxied by LLP and LLR.
3.1.2 Bank consolidation measures. Following prior literature in measuring
consolidation, concentration ratios and the Herfindahl-Hirschman indices are used
(e.g. Beck et al., 2006; Berger et al., 2009; Uhde and Heimeshoff, 2009; Yeyati and
Micco, 2007)[10]. In this paper, three concentration measures are used; the
concentration ratio for the largest three banks (CR-3) and the largest five banks
(CR-5) based on total bank assets and the Herfindahl-Hirschman index in terms of
total assets (HHI-A), defined as the sum of squared relative market shares of total
assets. The HHI-A is denoted as follows:
X
n
H H I A ¼ S 2i
i¼1
where S is the market share of bank i, calculated as the ratio of individual bank assets
to the total assets of the banking sector, and n is the number of banks. The HHI-A
measure in this study ranges from 0 to 1, where 0 indicates no concentration and 1
full concentration. Higher values for CR-3, CR-5 and HHI-A indicate high-market
concentration.
To check for the robustness of the results, I include two additional measures of
bank concentration, i.e., the three-bank deposit concentration ratio (CR3-D) (Rhoades
and Rutz, 1982), and HHI-A based on bank deposits (HHI-D) (Boyd et al., 2006; and
Jiménez et al. 2007).
3.1.3 Bank foreign ownership measures. Following prior literature, foreign status Bank risk
(FORN%) is designated if at least 50 percent or more of the bank shares are owned by taking in an
foreigners (e.g. Lee et al., 2012). Foreigners may include individuals, banks or any
foreign institutions. To test the robustness of the results, this study includes a dummy
emerging
variable (FOR) that takes the value of one if 50 percent or more of bank ownership is economy
held by foreigners and zero otherwise (Claesssens et al., 2001; Yeyati and Micco, 2007;
Jeon et al. 2011). The foreign ownership data are presented annually in Kompass-Egypt. 883
3.1.4 Measures of control variables. The following bank-specific and macroeconomic
variables are used in all regressions to capture the effects of bank reform, government
ownership, bank size, liquidity, diversification, cost efficiency, lending behavior and
operating leverage. The literature on bank ownership suggests that public sector banks
have poorer loan quality and higher insolvency risk than other types of banks (Iannotta
et al., 2007) and are less efficient than private ownership (Bonin et al., 2005). In emerging
countries, Mian (2003) argues that the three dominant types of bank ownership are
government, private domestic and foreign banks, and finds that government banks
perform poorly in terms of profitability, are under-capitalized, have high loan default
rates, have low sensitivity to macro shocks and survive only due to strong external
support provided from the government in times of trouble. To control for the effect of
government ownership on bank risk, GOV, the percentage of bank shares held by
government, will be included. Therefore, a negative (positive) relationship is expected
between the Z-score measure (credit risk) and government ownership.
Prior studies control for bank size, the natural logarithm of total assets (e.g. Liu et al.,
2012; Forssbaeck, 2011), as larger banks have more incentives to increase their risk than
smaller banks, believing that they are “too big to fail.” Thus, larger banks are expected to
take higher risk due to their complexity and less transparency (Beck et al., 2006). To
control for bank liquidity, LIQ, the ratio of liquid assets to total assets is included and
expected to be negatively associated with bank credit risk, as liquid banks are expected
to be safer and have less risky portfolios, while less liquid banks will have more risky
portfolios. However, liquid assets do not generate high yield; therefore, highly liquid
banks will not be profitable (Delis and Staikouras, 2011). Thus, a negative relation is
expected between liquidity and the Z-score measure, i.e., liquid banks will have lower
Z-score values. Following De Haan and Poghosyan (2012), Diversification (DIV ),
measured by the ratio of non-interest income to total income, indicates a bank’s ability to
diversify its income from sources other than traditional bank activities. It is expected that
well-diversified banks have lower risk, i.e., high diversification will increase the Z-score
measure and decrease the credit risk measures. To control for cost efficiency (EFF ), the
ratio of non-interest operating costs to total income is used (Boyd et al., 2006), as cost
inefficiency has an adverse effect on bank risk. Thus, the increase in the efficiency ratio is
expected to increase bank risk, reflected in high LLP and LLR ratios and a low Z-score.
The study also includes LOAN, the ratio of bank net loans to total assets to proxy
for bank lending behavior and asset composition, as one would expect that an increase
in bank loans will increase bank risk (Altunbas et al., 2007; Liu et al., 2012). To account for
bank operating leverage, the ratio of fixed assets to total assets (FIXED) is included
(Saunders et al., 1990), which shows that the increase in the bank’s fixed assets increases
the fixed cost, which is expected to be positively related to bank risk.
The following two bank-level control variables are used in regressions of credit risk
measures as dependent variables. Bank capital, CAP, measured by the ratio of bank
equity capital to total assets, is commonly used in the vast literature to control for bank
MF capitalization and proxy for leverage, as bank capital absorbs various bank risks.
41,9 Well-capitalized banks will be less risky than banks with low capital ratios; therefore,
a negative relation between capital ratios and bank credit risk measures is expected.
PROF is the ratio of bank profits before taxes to total assets and is included to account
for bank profitability, as high profitability may encourage banks to include risky assets
in their loan portfolios, which therefore increases their credit risk. However, high bank
884 profitability may mitigate bank managers’ risk-taking behavior and induce them to
take less risk. Thus, no directional prediction could be made for the PROF variable.
Further, to control for the effect of the 2004 reform plan, a dummy variable (RFM )
taking the value of one for the post-reform and restructuring period (2005-2011) and a
value of zero otherwise will be included in all regression specifications. The banking
sector reform plan results in restructuring events that affect banks’ risk and
performance (Brissimis et al., 2008), and should thus be considered when examining the
association between the study relationships. A positive (negative) relationship is
expected between the Z-score measure (credit risk measures) and the reform dummy
variable, as bank reform is expected to enhance bank stability. To take into account the
macroeconomic indicators that may affect bank assets’ quality and, thus, bank risk,
two main measures are included in the empirical models. GDP and inflation rates are
used to control for change in the economic development and economic environment.
The GDP annual growth rate is used to control for the economic conditions that may
affect the bank’s investment opportunities and therefore bank risk-taking behavior.
The GDP data are obtained from the CBE time-series publications. In addition, the
Consumer Price Index (CPI) is included to control for annual inflation. The high
inflation rate is expected to have an adverse effect on bank risk. The CPI data are
retrieved from the World development indicator provided by the World Bank.
3.2 Summary statistics and correlation

The descriptive statistics for the entire set of included variables are reported in Table II.
The table presents the descriptive statistics for the various bank characteristics
variables, in addition to those for the macroeconomic variables.
In Table II, bank risk variables show that the mean (median) Z-score of the sample is
approximately 15.68 (12.76), which is close to that reported by Pathan (2009) for a
sample of large US bank holding companies, but higher than the Z-score mean reported
by Bourgain et al. (2012) of 3.99 for a sample of banks in emerging countries. Thus, the
Z-score in this study indicates that the Egyptian banking system is more stable and
displays less variation across banks (1.17-53.02). Focussing more on the Z-score
components, Table II shows that the mean (median) ROAA is 0.98 (0.765), with a
minimum (maximum) of –2.103 (8.280). The σ (ROAA) shows a mean (standard
deviation) of 1.17 (1.12), which is slightly higher than the mean recorded by Uhde and
Heimeshoff (2009) of 0.985. The mean (median) (EQ/TA) ratio of 11.045 (8.734) is
slightly less than that reported by Boyd et al. (2006) of 11.71 and higher than mean
reported by Uhde and Heimeshoff (2009) of 7 percent. The means of ROAA, σ (ROAA)
and (EQ/TA) are comparable to those reported by Barry et al. (2011) in a sample of
European banks.
Bank concentration measures show that mean (median) CR-3 and CR-5 are 0.434
(0.433) and 0.526 (0.530), respectively, implying that approximately half of banking
sector assets are held by the largest five banks. Additionally, the statistics reveal that
50 percent of the banking sector deposits are concentrated in three banks, as shown by
Variable Obs Mean Median SD Minimum Maximum
Bank risk
taking in an
Bank characteristics of the entire sample
emerging
Bank risk variables
Z-score 406 15.684 12.760 12.041 1.173 53.022 economy
LLP 343 2.969 1.705 5.575 −1.81 50.650
LLR 355 13.482 11.070 10.712 0.820 96.350
ROAA 415 0.982 0.765 1.581 −2.103 8.280 885
σ(ROAA) 416 1.175 0.826 1.126 0.000 5.780
(EQ/TA) % 414 11.045 8.734 8.810 3.207 56.788
Bank concentration variables
CR-3 576 0.434 0.433 0.013 0.404 0.454
CR-5 576 0.526 0.530 0.019 0.486 0.548

