Issues That Need to Be Addressed by the Domestic Banks in Countries That Are Developing - Literature review Example

Issues that need to be addressed by domestic banks in developing countries to meet the challenges posed by multinational banks and by the global market in trade and finance Name: Instructor: Course: Date: Introduction In developing countries, domestic banks face many challenges that are posed by the multinational banks and also the ever evolving global market in trade and finance. As an illustration, the more nuanced view has been recently put forward that multinational banks at financing SMEs can have a comparative advantage; it is able to finance the SMEs through arms-length technologies of lending, for instance, credit scoring, fixed asset lending, leasing, factoring, and asset based lending and also through organizational structures that are centralized rather than relationship lending. This indicates that in lending SMEs, multinational banks can perform to the same extent as the domestic banks, but by using structures and techniques that are different. Claessen and Van Horen (2010) stated that compared to the domestic banks the multinational banks are especially profitable in developing countries. This paper will argue regarding the issues that need to be addressed by the domestic banks in countries that are developing to convene the challenges posed by multinational banks and also the challenges posed by the ever evolving global market in trade and finance. Issues that need to be addressed by domestic banks in developing countries to meet the challenges posed by multination banks There are diverse challenges that should be addressed by the domestic banks in developing countries to meet the challenges posed by multinational banks. The first challenge that multinational banks pose to the domestic bank is the “follow-the-customer” hypothesis. This challenge is posed by the multinational banks to the domestic banks due to the fact that the multinational banks have a comparative advantage over the domestic banks simply because, over the years through investment in relationship capital and information, they have lowered the rate of monitoring the financial condition of the foreign operations of their domestic corporate entities below what the domestic banks can. Compared to the domestic banks, well-established multinational banks in a foreign country can often provide advice and financial services, contacts, and useful information considering entering the foreign market. By serving clients in numerous countries they can achieve scale gains and efficiency (Berger and Mester, 2003) An additional concern that needs to be addressed by domestic banks in the developing countries is that, in some countries the domestic banks may be inefficient in that they may be technologically outdated or they may be uncompetitive. According to Walter (1985) foreign entrants may be attracted by such conditions to penetrate these markets by better marketing tools or by employing newer technology. Therefore, posing a challenge to the domestic banks, since the first foreign entrants are usually the multinational banks with geographical diversity that is existing sufficiently, as is evident from Korea and Japan case (Ursacki and Vertinsky, 1992) additionally, in general, banks face regulatory practices that are strict wherever they are based. The challenge that the domestic banks face is that some developing countries may choose to open up and the multinational banks to enter in a regulatory regime that is relatively lax if the gains perceived are high. For instance in the US, with the 1978 International Banking Act (IBA) the foreign banks interstate activities came to be restricted but numeral privileges were bestowed at the same time including checking facilities and Federal Deposit Insurance. Subsequently, there is the issue of diversification and interest rate differential between the domestic and the multinational banks. From a perspective of portfolio choice, the multinational bank optimal policy is to maximize profit for a level of risk given or to minimize risk given a level of profit that is desired. According to Rugman and Kamath (1987) in this area an empirical convergent conclusion is that the total risk of portfolio of the portfolio assets of both the foreign and domestic portfolio has been lower than a purely domestic portfolio risk, while the international asset return may not or may be higher than the domestic assets rate of returns. Additionally, Cosset and Lampron (1982) stated that the international market average returns are lower than the domestic rate of returns. There is also the issue of fear of foreign domination by the multinational banks. This is attributed to the fact that local depositors may have more faith in the big multinational banks than in the smaller domestic banks. According to Martinez Peria and Mody (2004) with more multinational entry evidence exist of financial mediation of better quality, for instance better economic performance of borrowers and lower loan-loss provision. Another issue that concerns the domestic banks is that, the multinational banks carve out a niche for themselves in the market’s richer end, and extend their services outside rarely, for instance to the market’s retail segment, accordingly, they cream-skim the market, thereby taking a share that is disproportional of the local business that is best away from the domestic banks. Compared to the domestic banks the multinational banks are especially profitable in developing countries (Claessen and Van Horen, 2010) Due to this, two facts emerge; first the much higher proportion of deposit that the multinational banks receive is from the corporate sector that entails both the non-financial and the financial, than do the domestic banks. Secondly, the multinational banks get a much higher of their deposit proportion from non-residents and foreigners than the domestic banks. The challenge to the domestic banks is that the multinational banks deposit accounts are usually believed to be the best and the safest, hence it has succeeded in claiming a disproportionate share in the developing countries market. On the side of the loans, around 80% of all credit that are outstanding by the multinational banks goes to either trade or industry. What is more, the multinational banks loans portfolio share of trade and industry is much higher than the corresponding share in the domestic banks. Around 75% of the multinational advanced total credits were to the corporate sectors that are private, for the domestic banks the corresponding figure was 30% (Nag and Shivaswamy, 1990) Conversely, the multinational