Factors Determining the Performance of Banks in Foreign Markets - Term Paper Example

Factors determining performance of banks in foreign markets TABLE OF CONTENTS 1.0 Introduction 3 2.0 Study findings 5 2.1 Continental Origin of the banks 5 2.2 Continental location of Foreign country 6 2.3 Profit realization by the banks 7 2.4 Bank turnover 9 2.5 Asset of banks 10 2.6 Correlations results of the test variables 12 3.0 Limitation of study and recommendation for further study further study 19 References 20 1.0 Introduction There are a number of key factors that play a pivital role in the decision of banks to operate in foreign markets. The level of economic interaction which the would be host and the foreign country foreign partner is one of the factors. The laid down tax regime for both the foreign participants and the local participants in the host country will greatly affect the foreign bank participants in the host country (Altunbas, 2001). Host countries with fewer restrictions to foreign banks in the market will always encourage foreign bank investments in the countries. The evidence from cross-country banking activities has revealed that with more restrictions in the banking sector there is always very high overhead cost in addition to high net interest margins. It is also evident that there is high probability of financial crisis occuring in countries where there is foreign bank participation restriction (Amel, 1991; Arellano, 1991). When it comes into venturing in foreign markets investments will always be directed in host countries where opportunities are perceived to be present. As observed by Parkhe (1998) countries with low interest rates and which have a high per capita income will be an attraction to foreign banks. Countries with low efficiency in the banking sector and recording high rates of economic growth are usually the target of foreign banks investments. A good host country will have initial GDP per capita and inflation that are negatively associated with the coming in of foreign banks but the stock market capitalization of the host country should be positive. Some of the manifestation of the host country being inefficient is the existance of very high average costs, cash flows being high and low net interest margin less charge offs. In condusive host countries there will always be many small banks which can easily be acquired by the foreign banks (Carbo et al, 2002). When there is a lot of competition from froreign banks in a country the banks local banks will find it appropriate to make investment abroad as away of survival. It is evident from many research which have been done that the reasons which drive foreign banks to make investments in developing world differs for reasons for investing in the developed countries. When investing in developing countries there is always a genuine desire of exploiting opportunities in this countries and following the customers is rarely the reason of the investments. This being the motive of investment the foreign banks have increased chances of having benefits in a host country especially when there is a market segments like SMEs that need financial services but appear to have been sidelined by the local banks. The effect of culture on the ability of a bank entering a foreign market and its performance cannot be ignored. This is clearly illustrated by an example highlighted by Berger, Klapper, and Udell (2000), where it was noted that foreign banks headquartered in South America countries appeared to lend to small businesses in Argentina as compared to other foreign banks whose headquarters were in other countries. The likely reason for this scenario is the similarity in culture and language which was an advantage to the Argentine banks as opposed to the other banks based in other places. The best indicator for participation in the destination market is an expansion of the foreign banks in the foreign countries. There is a general belief that large banks have higher ability of expanding abroad and according to research findings, there exists a positive correlation between the sizes of banks and the number of branches possessed by the banks (Vertinsky, 1992; Baumol, 1982). In terms of efficiency international banks have also been found to out perform banks operating locally. The regulations in the home country also have effect of the way of banks make entrance into foreign markets. Some of the ways that home countries affect banks ability expanding in foreign countries is placing a restriction of the extent and manner of making foreign investments and this affects the banks ability to compete in the foreign countries. In the US cross country regulation is believed to have brought down foreign banks cost in comparison to the costs incurred by US banks thus making the foreign banks to very competitive (Brozen, 1971; Bresnahan , 1989). 