HHI-A 576 0.087 0.087 0.006 0.077 0.099
HHI-D 576 0.113 0.113 0.007 0.097 0.124
CR3-D 576 0.502 0.508 0.018 0.455 0.522
Bank ownership variables
FOR 348 0.333 0.000 0.472 0.00 1.00
FORN% 348 36.442 35.980 36.167 0.00 100
GOV% 376 41.765 32.500 37.143 0.00 100
Bank-specific variables
SIZE 416 3.956 3.965 0.553 2.357 5.486
LIQ 408 28.716 26.723 17.231 0.893 79.049
CAP 414 10.989 8.578 9.454 2.28 69.22
DIV 395 46.470 43.013 20.054 −48.052 99.03
EFF 382 49.177 46.680 18.511 −0.050 99.90
PROF 412 0.980 0.890 2.425 −24.439 19.68
LOAN 413 0.456 0.446 0.177 0.0002 0.938
FIXED 407 0.011 0.009 0.009 0.0002 0.087
RFM 576 0.583 1.000 0.493 0.00 1.00
Macroeconomic variables
GDP 576 5.017 4.750 1.416 3.1 7.2
CPI 576 8.058 8.481 4.647 2.269 18.316
Note: The table presents the distribution of variables by showing mean, median, standard deviation, Table II.
minimum and maximum. See Table I for variable definitions Descriptive statistics
CR3-D. It is worth mentioning that although the number of banks decreased