banks have posed a challenge to the domestic banks by providing economies with better entrée to the international financial markets than what the domestic banks could do. Compared to the domestic banks, the multinational banks have assisted in introducing enhanced efficiency, the latest financial technology, and increased competition of the inter-bank. According to Fries and Tacie (2005) the multinational banks presence that than domestic banks are generally more efficient and can ensure the banking expertise and technology transfer required to improve the bank’s efficiency in the host country. From the side of macroeconomics, the challenge that the multinational banks pose to the domestic banks is that their presence can improve regulations of banking and ensure financing that is stable for the host country economic activities. In the economic recession event, it could be considered as a mean for risk diversification. Dell’ Ariccia (2000) implied that based on the empirical studies results, it is demonstrated by the researchers that increased competition following the multinational banks entry, than the domestic banks is considered to be more efficient may cause effects that are harmful. Another issue that needs to be addressed by the domestic banks is that the multinational banks tend to select best clients of the local market by offering products at low prices. This environment that is new could push the domestic banks failing to fund the projects that are riskier that were rejected previously by the system. According to Hersh (2001) the multinational banks with their well known competitive advantage would be reluctant to diffuse their technological know-how or their advantage management. Therefore, the gained efficiency is hence no guarantee for the domestic banks following the multinational banks entry. In developing countries, consumers consider that multinational banks can provide services that are better than the domestic banks, particularly, since the multinational banks train a great many professional managers to assist them and than the domestic banks they provide a great deal of know-how. Multinational banks make profits that are higher than domestic banks in developing countries, but in the developed countries the opposite is the case, hence implying that multinational banks have technologies that are better than domestic banks in developing countries (Claessens et al., 2001) According to Barajas (1999) multinational banks are productive more than the domestic banks. As an illustration, the domestic banks have advantages that are more than the multinational banks such as culture and regulations, market share and language, as well as asset size but the multinational banks have the advantage in terms of international expertise and technology. In developing countries the profitability and efficiency of multinational banks are more effective generally than those of domestic banks. Another challenge that multinational banks pose to domestic banks is that they have made consumers to always believe that they are better because of their services and technological skills which often before deregulation outran the domestic banks. Another challenge that the multinational banks pose to the domestic banks is that they tend to select only the customers who are the best, the domestic banks can be left with a credit pool that is worsening which can hurt their willingness as well as profitability to lend. The net impact of multinational banks presence in some cases on provision of credit can hence be negative, as their provision of credit is more than domestic banks offset by credit that is reduced (Detragiache, Gupta, and Tressel, 2008) Issues that need to be addressed by domestic banks in developing countries to meet the challenges posed by the ever evolving global market in trade and finance The issues that need to be addressed by domestic banks in developing countries to meet the challenges posed by the ever evolving global market in trade and finance include the endemic, epidemics, and macroeconomic collapses. Many domestic banking system crises in developing countries seem endemic, since they display a distress recurrent pattern with illiquidity and insolvency that are persisting for years. Other domestic banking systems have experienced epidemics involving sometimes the macroeconomic collapses. The degree to which the domestic banking system can absorb macroeconomic shocks without suffering failure institutionally obviously varies enormously. However, some banks survive even macroeconomic shocks that are very severe, implying that the domestic banks in developing countries could also have too, had they followed the designed policies to insulate themselves from disturbances. Similarly, one must be skeptical of contention that the domestic banking system has collapsed due to macroeconomic shock. In the issue of endogenous macroeconomic disturbances, the domestic banks riding on an optimism wave overlend to projects which have poor prospects that are long-term. A new era beginning was witnessed in the 1970’s in the international financial system (Mundell, 2000) Additionally, another issue that needs to be addressed by the domestic banks in the developing countries in trade and finance includes the government-permeated banking system endemic crisis. In many developing countries the functioning and the role of the sector of banking is linked intimately with the government financing and on behalf of the government. Consequently, due to these linkages the objectives of the government policies permeate the domestic banking system activities in this condition. Moreover, domestic banks in the developing countries face the challenge of innovation technologically and globalization in finance, the change of technology in trade and finance has been a factor that is underlying both in up untested and new areas of operation and increasing competitive pressure of undermining the domestic banks dominant position. A financial system that is functioning better with more credit is key since it fosters the growth of the economy (Levine, 2001) The ever evolving global market in trade and finance is far from homogenous. Success for the domestic banks operating in them is contingent on understanding the opportunities that are specific that exist in each and overcoming the unique and sometimes inevitable challenge. With the fast-growing customer base and expanding markets for financial services the ever evolving global markets are attractive for the domestic banks looking to grow their revenues. They also provide an antidote that is much needed to the challenge of the ever evolving global market in trade and