2.0 Study findings The findings of this study has been given under the following subheadings Continental Origin of the banks Continental location of Foreign country Profit realization by the banks Turnover of banks Correlations results of the test variables Investigation of the relationship between origin of bank and the foreign country location 2.1 Continental Origin of the banks From figure 1 the details of continental origin of all the foreign banks under the study have been given. Europe is the continent which has the highest number of banks as it contributed 26.67% of the banks while second placed continent was North America with 21.67%. From the figure it can be seen that the banks with their origin in Latin America, Asia, Middle East and Africa contibuted 15.00%, 16.675, 13.33% and 6.67% respectively. Figure 1: Bank continental origin 2.2 Continental location of Foreign country Figure 2 gives the continental location of all the banks that operate internationally. The figure indicates that Africa contributed the highest banks of all the foreign banks with 25.00% of all the foreign banks operating in the continent.The second placed in the ranking is Asia with 21.67% and in third position is Europe with a 20.00% representation. The other scores are 18.33%, 8.33% and 6.67% for North America, Middle East and Latin America respectively. The factor that could be leading to high number of foreign banks operating in Africa could be due to high inefficiencies in the banking sector in the continent but is being capitalised on by banks from other continents. Figure 1: Location of foreign country 2.3 Profit realization by the banks Table 1 gives the range of profit made by various bank categories. It can be seen from the table that 23.3% of the banks under study managed to make a profit of 10 to 20m dollars which is also the same number of banks that made a profit of 30 to 40m dollars and more than 40m dollars. Figure 3 gives the diagrammatic representation of the tabulated data. Table 1: Profit realized in US dollars Frequency Percent Less than 10m 7 11.7 10 to 20m 14 23.3 20 to 30m 11 18.3 30 to 40m 14 23.3 More than 40m 14 23.3 Total 60 100.0 Figure 3: Profit margins of the foreign banks 2.4 Bank turnover From table 2 and diagram 3 the performance of the banks in terms of turnover can be seen. It can be seen that the highest number of banks had a turnover of 300 to 400m dollars with 15 banks (25%) of the banks belonging to this group. There are 11 banks with a turnover of more than 500m dollars this being 18.3% of all banks that were studied. The 13 banks that were reported to have had a turnover of 400 to 500m dollars represented 21.7% of the 60 banks under study. Table 2 Turnover of banks Frequency Percent Less than 100m 1 1.7 100 to 200m 10 16.7 200 to 300m 10 16.7 300 to 400m 15 25.0 400to 500m 13 21.7 More than 500m 11 18.3 Total 60 100.0 Figure 4: Turnover for the foreign banks 2.5 Asset of banks From table 3 and figure 5 gives the total asset of banks that were studied. From the table it can be seen that the highest number of banks had asset value of 40 to 50b dollars with 20 banks (33.3%) of the banks belonging to this group. There were 12 banks with asset value of 20 to 30b dollars this being 20% of all banks that were studied. The number of banks with asset value of more than 50 billion dollars were 11 this being 18.3% of the 60 banks that were studied. Table 3: Asset of banks Frequency Percent 10 to 20 b 4 6.7 20 to 30b 12 20.0 30 to 40b 13 21.7 40 to 50b 20 33.3 More than 50b 11 18.3 Total 60 100.0 Figure 5 2.6 Correlations results of the test variables In order to establish the relationship between variables it was necessary to perform a correlation test. The variables which were included in the test as can be seen from table 5 are: age of the parent bank, profit made by the bank, age of the foreign bank, turnover and asset value of the bank. The test results clearly indicate that the strongest correlation is between the variables: profit made by banks and turnover where a significant Pearson correlation value of 0.955 was recorded. The very strong correlation between the two variables is an indication that high financial activities of the banks translates to high margin profits. This is also a manifestation that there is efficiency in the banks with the end results being the realization of profit which are proportional to the banks turnover. There is a significant correlation between the profit made by banks and the foreign bank age where the Pearson correlation of 0.483 is recorded. The explanation for this is the fact that when the banks stay in the markets for longer they accumulate experience which translates to increased efficiency. Another probable reason is that the banks are expected to be expanding as the years pass and this leads to increased profitability. The table indicates that there is a strong correlation between the variable age of mother bank and foreign bank age with a Pearson value of 0.716. This can be attributed to the likelihood of banks expanding in the local market with time thus exhaustion of the local market and soon there is need to venture into foreign markets. As a result of this; it is found that banks which have been in there home countries for many years will always have branches in foreign countries of comparable age. Correlations Age of the mother bank Foreign bank age Profit realised Turnover Asset of banks Age of the mother bank Pearson Correlation 1 .716** .152 .007 .048 Sig. (2-tailed) .000 .247 .955 .715 N 60 60 60 60 60 Foreign bank age Pearson Correlation .716** 1 .483** .319* .319* Sig. (2-tailed) .000 .000 .013 .013 N 60 60 60 60 60 Profit realised Pearson Correlation .152 .483** 1 .913** .826** Sig. (2-tailed) .247 .000 .000 .000 N 60 60 60 60 60 Turnover Pearson Correlation .007 .319* .913** 1 .895** Sig. (2-tailed) .955 .013 .000 .000 N 60 60 60 60 60 Asset of banks Pearson Correlation .048 .319* .826** .895** 1 Sig. (2-tailed) .715 .013 .000 .000 N 60 60 60 60 60 **. Correlation is significant at the 0.01 level (2-tailed). *. Correlation is significant at the 0.05 level (2-tailed). 