substantially during the sample period, starting from 62 banks in the year 2000 and
reaching 39 banks in the year 2011, the same three government-owned banks
dominated the financial sector market, with a combined market share for customer
deposits and assets of approximately 48 percent and with the ratio of their number of
branches to the total number of branches in the financial sector of 31 percent, as
published by the CBE. With regard to bank ownership, the mean (median) of FORN%
in Table II is 36.4 percent (35.9 percent), while the mean (median) value of GOV is
41.7 percent (32.5). Turning to the bank-specific variables in Table II, the bank liquidity
LIQ mean (median) is 28.7 (26.7), denoting high bank liquidity. The CAR CAP is
determined by the CBE and obligates all banks to maintain 10 percent as a minimum
capital ratio, which is shown in the mean of 10.98 percent for the bank capital ratio.
There is wide variation in bank diversification across banks, as measured by the
ratio of non-interest income to operating income (minimum: −48.05; maximum: 99.03).
MF Finally, the operational leverage (FIXED) ratio reflects very low ratio of fixed assets to
41,9 total assets (mean is 0.011), which is normal in the banking industry and reflects
the fact that banks are characterized by high financial leverage to increase their
lending levels.
When the descriptive statistics for the bank-specific variables of the sample are
split into pre-reform (2000-2004) and post-reform (2005-2011) periods to capture the
886 differences between the two periods, some implications were observed. For brevity,
the descriptive statistics for pre- and post-reform periods are omitted. The mean
(median) of all bank-specific variables are greater in the post-reform period than those
reported for the pre-reform period, except for operational leverage (FIXED), which
remains the same. For instance, LIQ mean for the pre-reform (post-reform) period is
21.7 (34.5), denoting an increase in bank liquidity after restructuring. The mean
(median) CAR CAP is 10.2 percent (7.9 percent) for the pre-restructuring period and
increases to 11.7 percent (9.6 percent) in the post-restructuring period. Likewise, bank
size (SIZE ) mean (median) increases from 3.7 (3.6) in the pre-reform period to 4.2 (4.1) in
the post-reform period, indicating that reform and restructuring activities lead to an
increase in bank size. Similarly, the mean (median) PROF of 1.03 (1.2) in the post-reform
period is higher than that reported in the pre-reform period of 0.91 (0.56). Finally, the
mean (median) EFF is 47.9 (45.1) for the pre-restructuring period and increases to 50.3
(49.1) in the post-restructuring period.
Furthermore, Table III presents the concentration and foreign ownership ratios for
the Egyptian banking sector from 2000 to 2011. In Table III, average of CR-3 for the
pre-restructuring period 2000-2004 is 42.98 percent, while that for the post-restructuring
years 2005-2011 is 43.75 percent. The foreign ownership ratio is calculated as the
number of banks with 50 percent or more foreign-owned banks in the total number
of banks. The ratio shows increase in the foreign ownership from 9.67 percent in
2000 to 35.90 percent in 2011. The average foreign ownership is 10 percent for the
2000-2004 period and 33 percent for the 2005-2011 period.
Table IV displays the Pearson pairwise correlation matrix between the main
variables of the study.
As shown in Table IV, the highest correlation coefficient is 0.753, which is between
the LLP and LLR regressors; therefore, the relatively low levels of correlation between
the study’s independent variables indicates that multicollinearity should not be of
concern. The correlation coefficients between CR-3 and the Z-score, LLP and LLR risk
measures are insignificant. Unexpectedly, the correlation coefficient between FORN%
and the Z-score is significantly negative, while the coefficients for LLP and LLR are
negative, as expected, but not significant.
Years 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011
No. of banks 62 62 62 62 61 52 43 41 40 39 39 39
CR-3 42.67 43.32 43.12 43.47 42.32 44.38 44.79 42.77 40.42 43.64 45.40 45.02
CR-5 50.17 53.92 52.52 53.39 52.62 54.17 54.88 50.09 48.58 52.65 54.41 54.01
CR3-D 52.12 52.20 51.17 49.94 48.39 51.15 51.60 48.37 45.53 50.08 50.72 51.00
Table III. Foreign ownership % 9.67 9.67 9.67 11.29 9.84 15.38 27.91 41.46 37.50 35.90 35.90 35.90
Concentration ratios No. of banks ⩾ 50% 6 6 6 7 6 8 12 17 15 14 14 14
and foreign foreign ownership
ownership ratio Note: The table presents concentration and foreign ownership ratios for Egyptian banking sector
Variables 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19
1 Z-score 1.00
2 LLP −0.106** 1.00
3 LLR −0.169* 0.753* 1.00
4 CR-3 0.020 −0.062 0.055 1.00
5 FORN% −0.221* −0.054 −0.073 0.040 1.00
6 CR × RFM 0.119* −0.077*** 0.167* 0.662* −0.020 1.00
7 FOR × RFM −0.178* −0.108** −0.118** 0.156* 0.588* 0.156* 1.00
8 RFM 0.098** −0.086** −0.145** 0.292* 0.348* 0.129* 0.698* 1.00
9 GOV 0.188* 0.052 0.110** −0.033 −0.696* 0.010 0.544* −0.215* 1.00
10 SIZE 0.108** −0.186* −0.162* 0.109** −0.148* 0.050 0.158* 0.411* 0.244* 1.00
11 DIV −0.023 0.099** 0.190* −0.086** −0.334* 0.051 0.413* −0.285* 0.308* −0.185* 1.00
12 EFF −0.321* −0.080*** 0.095** 0.005 0.035 0.017 0.026 0.064 0.002 −0.092** 0.114** 1.00
13 LIQ −0.099** 0.041 0.191* 0.034 0.485* −0.019 0.498* 0.369* −0.313* 0.137* −0.172* 0.044 1.00
14 LOAN 0.067*** −0.274* −0.475* −0.092** −0.327* −0.057 −0.270* −0.264* 0.141** −0.163* −0.088** −0.078*** −0.688* 1.00
15 FIXED −0.135* 0.098** 0.147* 0.034 0.330* 0.023 0.179* 0.017 −0.370* −0.339* 0.063 0.208* −0.055 −0.050 1.00
16 PROF 0.261* −0.444* −0.322* −0.001 0.117** 0.000 0.010** 0.023 −0.152* 0.070*** −0.003 −0.375* 0.049 −0.049 0.129* 1.00
17 CAP 0.347* −0.062 −0.136* 0.004 0.165* −0.011 0.049 0.081** −0.211* −0.275* 0.092** −0.064* −0.074*** 0.065*** 0.157* 0.500* 1.00
18 GDP −0.013 0.001 −0.030 −0.233* 0.248* −0.290* 0.486* 0.631* −0.145* 0.232* −0.166* −0.005 0.253* −0.159* −0.056 0.039 0.067*** 1.00
19 CPI −0.011 −0.058 −0.066 −0.316* 0.289* −0.375* 0.469* 0.612* −0.185* 0.370* −0.255* 0.119* 0.358* −0.206* 0.011 0.036 0.053 0.542* 1.00
Notes: The table shows Pearson pairs-wise correlation matrix. *,**,***Significant at 1, 5 and 10 percent levels, respectively. Variables definition is presented in Table I
emerging
economy
Bank risk
Correlation matrix
Table IV.
887
taking in an
MF 3.3 Econometric models
41,9 Following prior studies (e.g. Yeyati and Micco, 2007; Barry et al., 2011), this study uses
pooled Ordinary Least Squares (OLS) regression models under two main analyses to
test the relation between concentration and foreign ownership on one hand and bank
risk-taking behavior on the other hand, where observations are pooled across banks
and years for the 2000-2011 period.
888 The reform plan was launched in 2004 and resulted in various restructuring
activities in the banking system. Thus, to control for the effect of implementing the
financial sector reform plan on bank insolvency and credit risk, this study includes a
reform dummy variable (RFM ) for the post-reform period in models testing the
association between consolidation, foreign ownership and bank risk. Therefore, this
categorical variable identifies whether bank risk is related to the reform activities that
have been observed during the post-restructuring period, 2005-2011. Moreover, to
accommodate the possibility that effects of bank concentration and foreign ownership
on bank risk differ due to the implementation of the reform plan, I create two
interaction terms: one uses the product of the reform dummy variable and
concentration measures, while the other uses the product of the reform dummy and
foreign ownership variables to capture interactions. These interaction terms and the
dummy variable provide ample room to capture the effect of bank concentration and
foreign ownership on bank risks during the post-reform period.
Many tests are used to ensure unbiased estimates of coefficients are obtained
and, thus, confirmed using OLS regression. OLS assumes normality, linearity,
homoscedasticity and the independence of errors (Tabachnick and Fidell, 2006).
Histograms and scatter plots are used to assess normality, linearity and
homoscedasticity assumptions[11]. For the independence of errors, I use the
Durbin-Watson statistics, which suggest no presence of autocorrelation in the
residuals. These methods confirm that OLS assumptions are met in all regression
models. The dependent variables used in this study are continuous variables
(i.e. unlimited dependent variables that take a greater range of scores). “A normally
distributed error term implies an unrestricted range of variation in the dependent
variable. A severely restricted range of variation in the dependent variable tends to
undermine the assumption of normally distributed error” (Aldrich and Cnudde, 1975,
p.577). Multicollinearity tests are also conducted on all regression models. The variance
inflation factor (VIF) is used to test for multicollinearity in the explanatory variables of
the data. Because mean VIF (tolerance) ranges from 2.17 (0.46) to 2.76 (0.36) for all
regression models in the study, no multicollinearity concerns are indicated. Although
this study is designed to explore the impact of foreign ownership on bank risk, possible
endogeneity between foreign ownership and risk may arise. Prior studies suggest that
ownership may be endogenous and influenced by firm risk and argue that investors
may choose to invest in banks with high risk to maximize their expected utility
(e.g. Gugler and Weigand, 2003). I use the Hausman test to determine if the continuous
variables FOR% and GOV are endogenous in models estimating the relation between
foreign ownership and risk, which would bias the estimated coefficients. The Hausman
test shows that endogeneity problems are not of concern[12]. Accordingly, OLS should
be an appropriate method to estimate the relations in this study.
3.3.1 Estimation of concentration and bank risk-taking equation. To examine the
first hypothesis (H1) and test the relation between bank concentration and risk taking,
a multiple time-series, cross-sectional regression analysis is used.
Models (1a-3c): bank risk ¼ f (concentration variables, control variables)
Three OLS regression models (Equation (1)-(3)) are formulated to empirically test the Bank risk
relation between concentration and bank risk using three different bank risk measures: taking in an
the Z-score as a proxy for bank soundness in model 1, in addition to LLP and LLR to
proxy for bank credit risk in models 2 and 3, respectively, and sub-models for different
emerging
concentration measures. The equations to be estimated are as follows: economy
Z scoreit ¼ b0 þ b1 CR 3t þ b2 RFM t þ b3 CR RFM t þ b4 GOV it 889
þ b5 SI Z E it þ b6 DI V it þ b7 EFF it þ b8 LI Qit þ b9 LOAN it
þ b10 FI X EDit þ b11 GDP t þ b12 CPI t þ eit (1)
where i and t denote bank i and time t, respectively; bank risk, the dependent variable,
is measured by Z-scorei as a proxy for insolvency risk. CR-3t, the main explanatory
variable, is a measure of concentration in year t. RFMt is a dummy for bank reform
years, and it is used to potentially highlight the effect of the reform plan that leads to
restructuring activities. CR × RFMt is the interaction term between concentration
measures and bank reform and shows the effect of bank concentration on bank risk in
the post-restructuring period[13]. GOVit, SIZEit, DIVit, EFFit, LIQit, LOANit and FIXEDit
are control variables for bank characteristics, in addition to two macroeconomic
variables; GDPt and CPIt, and εit is the error term. The variables are defined in Table I
and discussed in Section 3.1:
LLP it ¼ b0 þ b1 CR 3t þ b2 RFM t þ b3 CR RFM t þ b4 GOV it
þ b10 FI X EDit þ b11 CAP it þ b12 PROF it þ b13 GDP t þ b14 CPI t þ eit (2)
In Equation (2), LLPit is used to proxy for bank credit risk, CR-3t is a concentration
measure, RFMt is the dummy variable for reform years, CR × RFMt is the interaction
term, and the control variables include GOV, SIZE, DIV, EFF, LIQ, LOAN, FIXED, CAP
and PROF, in addition to GDP and CPI:
LLRit ¼ b0 þ b1 CR 3t þ b2 RFM t þ b3 CR RFM t þ b4 GOV it þ b5 SI Z E it
þ b6 DI V it þ b7 EFF it þ b8 LI Qit þ b9 LOAN it þ b10 FI X EDit
þ b11 CAP it þ b12 PROF it þ b13 GDP t þ b14 CPI t þ eit (3)
In Equation (3), LLR is used to proxy for bank credit risk, and all other variables are the
same as in Equation (2). Further, three sub-models (a-c) are created for each of the
previous Equation (1)-(3) using different concentration measures in each model to check
the robustness of the results. In particular, models 1a-3a, 1b-3b and 1c-3c assign CR-3,
CR-5 and HHI-D, respectively.
3.3.2 Estimation of foreign ownership and the bank risk-taking equation. Three
pooled OLS regression models (Equation (4)-(6)) are designed to estimate the relation
between foreign ownership and bank risk and to test the second hypothesis (H2).
Models (1a-3b): Bank risk ¼ f (Foreign ownership, control variables):
Z scoreit ¼ b0 þ b1 FORN %it þ b2 RFM t þ b3 FOR RFM it þ b4 GOV it
þ b10 FI X EDit þ b11 GDP t þ b12 CPI t þ eit (4)
MF where i and t denote bank i and time t, respectively, Z-scorei is a proxy for bank
41,9 insolvency risk, FORN% is a measure of foreign ownership and RFMt is the bank
reform dummy variable. FOR × RFMit is the interaction term between foreign
ownership measures and bank reform and shows the effect of foreign ownership on
bank risks during the post-restructuring period, and εit is the error term[14]. The
variables are defined in Table I. Moreover, two different risk measures are used to
890 proxy for bank credit risk: LLPit and LLRit in Equation (4)-(6), respectively. All
variables are defined in Section 3.1 and summarized in Table I:
LLP it ¼ b0 þ b1 FORN %it þ b2 RFM t þ b3 FOR RFM it þ b4 GOV it
þ b10 FI X EDit þ b11 CAP it þ b12 PROF it þ b13 GDP it þ b14 CPI it þ eit (5)
LLRit ¼ b0 þ b1 FORN %it þ b2 RFM t þ b3 FOR RFM t þ b4 GOV it

þ b10 FI X EDit þ b11 CAP it þ b12 PROF it þ b13 GDP it þ b14 CPI it þ eit (6)
As a robustness test, three separate additional models (1b, 2b and 3b) are created using
different measures of foreign ownership, i.e., dummy variable (FOR). In a separate
robustness section, the study describes several other approaches to ensure the validity
of the results.
4. Empirical results
Tables V and VI present the main regression results of the study sample; the relation
between explanatory and dependent variables is predicted, and the expected sign is
shown in the tables.
4.1 Effect of concentration on bank risk