finance. The advancement of technology can open up previously unprofitable and inaccessible customer pool. According to Kaminsky and Schumukler (2002) even though the capital account and the domestic financial sector were regulated heavily, over time the restrictions have been lifted. As the global market evolve rapidly, it is vital for the domestic banks in these markets to monitor the appetite for services and products that is evolving, to understand the driving force of demand and to identify how most profitably they can operate. There is a thread that is common running through the evolving market. The developing countries are experiencing growth that is rapid, and as their economies grow they are seeing increased dramatic returns for banking services and products. The domestic banks operating in these evolving markets face challenges such as: the way they can stay profitable in the heightened competition face, secondly, the way they can meet demands that are growing for corporate and retail lending when the capital markets are underdeveloped and their balance sheet are constrained. Lastly, the way they can serve the unbanked without infrastructure of developed market. To achieve growth that is profitable, domestic banks in the evolving global market must balance their desire to rapidly expand with the need to efficiently do so. Consequently, the pressure of efficiency, declining margins and competition, as well as funding is becoming the watchdog of the domestic bankers. Domestic banks are looking to cut costs and maximize returns on assets that are existing. Conversely, they must as well invest in growth, and some of these costs may require to be reinvested in areas of growth. Changes at the universal intensity and also changes in both the developing and developed countries explain the financial institutional role as a globalization force (International Monetary Fund, 2000) In the ever evolving global market strong capability in equity and debt financing will be vital increasingly for domestic banks looking to fund infrastructure programs that are transformative. The demand for credit is expected to be high but domestic banks with balance sheets that are restricted, may struggle to meet these demands. Without investment that is significant in investment and corporate banking capabilities, multinational banks with balance sheets that are large and access to funding that is cheaper will gain market share in the evolving global market. Hedging products and advisory services will be critical for the domestic banks that want to grow and retain their business customers. Mishkin (2003) stated that usually the financial system do not always operate as desired since problems of asymmetric information is confronted by lenders, which can lead to selection that are adverse and moral hazards. As organizations, especially those in global market that is more established expand their presence beyond the domestic borders; they will require support to the complexities and the risks of international trade. Numerous domestic banks play already a leading role in the hedging product provision, but to develop products that are more advanced as the needs of their clients evolve they will need to invest. In the ever evolving global market, the investors who are wealthy are likely to favor global wealth management brands that are established. The domestic banks that will offer a broad range of services and products will be positioned better to nurture and capture mass affluent customers. As domestic investment opportunities become established more, individuals of high-net-worth may as well be tempted to invest onshore some of their wealth using the local banks for these services. Retail banking product low-cost will be critical for domestic banks expanding lending into segments of lower income. Many domestic banks have been reluctant to serve this base of customers as it is costly to manage transactions of high volume of low value. But with the easy growth limit being reached in the evolving global market, the domestic banks now see the segment that is unbanked as an opportunity. However, the posed challenge is that many traditional products are not appropriate to these individuals needs, hence in the evolving global market in trade and finance the domestic banks targeting this segment must develop products that are innovative and that can match better the needs of the customers at a rate that is lesser to both the bank and the customer. Following liberation it is estimated that the growth of output has increased by about one percent point (Bekaert, Harvey, and Lundblad, 2001) In the ever evolving global market in trade and finance, there is need for domestic banks to address the issue of investing in technology. This is an enabler that is crucial high-touch, low-cost banking in the evolving global market. In reaching new retail customers, technology will be a factor that is critical without the cost of establishing network branch that are extensive and improving cross-selling prospect and relationship with the existing customers. In addition, financial liberation average long-run growth that is higher although it as well leads to some crises and to cycles boom-burst (Tornell, Westermann, and Martinez, 2003) Conclusion In order to address the challenges posed by multinational banks to the domestic banks, the domestic banks must react to the presence of the multinational banks and compete fiercely to retain there previous market share, hence lifting the sector of domestic banking to efficiency of international level. According to Germid and Michalet (1984) it is hoped that the new technology introduction should cause the domestic banks to imitate the multinational banks. In the ever evolving global market in trade and finance, the challenges posed to the domestic banks are increasing capital pressure, which they must struggle to fulfill the demand expected for credit and rural deposit and other groups that were previously unbanked, whereby they can provide a new source of funding. In order to address these issues, the domestic banks should be increasingly focused on finding ways that are innovative to reach these clients. It is expected that technology will be a major area for investment in the ever evolving global market, as the domestic banks in developing countries redesign their product and develop new models of distribution to serve their customers efficiently more and to attract more deposit. References Barajas A., R. Steiner and N. Salazar. (1999) “Foreign investment in Colombia’s financial sector”, IMF Working Paper 99. Berger A.N., and L.J. Mester. 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