The Impact of Bank Ownership Structure and Board of Directors Attributes on Credit Portfolio Quality: The Case of the Libyan Commercial Banks

Abstract

<p>In recent times, many countries in the developing world, including countries in the Middle East region, have taken positive steps toward restructuring, reforming and modernising their economies to enhance and boost the level of these economies and expand the opportunity for their long-term survival and sustainability. Among these positive steps an increasing interest is given to two matters: corporate governance and ownership structure. The stability and sustainability of the global financial market are, to a great extent, associated with the stability of the banking industry. Undeniably, banks are an important constituent of the world financial market and the engine of economic growth both in the world and individual country levels.</p> <p>Among the banks’ functions that are crucial for a country’s economic development, the granting of credit facilities, both tangible and intangible, is of the highest significance. In many countries, particularly developing, this vital role is increasingly threatened by an ever-increasing volume of non-performing loans and a decrease in the credit portfolio quality, with alarming consequences for the world financial and economic stability and sustainability. As endorsed by a wide body of empirical and theoretical literature, corporate governance and board ownership structure play a vital role in ensuring the peculiar ‘credit granting’ role of contemporary banking receives due care and attention. As such, corporate governance and ownership structure have received increasing attention in the process of introducing positive reforms in the banking sector, both in the world and individual country level.</p> <p>In Libya, non-performing loans emerged as a serious problem in the 1970s, a trend that continued through the mid-to-late 2000s and worsened during the mid-2000s. In 2004, a third of the credit facilities extended by Libyan banks were classified as nonperforming/ badly resulting in the tarnishing of the country’s overall credit portfolio quality. As a result, reforming the country’s banking sector and, in turn, its economy, was identified by the country’s then-governing body as the vital step to put the country’s economy back on track and ensure its financial sustainability. Subsequently, in recent years, several reforms were introduced to multiple economic sectors, particularly the banking sector. These reforms included decreased government participation in the country’s economic sector, increased private sector participation, entrance of foreign investors, encouraging the implementation of good corporate governance, and modifying the related legislation and regulations. These changes were introduced with the specific aim of improving the performance of the business organisation, particularly the Libyan commercial banks.</p> <p>Nevertheless, the impact of these economic reforms on the credit portfolio quality of Libyan commercial banks has not been empirically investigated, particularly from the point of view of the impact different ownership / board structures may have on the quality of their credit portfolio. Additionally, there has been little, if any, empirical investigation of the interrelationship of these variables in the case of developing countries, especially those in the Middle East and North Africa. There is a gap in the literature regarding the connection between different forms of bank ownership structures—private, state-owned and privatised banks—and the credit portfolio quality. As such, this study is devoted to filling this gap. This study is particularly concerned with the evaluation of the Libyan banking reforms and their impact on the performance of Libyan commercial banks, operating under the three ownership types in terms of the quality of credit portfolio, during the period 2005– 2010. This time period was selected for the following reasons:</p> <p>1. Law No. 1 in 2005 brought significant changes to the banking sector of Libya when the privatisation policy was introduced in to allow the entrance of foreign investors into the sector.</p> <p>2. The period marked the promulgation of several regulations that were aimed at improving corporate governance efficacy in the sector.</p> <p>3. The corporate governance handbook was introduced in 2005, approving the implementation of effective corporate governance strategies in the sector.</p> <p>The cutoff year of 2010 was determined based on the subsequent lack of available pertinent data as a result of the civil unrest and political upheaval in the country that started in early 2011. Further, the data until 2010 sufficiently addressed the study’s core objectives.</p> <p>The main purpose of this study is to examine the impact of bank ownership structures and board of directors attributes on the credit portfolio quality in the context of Libyan commercial banks operating under the three ownership structures referred to above. To achieve this goal, this thesis covers three related empirical studies:</p> <p>1. Investigating the impact of ownership structures and attributes of the board of directors on credit portfolio quality of Libyan commercial banks during the period 2005–2010.</p> <p>2. Investigating the impact of implementing the privatisation policy in the banking sector on the relationship between credit portfolio quality of Libyan commercial banks and the attributes of the board of directors. The study period is divided into pre- and post-privatisation, 2005–2007 and 2008– 2010, respectively.</p> <p>3. Investigating the impact of the attributes of the board of directors on credit portfolio quality of Libyan commercial banks during the period 2005–2010, under the three ownership categories: public banks, private banks, and privatised banks.</p> <p>A total of 15 commercial banks operates in Libya. Based on the availability of relevant data for successfully executing the study, a sample of 13 Libyan commercial banks was chosen. The data for the study was mainly extracted from the annual reports of these banks. In addition, annual reports of the Central Bank of Libya and the database of the World Bank were also explored for the period covering the study. Ordinary least squares(OLS) and generalised least squares (GLS) were applied in analysing the data. A combination of agency theory and institutional theory was employed to interpret the results, thus providing the reader with a theoretical lens to view the empirical data and assess how it addressed the objectives.</p> <p>The study revealed three main results. First, among the attributes of the board of directors that were examined, only the size of the board and the size of the audit committee were found to be significantly influenced. It was positively significantly related to the credit portfolio quality for the size of the board and it was significantly negatively related to the credit portfolio quality for the size of the audit committee. While the relationship of the board attributes was positively related to the credit portfolio quality, it was negatively related to the audit committee size. With regard to the ownership structure, the study results revealed that only government ownership had a significant negative relationship with the credit portfolio quality of the Libyan commercial banks. The study also found that the privatisation strategy introduced to the Libyan banking sector had a positive impact on the relationship between credit portfolio quality and corporate governance, which was demonstrated to have a positive impact on the quality of credit portfolios of Libyan commercial banks (the significance was higher in the post-privatisation period compared to the preprivatisation period). Lastly, the results demonstrated that the effectiveness of corporate governance in enhancing the credit portfolio quality was higher in the case of private and privatised banks compared to public banks. Hence, the study results highlighted the significance of implementing effective corporate governance mechanisms in the Libyan commercial banking sector, and endorsed the suitability and value of the privatisation policy for enhancing credit portfolio quality of Libyan commercial banks, in turn ensuring the long-term sustainability of the country’s economy.</p>