The empirical results for testing the relation between concentration and bank risk are
presented in Table V, showing bank-level OLS regression estimates of Equation (1)-(3),
where the dependent variable is bank risk measured by the Z-score in models (1a-1c),
LLP in models (2a-2c) and LLR in models (3a-3c).
Models (1a, 2a and 3a) use CR-3 as the main explanatory variable, while CR-5 is
used in models (1b, 2b and 3b) and HHI-D in models (1c, 2c and 3c). Controls for
bank-specific variables and macroeconomic conditions are used in all models[15].
Model specification statistics show that all models (1a-3c) have highly significant
F-statistics at 1 percent level. The explanatory power is measured by R2 and adjusted
R2 and displayed for each model. The mean of the VIF is recorded for all models as
shown, and it indicates that the multicollinearity problem between the regressors in the
nine models is not substantial. The VIF statistics (<10) do not indicate any
multicollinearity concerns. The mean of the VIF ranges between 2.17 and 2.72 (VIF
more than 10 with tolerance less than 0.1 will indicate a multicollinearity problem),
which suggests that multicollinearity should not bias the estimates of the coefficients in
any of the study’s regression models (Pathan, 2009).
The results of estimating Equation (1) are presented in models (1a-1c) in Table V,
using the Z-score as the dependent risk measure and CR-3, CR-5 and HHI-D to proxy
Dep. v. Z-score (Equation (1)) LLP (Equation (2)) LLR (Equation (3))
Exp. v. p sign Model 1a Model 1b Model 1c p sign Model 2a Model 2b Model 2c p sign Model 3a Model 3b Model 3c
CR-3 + −0.340 − 0.145 − −0.210

(−1.670)*** (0.720) (−1.041)
CR-5 + −0.162 − −0.040 − −0.118
(−1.537)*** (−0.404) (−1.187)
HHI-D + −0.425 − 0.193 − −0.554
(−1.976)** (0.948) (−1.264)
RFM + 0.133 0.127 0.225 − −0.109 −0.094 −0.170 − 0.373 0.331 0.514
(1.760)** (1.509)** (2.138)* (−1.668)** (−1.766)** (−1.897)** (5.413)* (5.921)* (5.933)*
CR × RFM + 0.318 0.129 0.329 − −0.281 −0.107 −0.267 − 0.205 0.111 0.476
(1.613)** (1.211)** (1.921)** (−1.446)** (−1.078)** (−1.469)** (1.051)** (1.104)** (2.663)*
GOV − −0.157 −0.160 −0.159 + 0.312 0.310 0.305 + 0.327 0.328 0.324
(−2.697)* (−2.739)* (−2.728)* (5.576)* (5.542)* (5.008)* (5.860)* (5.882)* (5.877)*
SIZE − 0.129 0.141 0.145 + −0.133 −0.141 −0.129 + 0.002 0.013 0.028
(2.051)** (2.229)** (2.307)** (−0.636) (−1.741) (−1.593) (0.062) (0.355) (0.558)
DIV + −0.268 −0.265 −0.152 − 0.020 0.024 −0.069 − −0.050 −0.051 −0.059
(−0.836) (−0.682) (−0.705) (0.352) (0.436) (−1.126) (−0.877) (−0.901) (−1.046)
EFF − −0.395 −0.378 −0.373 + −0.314 −0.318 −0.320 + −0.149 −0.148 −0.176
(−7.747)* (−7.424)* (−7.322)* (−5.634)* (−5.744)* (−5.464)* (−2.690)* (−2.683)* (−3.158)*
LIQ − −0.074 −0.064 −0.052 − −0.214 −0.220 −0.225 − −0.128 −0.128 −0.164
(−1.082) (−0.926) (−0.767) (−3.049)* (−3.125)* (−3.051)* (−1.850)*** (−1.851)*** (−2.365)**
LOAN − −0.195 −0.198 −0.194 + −0.537 −0.542 −0.546 + 0.042 0.041 0.041
(−3.092)* (−3.131)* (−3.088)* (−7.770)* (−7.813)* (−7.891)* (0.667) (0.651) (0.664)
FIXED − −0.111 −0.112 −0.110 + 0.131 0.130 0.243 + 0.147 0.146 0.136
(−1.902)** (−1.924)** (−1.896)** (2.569)* (2.528)* (3.976)* (2.620)* (2.597)* (2.440)*
PROF ± −0.542 −0.558 −0.423 ± −0.138 −0.133 −0.144
(−7.277)* (−7.472)* (−6.362)* (−2.129)** (−2.054)** (−2.252)**
CAP − 0.299 0.308 0.304 − −0.233 −0.235 −0.234
(4.177)* (4.290)* (4.261)* (−4.175)* (−4.209)* (−4.245)*
GDP + 0.060 0.056 0.051 − 0.024 −0.046 0.015 − 0.036 0.090 0.063
(0.672) (0.563) (0.554) (0.257) (−0.431) (0.213) (1.204) (1.392) (1.296)
(continued )
emerging
economy
concentration and
bank risk
Regression results of
Bank risk
Table V.
891
taking in an
MF
41,9
892
Table V.
Exp. v. p sign Model 1a Model 1b Model 1c p sign Model 2a Model 2b Model 2c p sign Model 3a Model 3b Model 3c
CPI − 0.042 0.061 0.074 + −0.043 −0.051 −0.093 + −0.064 −0.020 −0.103
(0.437) (0.786) (0.947) −(0.414) (−0.619) (−0.759) (−0.977) (−0.370) (−1.360)
Model specification statistics
Observations 311 311 311 265 265 265 289 289 289
F-stat 13.913* 13.863* 14.090* 14.776* 14.659* 14.589* 16.095* 16.141* 17.063*
R2 0.294 0.293 0.296 0.328 0.326 0.388 0.390 0.391 0.404
2
Adj. R 0.273 0.272 0.275 0.306 0.304 0.362 0.366 0.366 0.380
Mean VIF 2.43 2.40 2.34 2.24 2.56 2.17 2.69 2.72 2.25
Notes: The variables are defined in Table I. The coefficients are reported with t-values in parenthesis. The p sign is the predicted sign for each variable in the
regression (shown only for Panel A for brevity). Mean values of variance inflation factor (VIF) are used to test for multicollinearity in the regression. As the rule
of thumb, if VIF exceeds 10 (tolerance is less than 0.1), multicollinearity will be a problem. The constant term is included in all the regression analyses but not
reported in the results. *,**,***Significant at 1, 5 and 10 percent levels, respectively
Bank risk
Exp. v. p sign Model 1a Model 1b p sign Model 2a Model 2b p sign Model 3a Model 3b taking in an
emerging
FORN% + 0.147 − 0.120 − 0.102
(1.353)*** (1.011) (1.119) economy
FOR + 0.403 − 0.076 − 0.079
(4.340)* (0.739) (1.039)
RFM + 0.219 0.146 − −0.158 −0.017 − −0.283 −0.237
893
(2.219)** (1.654)** (−1.703)** (−1.175)** (−3.087)* (−2.936)*
FOR × RFM + −0.430 −0.448 − −0.348 −0.271 − −0.336 −0.269
(−3.560)* (−4.196)* (−2.648)* (−2.329)* (−3.307)* (−3.044)*
GOV − −0.162 −0.072 + 0.138 0.138 + 0.178 0.179
(−2.049)** (−1.921)** (1.765)** (1.937)** (2.885)* (3.172)*

SIZE − 0.140 0.141 + 0.490 0.489 + 0.707 0.716
(1.887)*** (1.913)** (5.789)* (5.448)* (10.415)* (10.460)*
DIV + −0.185 −0.142 − 0.110 0.119 − −0.002 0.004
(−3.088)* (−2.402)* (1.636)** (1.773)** (−0.048) (0.084)
EFF − −0.280 −0.273 + −0.234 −0.240 + −0.063 −0.059
(−5.030)* (−4.963)* (−3.855)* (−3.827)* (−1.311) (−1.225)
LIQ − 0.035 0.007 − 0.230 0.209 − 0.087 0.084
(0.526) (0.111) (2.902)* (2.589)* (1.403) (1.352)
LOAN − −0.018 −0.019 + 0.044 0.022 + −0.069 −0.078
(−0.276) (−0.284) (0.583) (0.292) (−1.218) (−1.393)
FIXED − −0.083 −0.103 + 0.153 0.147 + 0.083 0.078
(−1.240) (−1.578) (2.169)** (2.097)** (1.564)** (1.488)***
PROF ± −0.229 −0.227 ± −0.224 −0.214
(−3.077)* (−3.022)* (−3.889)* (−3.696)*
CAP − 0.211 0.202 − 0.126 0.112
(2.589)* (2.409)* (2.100)** (1.886)**
GDP + −0.023 −0.028 − 0.087 0.087 − 0.063 0.064
(−0.308) (−0.382) (1.168) (1.164) (1.094) (1.115)
CPI − −0.022 −0.010 + 0.082 0.095 + −0.007 0.000
(−0.300) (−0.135) (1.056) (1.239) (−0.119) (0.003)

Observations 300 300 255 255 279 279
F-stat 7.425* 8.247* 10.618* 9.345* 25.188* 24.921*
R2 0.221 0.240 0.345 0.353 0.572 0.569
Adj. R2 0.191 0.210 0.312 0.315 0.549 0.546
Mean VIF 2.50 2.19 2.76 2.50 2.72 2.40
Notes: The variables are defined in Table I. The coefficients are reported with t-values in parenthesis. The p sign is
the predicted sign for each variable in the regression (shown only for Panel A for brevity). Mean values of variance Table VI.
inflation factor (VIF) are used to test for multicollinearity in the regression. As the rule of thumb, if VIF exceeds 10 Foreign ownership
and tolerance is less than 0.1, multicollinearity will be a problem. The constant term is included in all the regression and bank risk
analyses but not reported in the results. *,**,***Significant at 1, 5 and 10 percent levels, respectively regression results
for bank concentration in models (1a-1c), respectively, in addition to the interaction

term. The estimates of the regression coefficients in the three models show the same
results and significance level, which ensures robustness. The results show that there is
a negative marginal significant relation at the 10 percent level between the three
concentration measures and the Z-score, suggesting that concentration has a negative
effect on bank insolvency risk. This result is consistent with the findings of Boyd and
De Nicolo (2005) and Koetter and Poghosyan (2009) that a more concentrated banking
MF industry increases fragility and bank crisis. With regard to the bank reform dummy
41,9 variable, as hypothesized, the coefficient on RFM is positive across all bank
concentration measures and statistically significant. That is, bank insolvency risk
decreases in the post-reform period. To examine the effect of bank concentration on
insolvency risk during the post-restructuring period, an interaction term between the
concentration measure and the reform dummy is incorporated in all models. Consistent
894 with expectations, the coefficient on the interaction term CR × RFM is positive and
statistically significant at the 5 percent level[16], suggesting that bank concentration
has a favorable effect on insolvency risk during the post-restructuring and reform
periods. Thus, the first hypothesis (H1) is supported for the post-reform period.
With regards to bank-specific variables, the coefficient on GOV is negative, as
expected, across all concentration measures and statistically highly significant

( p<0.001). This illustrates that government ownership is a significant determinant of
insolvency risk and supports the notion that public sector banks have higher
insolvency risk than other types of banks (Iannotta et al., 2007) due to poor loan quality
and high credit risk (Mian, 2003; Bonin et al., 2005). As predicted, EFF shows a highly
significant negative relation with the Z-score across the three models, indicating that
inefficient banks tend to assume higher risk to increase their profitability.
The coefficient on SIZE is positive and significant at the 5 percent level in models
(1a-1c), supporting the notion that large banks decrease the insolvency risk shown by
high Z-score values. As expected, FIXED enters the regression significantly negative at
the 5 percent level, indicating that high bank operating leverage is associated with high
insolvency risk (a low Z-score). LOAN enters negatively and significantly in all of the
Z-score specifications, suggesting that an increase in bank loans will increase bank
insolvency risk (Liu et al., 2012). LIQ and DIV fail to enter the regressions significantly,
indicating that bank liquidity and diversification have an insignificant impact on bank
risk-taking behavior. Regarding the macroeconomic variables, GDP and CPI were
found to have no influence on the Z-score.
Models (2a-2c) in Table V estimate Equation (2) and present the regression results
when including the dependent variable LLP and three different measures of
concentration; CR-3, CR-5 and HHI-D in models (2a-2c), respectively. Although the
coefficients on the three measures of concentration are insignificant in all three models,
the results also show that the impact of concentration depends on the reform of the
banking system. As predicted, the interaction term CR × RFM and the dummy variable
RFM enter negatively and significantly (p < 0.005) in the three regressions (2a-2c). This
gives support to the first hypothesis that bank concentration reduces bank risk taking
in post-restructuring period as banks become more concentrated.
The coefficients on bank-specific control variables offer some important insights.
The reported coefficient estimates in Table V for models (2a-2c) show that GOV, EFF,
LIQ, LOAN, FIXED, PROF and CAP are significant determinants of LLP. For instance,
GOV enters regression Equation (2) significantly positive, suggesting that government
ownership has an unfavorable impact on bank credit risk and supporting the notion
that public sector banks have poor loan quality (e.g. Bonin et al., 2005). The coefficient
on EFF shows a negative and significant relation with LLP at the 1 percent level in all
models, suggesting that inefficient banks, as they are less profitable, tend to be more
risk averse and decrease their credit risk in an attempt to avoid losses from high-risk
profiles. Expectedly, the coefficient estimate on LIQ shows a negative and highly
significant relation with LLP in all three models (2a-2c), implying that highly liquid
banks have lower credit risk. Surprisingly, the coefficient on LOAN is negatively
related to LLP, and this relation is significant at the 1 percent level in all models, Bank risk
indicating that a high-lending ratio decreases bank LLR. Although this result is against taking in an
the study’s predicted sign, it is consistent with Liu et al. (2012) and Altunbas et al. (2007).
As hypothesized, the coefficient on FIXED is positive and significant at the 1 percent level
emerging
for LLP in all models. This is similar to the findings of Chou and Lin (2011) and indicates economy
that banks with more fixed assets and a high number of branches take more risk. PROF is
found to be inversely related to LLP, and this relation is highly significant, indicating that 895
unprofitable banks increase their risk in an attempt to enhance their profitability.
Interestingly, the results show that the relation between bank capital CAP and LLP is
significantly positive, showing that banks with high capital levels (low leverage) increase
their risk. This implies that the increase in capital requirements under the Egyptian
financial reform plan induces banks to increase the riskiness of their portfolios. This
is consistent with the argument of Kim and Santomero (1988) and Rochet (1992) that
an increase in equity capital and a decrease in leverage are expensive and will lead to
a reduction in bank returns; therefore, banks will increase their risk to compensate for
the decrease in returns. Finally, the GDP and CPI fail to enter the regression significantly
in all three models.
The regression results of models (3a-3c), used to estimate Equation 1.3, are shown in
Table V. LLR are included as a proxy for credit risk, and three concentration measures,
CR-3, CR-5 and HHI-D, are used in models 3a, 3b and 3c, respectively. The coefficients
on CR-3, CR-5 and HHI-D are negative, as predicted, but statistically insignificant,
indicating that concentration does not affect bank credit risk (LLR). However, the
coefficients associated with the dummy RFM and the interaction term CR × RFM
provide some important insights regarding the influence of banking reform on bank
credit risk LLR. The coefficients on RFM and CR × RFM in models (3a-3c) in Table V
are positive and statistically significant for all concentration measures. That is, there
seems to be a significant effect of banking reform on credit risk, where more
concentrated banks increase their bank reserves in the post-reform and restructuring
periods. I may interpret this result to mean that more concentrated banks are more
prudent in the post-reform period regarding the management of their loan portfolios
and prefer to maintain higher levels of reserves to meet expected future losses. In this
context, Altunbas et al. (2007) argue that bank reserves are stock items in which
managers may determine the timing of these reserves at their discretion to minimize the
regulatory cost; therefore, it is argued in the literature that well-reserved banks have
substantial resources to decrease their losses and risk (Liu et al., 2012).
For the control variables, the results are the same for all coefficients and significance
levels throughout the three regressions (3a-3c), which ensures the robustness of the
results using different concentration measures. The interpretation of the coefficients in
models (3a-3c) remains the same as in models (2a-2c) for most of the control variables,
for instance, GOV, EFF, LIQ, FIXED, PROF and CAP. The results show a negative and
significant relation at the 1 percent level between EFF and LLR, indicating that
cost-inefficient banks tend to decrease their credit risk to avoid excessive losses.
As predicted, the LIQ coefficient is found to be negative and significant in all models
(3a-3c), suggesting that banks with highly liquid assets hold less reserves to meet
expected loan losses; this result is not consistent with Liu et al. (2012), who find that
liquidity has no significant impact on bank risk taking. The FIXED coefficient, as
predicted, records a positive significant relation at the 5 percent level, reflecting the
positive relation between operating leverage and bank credit risk. Similarly, the coefficient
on PROF is negative and significant, which may be interpreted to mean that high
MF profitability may encourage bank managers to take less risk. Finally, the results show a
41,9 negative and significant relation between CAP and LLR, suggesting that well-capitalized
banks decrease their loan reserves. As in models (2a-2c), the coefficients on SIZE, DIV,
GDP and CPI show no significant relation with bank credit risk.
In a nutshell, the results support the first hypothesis that bank consolidation
mitigates bank insolvency risk and credit risk in post-restructuring and reform periods
896 when measured by the Z-score and LLP, respectively. However, contrary to
expectations, the positive relation between the interaction term (CR × RFM) and LLR
suggests that bank consolidation in the post-reform period increases bank LLR, which
may be interpreted to mean that well-reserved banks are able to alleviate their credit
risk. Further, GOV, EFF and FIXED are important determinants of bank insolvency
and credit risk. To check for the robustness of the above results, two additional
concentration measures are used, i.e., HHI-A and CR3-D, to examine the effect of
concentration on bank risk (Z-score, LLP and LLR).
When these two additional explanatory variables are used to estimate Equation 1.1-
1.3, the same sign of the coefficients and significance levels are obtained, except for the
level of significance of the coefficient on LIQ with the LLP, which become insignificant
when using HHI-A. These additional models are not presented in a table for the sake of
brevity and simplification of the results.
4.2 Effect of foreign ownership on bank risk

Table VI presents the OLS regression models (1a-3b) with Equation 2.1-2.3, which are
used to examine the effect of foreign ownership on bank risk. To account for the effect
of implementing the 2004 reform plan and restructuring activities in the Egyptian
banking system, a reform dummy variable for the post-restructuring years (2005-2011)
and an interaction term between foreign ownership and the post-reform period are
included in all specifications[17].
In Table VI, the dependent variable, bank risk, is measured by the Z-score, LLP and
LLR in models (1a and 1b), (2a and 2b) and (3a and 3b), respectively. FORN%
(ownership percentage held by foreigners) is the main explanatory variable used in
models 1a, 2a and 3a, while FOR (dummy variable) is used in models 1b, 2b and 3b as
an additional measure of foreign ownership to check the robustness of the results.
Controls for bank reform, bank-specific and macroeconomic variables are included in
all models. Model fit statistics indicate that Equation (4)-(6) are properly fitted with
adjusted R2-values of 19.1, 21.0, 31.2, 31.5, 54.9 and 54.6 percent for models (1a-3b),
respectively. The F-statistic is highly significant for all models. The mean VIF for all
estimated models does not exceed 2.76, indicating that multicollinearity between
regressors is of no concern.
As shown in Table VI, the relationship between foreign ownership and bank
risk is estimated. Average foreign ownership, as calculated in Table III, is 10 percent
for the pre-restructuring period of 2000-2004 and increases to 33 percent in the
post-restructuring period of 2005-2011. In model 1a, where the Z-score is the
independent risk measure, the coefficient on FORN% is positive and statistically
significant at the 10 percent level. That is, foreign ownership is associated with low
insolvency risk, as shown by a higher Z-score. This result remains robust when using
the dummy variable (FOR) as a foreign ownership measure in model 1b. However,
including the dummy RFM and interaction term FOR × RFM in all specifications
provides the opportunity to glean more detailed insight into other factors that affect the
relationship between foreign ownership and bank risk. Against the predictions, the Bank risk
coefficient on FOR × RFM is negative and statistically significant at the 1 percent level taking in an
[18]. The results remain valid if foreign ownership is proxied by the dummy variable
FOR. This illustrates that after accounting for the reform effect on the relationship
emerging
between foreign ownership and insolvency risk, foreign ownership is found to be economy
associated with high insolvency risk in the post-reform period. Although evidence does
not support the second hypothesis (H2), it is in line with prior empirical studies arguing 897
that foreign banks are associated with higher insolvency risk as measured by the
Z-score (Angkinand and Wihlborg, 2010; Fungáčová and Solanko, 2008; Yeyati and
Micco, 2007; De Nicolo and Loukoianova, 2007).
Consistent with H2, when LLP and LLR are used as dependent variables in models
(2a-3b), coefficients associated with RFM and FOR × RFM are negative and highly
significant at the 1 percent level, and this finding is robust to the use of FORN% as an
alternative foreign ownership measure. In other words, foreign ownership is associated
with low credit risk in the post-reform period. This result may be interpreted to mean
that foreign banks follow more prudent policies in evaluating and pricing their credit
risks (Barth et al., 2004) in the post-restructuring and reform periods. Moreover, foreign
banks have stable sources of funding, as they have access to international markets and
depend on their parents (Giannetti and Ongena, 2009).
With regards to bank characteristics, GOV, SIZE, DIV and EFF appear to be
significant determinants of the Z-score in models (1a and 1b). While in models (2a-3b),
GOV, SIZE, FIXED, PROF and CAP are significant determinants of credit risk
measures. The coefficients on GOV are negative and statistically significant for the
Z-score measure, while they are positive and statistically significant for LLP and LLR
measures. These findings are consistent with predictions and provide support for the
notion that government ownership has an adverse effect on bank insolvency risk and
credit risk. Bank size (SIZE ) has a positive and significant effect on all bank risk
measures, suggesting that large banks decrease insolvency risk, while having
increased credit risk. All the results appear to be robust when using both measures of
foreign ownership. The interpretation of the results of these variables remains the same
as in Table V. Finally, coefficients on GDP and CPI are insignificant across all risk
measures. Further, the results of control variables for regressions in Table VI are
almost similar to those in Table V. Therefore, the interpretation of the results of these
variables remains the same as in Table V.
4.3 Robustness tests

To check the robustness of the study results, a number of additional robustness tests
are performed. First, I use five alternative bank concentration measures in all
regressions to re-estimate Equation (1)-(3). I report the regression results for three
measures only (CR-3, CR-5 and HHI-D) for simplicity purposes. Second, two foreign
ownership measures (FORN% and FOR) are used to estimate Equation (4)-(6) in
different specifications. Third, to examine the empirical association between
concentration, foreign ownership and bank risk, this study employs three different
bank risk measures (Z-score, LLP, LLR), where credit risk is proxied by two different
credit risk measures. Fourth, to ensure the validity of the results and to control for
outliers, all financial variables are winsorized at the 1 and 99 percent tails[19]. The main
results of all regressions are found to be unaffected by these changes and remain
robust. Furthermore, when all financial variables are winsorized at the top and bottom
5 percent of the distribution and all main regressions are re-estimated, the results are
MF found to remain qualitatively similar and unchanged[20]. For space and brevity
41,9 reasons, these results are not reported in the tables. Finally, as an additional analysis to
check the robustness of the main results of estimating Equations (1) and (4), each of the
Z-score components are examined separately, i.e., the Z-score is replaced with its
components in the regression models. Equations (1) and (4) are re-estimated using OLS
regression models, where the dependent variables are ROAA in models (1 and 2),
898 (EQ/TA) ratio in models (3 and 4) and σ (ROAA) in models (5 and 6) to proxy for bank
profitability, capitalization and the volatility of returns, respectively. The regression
results for the additional analyses are presented in Table VII and discussed below.
Dependent v. ROAA EQ/TA ratio σ (ROAA)

Explanatory v. Model 1 Model 2 Model 3 Model 4 Model 5 Model 6
CR-3 −0.187 0.239 0.237

(−3.289)* (4.540)* (4.056)*
FORN% 0.318 −0.182 −0.168
(3.407)* (−2.179)* (−1.820)**
RFM 0.100 0.157 0.126 0.267 0.222 0.050
(1.802)** (1.748)** (2.284)** (3.255)* (3.338)* (0.550)
CR × RFM −0.275 0.665 −0.433
(−5.081)* (10.929)* (−6.387)*
FOR × RFM −0.261 0.160 0.238
(−2.420)* (1.658)** (2.226)*
GOV −0.145 −0.143 0.244 0.074 −0.050 −0.058
(−0.525) (−2.054)** (0.908) (1.190) (−0.814) (−0.841)
SIZE −0.072 −0.080 0.152 −0.629 0.156 −0.447
(−1.153) (−1.097) (1.091) (−9.711)* (0.523) (−6.204)*
DIV 0.013 −0.203 −0.097 −0.251 0.028 0.236
(0.088) (−3.378)* (−0.443) (−4.688)* (0.181) (3.972)*
EFF −0.409 −0.282 −0.198 −0.215 0.005 −0.015
(−8.301)* (−5.262)* (−4.162)* (−4.501)* (0.093) (−0.287)
LIQ 0.014 −0.076 −0.106 −0.115 0.186 0.144
(0.211) (−1.009) (−1.648)*** (−1.709)** (2.594)* (1.939)**
LOAN −0.075 −0.141 −0.102 −0.154 −0.087 0.158
(−1.216) (−2.047)** (−1.711)*** (−2.498)* (−0.357) (2.317)**
FIXED 0.105 −0.050 0.107 0.133 0.037 0.019
(0.465) (−0.786) (1.983)** (2.352)* (0.616) (0.305)
GDP 0.014 −0.061 −0.049 −0.131 −0.080 −0.152
(0.172) (−0.863) (−0.595) (−1.946)** (−0.885) (−2.036)**
CPI 0.082 0.029 0.271 0.142 0.259 0.185
(0.860) (0.400) (2.906)* (2.179)** (2.504)* (2.552)*
Observations 315 303 314 302 315 303
F-stat 14.675* 8.907* 17.118* 17.418* 8.976* 9.547*
R2 0.368 0.269 0.406 0.420 0.263 0.283
Adj. R2 0.343 0.239 0.382 0.396 0.234 0.254
Mean VIF 2.600 2.304 2.610 2.342 2.422 2.344
Notes: The variables are defined in Table I. The coefficients are reported with t-values in parenthesis.
Mean values of variance inflation factor (VIF) are used to test for multicollinearity in the regression.
Table VII. As the rule of thumb, if VIF exceeds 10 and tolerance is less than 0.1, multicollinearity will be a
Regression results of problem. The constant term is included in all the regression analyses but not reported in the results.
Z-score components *,**,***Significant at 1, 5 and 10 percent levels, respectively
In Table VII, the main explanatory variable is the concentration measure CR-3 in Bank risk
models 1, 3 and 5, while the foreign ownership measure FORN% is used in models 2, 4 taking in an
and 6. Analyzing the components of the Z-score allows for more robust analyses for the
relation between bank concentration, foreign ownership and the Z-score.
emerging
Moreover, this analysis gives insight into how individual components of the Z-score economy
are affected by bank concentration to interpret the negative marginally significant
coefficient on CR-3, and the positive significant coefficient on CR × RFM obtained from 899
the main analysis in Section 4.1. Likewise, this additional analysis will note the main
Z-score components that affect the signs and significance of the coefficients on FORN%
and FOR × RFM in Section 4.2.
Model specification statistics in Table VII show that the F-statistics of these models
are highly significant at the 1 percent level, the R2 and adjusted R2-values are reported,
and the mean of VIF indicates that multicollinearity problem between independent
explanatory variables is not fundamental.
The main results in Table V show a significant negative relationship between CR-3
and the Z-score measure. Similarly, when this relationship is examined using the Z-score
components separately, a statistically significant relation between concentration and each
component is reported as shown in Table VII in models 1, 3 and 5. The results show that
CR-3 decreases ROAA, while it increases the EQ/TA ratio and σ (ROAA). However,
when considering the influence of bank reform, the coefficients on CR × RFM are negative
and significant for ROAA and σ (ROAA), while they are positive and significant for the
(EQ/TA) ratio. In other words, concentration in the post-reform and restructuring periods
decreases bank profitability and the volatility of returns and increases capitalization.
Therefore, the coefficients on CR × RFM for the Z-score components indicate that the
positive significant relationship between CR × RFM and the Z-score, reported in Table V
in the main regression, may be driven by the high capitalization and a low volatility of
returns in the post-reform period.
With regards to foreign ownership, the FORN% has a significant negative relationship
with the EQ/TA ratio and σ (ROAA), shown in models 4 and 6, respectively, and a positive
significant relationship with ROAA in model 2. These results suggest that the positive
significant relationship between FORN% and the Z-score in Table VI may be explained by
an increase in profitability and a decrease in the standard deviation of average returns on
assets, which proxy for volatility in returns. After controlling for bank reform by using the
interaction term FOR × RFM, models 2, 4 and 6 provide some useful information. For
instance, the positive coefficient on FOR × RFM shows that both the EQ/TA ratio and
σ (ROAA) increase with foreign ownership in the post-reform and restructuring periods.
Likewise, the negative coefficient on FOR × RFM in model 2 indicates that ROAA
decreases with bank foreign ownership in the post-reform period. First, these results
confirm the highly significant relation between foreign ownership in the post-reform
period (FOR × RFM) and the Z-score measure obtained in Table VI, as the coefficients on
(FOR × RFM) are significant across all Z-score components. Second, these findings
provide some important insights into the components of the Z-score, as it seems that the
negative relation between foreign ownership in the post-reform period and the Z-score is
mainly driven by the low profitability and high volatility of returns.
5. Conclusion
In recent years, the Egyptian government has undergone an aggregate economic
reform plan for which the financial sector reform was a major part. Under the reform
plan, the banking sector was restructured into a smaller number of adequately
MF capitalized banks with a larger foreign ownership base. Motivated by these
41,9 developments, this study examines the effect of consolidation and foreign ownership on
bank risk-taking behavior using OLS regressions of these relations based on bank-level
panel data. Using cross-period analyses, these relations are examined while controlling
for the effect of banking sector reform and restructuring to capitalize on reform
activities. Evidence shows that the risk-taking behavior of Egyptian banks changes in
900 the post-reform period (2005-2011). In particular, this study finds empirical evidence
that the reform activities resulted in a favorable impact on bank risk behavior, as
shown in the regression results of Tables V and VI and as discussed above.
To my knowledge, this is the first study to examine the association between
consolidation, foreign ownership and bank risk in an Egyptian context. Accordingly,
this study’s findings should be useful to Egyptian policy makers (and those of other
emerging countries).
The empirical evidence provides support for the following important conclusions.
First, bank concentration has no effect on bank credit risk, but evidence shows that
concentration increases insolvency risk. However, after controlling for the bank reform
effect, the results reveal that and increase in bank concentration reduces bank insolvency
risk and credit risk measured by the LLP ratio, while increasing bank reserves in the
post-reform period. These results provide support for the “concentration-stability” view
and maintain consistency with the findings of Beck et al. (2006), who suggest that
more concentrated banking systems are less vulnerable to credit risk, and Liu et al. (2012),
who argue that there is a negative relation between concentration and insolvency risk.
The results are robust to using alternative measures of concentration.
Second, in general, foreign ownership is found to decrease the insolvency risk
measured by the Z-score, while there is no statistically significant relationship between
foreign ownership and credit risk measures. However, examining these relationships in
the post-reform period indicates that foreign ownership has a negative, statistically
significant effect on all risk measures, suggesting that foreign ownership is associated
with higher insolvency risk but lower credit risk in the post-reform period. This result
is robust to using an alternate measure of bank foreign ownership. These findings are
similar to those of Angkinand and Wihlborg (2010), who find empirical evidence that
foreign ownership in emerging countries is associated with higher risk taking, as
measured by the Z-score. Likewise, Chou and Lin (2011) find evidence in a sample of
Taiwanese banks that foreign banks have lower overdue loans and higher CARs than
domestic banks. Additionally, Berger et al. (2005) find that foreign-owned banks tend to
have lower NPL ratios in Argentina.
Third, empirical analyses conducted using the Z-score components indicate that
concentration in the post-reform period is associated with a high capital ratio, consistent
with Uhde and Heimeshoff (2009), low profitability and low volatility of returns.
The results suggest that the positive significant relation between concentration and the
Z-score is due to a high capital ratio and low return volatility. Furthermore, when
the Z-score components are regressed individually against foreign ownership in the
post-restructuring period, the results show that foreign ownership is associated with a
higher capital ratio and standard deviation of returns and lower bank profitability,
which may suggest that the significant negative relationship between foreign ownership
and the Z-score in the post-reform period is driven by low profitability and a high
volatility of returns. Fourth, the regression results show that the post-reform period,
proxied by the dummy variable RFM, is significant in all models of the study, suggesting
that the reform plan that was implemented in 2004 and that resulted in bank
restructuring activities has a favorable, significant effect on bank risk taking. This Bank risk
is shown by the positive significant relationship between bank restructuring and taking in an
insolvency risk and its negative significant relationship with credit risk, as measured by
LLP. Fifth, consistent with expectations, the reported results show that bank government
emerging
ownership has an adverse effect on all bank risk measures. This result is consistent with economy
the literature, which argues that government-owned banks are more exposed to
instability and financial fragility (e.g. Mian, 2003; Uhde and Heimeshoff, 2009). 901
Finally, the empirical evidence suggests that government ownership, profitability,
bank capitalization and operating leverage are significant determinants of bank credit
risk. For the Z-score measure, bank government ownership, size and cost efficiency are
found to be the main determinants of bank insolvency risk.
Against the background of these empirical results, the following implications could
be drawn. There is evidence that concentration significantly reduces bank credit risk
measured by LLP after implementation of bank reform plan over the 2005-2011 period.
This finding suggests that restructuring activities, such as consolidating the number of
banks and increasing capital ratios, are important determinants of bank risk taking
during the post-restructuring period. Further, bank concentration may reduce the
overall risk in the banking sector. This finding is supported by the statistically
significant negative association between profitability and bank credit risk, which
implies that higher profitability may induce bank managers to assume less risk.
Notwithstanding these relationships, evidence shows that in the post-restructuring
period, higher concentration leads to an increase in banks’ CAR. However, a high
capital ratio leads to an increase in bank credit risk, suggesting that when regulators
increase capital requirements, bank managers increase their risk-taking activities,
relying on their high bank capital that serves as a cushion against various risks.
An alternative interpretation is that high equity capital is expensive and decreases
bank returns and, hence, encourages managers to increase risk to compensate for the
low returns. These results lead to an interesting conclusion for bank supervisors and
regulators. It appears that the mandatory CAR imposed by regulators is high enough to
encourage mangers to increase their risk-taking activities. Hence, regulators should
take into consideration the impact of these requirements on managers’ risk-taking
behavior when assessing capital adequacy requirements. Moreover, bank supervisors
should intensely monitor banks with high-CARs that exceed mandatory requirements
because they may be more likely to engage in more risk-taking activities. Furthermore,
against the expectations and findings of Beck et al. (2006), results show that smaller
banks tend to have higher insolvency risk. To control this risk, bank supervisors
should monitor smaller banks and potentially require those banks to make additional
disclosures related to lending practices and asset quality. Likewise, results indicate that
government-owned banks are more prone to insolvency and credit risks; thus, their
ownership should not be encouraged.
For the foreign ownership effect on bank risk in the post-reform period, evidence
reveals that there is a statistically significant relation between foreign ownership and
bank risk taking, suggesting that foreign ownership is an important determinant of
bank risk taking. While foreign ownership appears to increase insolvency risk, the
findings in this study imply that foreign ownership reduces LLP, and this result is
robust to using LLR as an alternative measure of credit risk. Evidence suggests that
foreign ownership has a favorable effect on credit risk; therefore, bank regulators and
policy makers in emerging markets such as Egypt may encourage foreign investment
in banks by alleviating excessive requirements and restrictions on foreign ownership
MF and management vis-à-vis local banks, and this is expected to have healthy effects on
41,9 local competitors. Bank regulators should support well-run foreign banks’ activities
and focus on transferring knowledge, managerial skills and systems.
In sum, this research suggests that the consolidation of the banking sector decreases
insolvency risk and credit risk, as measured by LLP in the post-reform period. This study
proposes that bank supervisors implement prudent polices in determining the bank CAR,
902 and monitor intensively less profitable, well-capitalized and smaller banks, as they have
incentives to increase risk. In addition, regulators should encourage foreign investment in
the banking sector and facilitate their operations in Egypt. The results of this study
should motivate future research on the impact of restructuring activities in the banking
sector on the profitability and risk of firms in emerging countries, where the banking
sector represents the backbone of their economy.
Notes
1. For instance, an 80 percent stake in the Bank of Alexandria (BoA) (the state-owned bank) was
sold to the Italian Sanpaolo IMI bank in 2006; thus, the ownership of the BoA was transferred
to a foreign bank.
2. There are many motives behind bank mergers mentioned in the literature, such as
achieving different types of synergy (e.g. Wheelock and Wilson, 2004), improving profit
efficiency (Cornett et al., 2006), gaining economies of scale, which causes cost reduction
(e.g. Ogden et al., 2003), and diversification and risk reduction (Brewer et al., 2000).
Moreover, merger and acquisition activities lead to the restructuring of bank management,
changes in banks’ boards of directors and executives, and changes in banks’ ownership
structure (see, e.g. Williams and Nguyen, 2005).
3. The literature on the relation between bank size and risk is ample. Some studies argue that
smaller banks are riskier than larger banks because they make loans for small risky
businesses (Carter and McNulty, 2005), and allocate capital for riskier borrowers with high
asymmetric information (Berger et al., 2005). In contrast, other studies provide empirical
evidence that bank risk increases with bank size (e.g. De Nicolo, 2000; De Nicolo et al., 2004;
Boyd et al., 2006).
4. Starting from early literature that supports this relation, Rhoades and Rutz (1982), Keeley
(1990) and Demsetz et al. (1996) argue that bank concentration will increase market power
and franchise value and, thus, banks with high franchise value have much to lose if they
become insolvent, so they hold more capital, have more diversified loan portfolios and
therefore have less excessive risk taking. Franchise value is defined as the present value of
the future profits that a firm is expected to earn and is measured by market-to-book asset
ratio (Demsetz et al., 1996), in other words, it is the value that would be foregone in the event
of a closure, and in the banking industry, the franchise value arises from regulatory
restrictions on entry and competition (Konishi and Yasuda, 2004).
5. See Claessens and Van Horen (2012) for an excellent review of the literature on foreign bank
performance.
6. Several studies test the influence of the foreign-owned banks on the performance of domestic
banks (see, e.g. Laeven, 1999; Claessens et al., 2001; Bonin et al., 2005; Micco et al., 2007).
7. For a survey of the literature on the impact of foreign banks’ entry into transition countries,
see Bonin et al. (2005).
8. Bankscope is a comprehensive global database of banks’ financial statements provided by
Bureau van Dijk. KOMPASS-EGYPT is owned by Fiani and partners, and it provides
financial services information in a business database. Now, Fiani and partners/Kompass-
Egypt operates as a subsidiary of Coface SA.
9. Liu et al. (2012) use loan loss provisions in addition to loan loss reserves to measure risk. Bank risk
They argue that loan loss provisions reflect the actual funds already expended to cover loan
losses, while the loan loss reserves ratio is a controversial measure. Bank loss reserves are
taking in an
estimated losses and may increase according to the loan loss provisions in bad economic emerging
conditions. economy
10. Note that concentration ratios are also used in the literature to measure competition and
market power; for more details on the measures of competition and the link to concentration, 903
see Liu et al. (2012).
11. Tests are conducted to confirm the normality of distribution. I examine the distribution of
each dependent variable to check its normality. A histogram of standardized residuals and
normal probability plots are used to test for the normality of the distributed error.
Homoscedasticity is tested by a standardized scatterplot, that is, a scatterplot of the

standardized predicted dependent variable against the standardized residuals. These tests
verify that normality and homoscedasticity assumptions are valid.
12. Hausman test shows that the null hypothesis is not rejected for FOR% and GOV, implying
no endogeneity.
13. The interaction term CR × RFMt is calculated for each concentration measure; CR-3, CR-5,
HHI-D, HHI-A, and CR3-D are used in the different concentration regression models.
14. The interaction term (FOR × RFM) is calculated using the two foreign ownership measures;
FORN% and FOR. For instance, for models using FORN% as the foreign ownership
measure, the interaction term is the product of FORN% and the reform dummy.
15. The interaction term CR × RFM used in models (1a, 2a and 3a) is the product of CR-3 and
RFM, while the product of CR-5 and RFM is used in models (1b, 2b and 3b) and the product
of HHI-D and RFM is used in models (1c, 2c and 3c).
16. Table IV reveals that the correlation between CR × RFM and the Z-score is positive
(r ¼ 0.119) and highly significant ( p ¼ 0.009).
17. The interaction term (FOR × RFM) used in models (1a, 2a and 3a) is the product of FORN%
and RFM, while the product of the FOR dummy and RFM is used in models (1b, 2b and 3b).
18. The correlation coefficient between the Z-score and FOR × RFM is negative (r ¼ −0.178) and
highly significant ( p ¼ 0.000), as displayed in Table IV.
19. Financial variables are winsorized at the 1st and 99th percentiles of their respective
distributions by giving the outliers beyond the top and bottom 1 percent of the distribution
a value equal to the value of the 1st or 99th percentiles. In other words, replace values above
the 99th percentile with the 99th percentile and values below the 1st percentile with the 1st
percentile of the distribution.
20. Again, all financial variables are winsorized at the 5th and 95th percentile levels to ensure
that the main results are valid.
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Corresponding author
Dr Mona A. ElBannan can be contacted at: mona.elbannan@guc.edu.eg
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Do consolidation and foreign ownership affect bank risk taking in an emerging

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2. Literature review and hypothesis development

2.2 Ownership structure and bank risk-taking behavior

achieve more favorable performance in developing countries than in developed

CR-3 ¼ 3 largest bank’s assets/total

3.2 Summary statistics and correlation

CR-5 576 0.526 0.530 0.019 0.486 0.548

CR3-D. It is worth mentioning that although the number of banks decreased

LLRit ¼ b0 þ b1 FORN %it þ b2 RFM t þ b3 FOR RFM t þ b4 GOV it

4.1 Effect of concentration on bank risk

CR-3 + −0.340 − 0.145 − −0.210

(−2.049)** (−1.921)** (1.765)** (1.937)** (2.885)* (3.172)*

Model specification statistics

for bank concentration in models (1a-1c), respectively, in addition to the interaction

expected, across all concentration measures and statistically highly significant

4.2 Effect of foreign ownership on bank risk

4.3 Robustness tests

Dependent v. ROAA EQ/TA ratio σ (ROAA)

CR-3 −0.187 0.239 0.237

sector represents the backbone of their economy.

Homoscedasticity is tested by a standardized scatterplot, that is, a scatterplot of the

1. Changjun Zheng, Syed Moudud-Ul-Huq, Mohammad Morshedur Rahman, Badar Nadeem

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(−2.049) (−1.921) (1.765) (1.937) (2.885)* (3.172)*