2.6 Comparison of continental origin of banks and foreign country location It was important to perform a chi-square test and cross-tabulate the variables so as to be able to establish the relationship between the variables: origin of the bank and foreign country. The results of this test were as in table 5 and table 6. It can be observed from table 5 that there is no African bank which have ventured into countries outside the continent. This could be attributed to the fact that there is more competition in the banking sector outside Africa and that banks of African origin are not efficient enough to withstand this competition. It could also be due to the fact that there is a lot of market in the banking sector in African continent compared to the other continents and thus there is no need to venture outside the continent. Middle East, Latin America and Asia each had only 1 bank in North America market. This low presence in North America can be attributed to stringent regulation of foreign banks in these regions especially targeting these three regions. The presence of one bank representing each of the three regions may be necessitated by a bank which is required to fulfill some cultural and religious needs. The presence of banks originating from Latin America and Asia in North America may be attributed to the facts the banks are following there loyal clients in the region (North America). Europe recorded the highest number of foreign banks undertaking their activities in North America with a total of 6 banks in the region. The higher number of the banks may be a manifestation that agreement of culture plays a vital role when banks are choosing to start investment abroad. High competition in the European market may also be a major factor that compels the banks in the region to venture in North America market. Having a close look at the Europe row it is observed that 7 banks operating in this region as foreign banks are from the same continent. North America and Latin America have each two banks in Europe, Asian Bank is one while there is no bank from Africa or Middle East operating in Europe. It is clear that many foreign banks are operating in the same continent as there origin and this can be attributed to compatibility of culture. Strict banks regulation may be a major contributing factor to minimal participation of banking activities of foreign banks in Europe. From the table it can be seen that out of the 13 banks operating in Asia 5 hail from the same region 4 originate from North America while Europe and Middle East each have two banks undertaking there activities in the region. The presence of multinational in Asia maybe the reasons on there being banks of North American origin in the region while the Middle East banks presence serve to offer unique services demanded by diaspora in the region. The 5 foreign banks in Asia which originate in the same region have there high presence due geographical proximity and cultural compatibility. It can also be seen from table 5 that there are a total of 5 International banks that operate in the Middle East four of which having their origin in the same region with only one being from Asia. This can be attributed to the existence of banking laws in the region that does not favour the establishment of their banks in the region and the cultural uniqueness of the region. Illuminating the Africa raw it can be observed that there are a total 15 international banks in this region 4 of which originate from the same Africa content. Latin America have 3 contribute 3 of the 15 banks, North America 4 while Middle East and Europe each contribute one bank. Lack of efficiency in banking industry in Africa may be the major factor of high number of foreign banks in the region. Investors may be following there clients in this region in addition to the fact that Africa is one of the continent with countries that are registering high growth rate. It is easy for foreign international banks to start their business in Africa due to the fact that regulations are not strict in comparison to other regions like Europe and Middle East. From table 5 it has been evident that a variation exists in terms of the origin of banks and the foreign region where they undertake there activities. This is clearly manifested in the chi-square test table where the chi-square value is From the table it has been clear that there is a variation in terms origin of the banks and the foreign region in which they operate. The chi-square analysis indicate the variation is significant with Pearson Chi-square value being 64.665 at p=0.000. Table 4: Foreign country location * Origin of bank Cross-tabulation Foreign country location * Origin of bank Crosstabulation Origin of bank Total North America Europe Latin America Asia Africa Middle East Foreign country location North America Count 2 6 1 1 0 1 11 Expected Count 2.4 2.9 1.7 1.8 .7 1.5 11.0 % within Foreign country location 18.2% 54.5% 9.1% 9.1% .0% 9.1% 100.0% Europe Count 2 7 2 1 0 0 12 Expected Count 2.6 3.2 1.8 2.0 .8 1.6 12.0 % within Foreign country location 16.7% 58.3% 16.7% 8.3% .0% .0% 100.0% Latin America Count 1 0 3 0 0 0 4 Expected Count .9 1.1 .6 .7 .3 .5 4.0 % within Foreign country location 25.0% .0% 75.0% .0% .0% .0% 100.0% Asia Count 4 2 0 5 0 2 13 Expected Count 2.8 3.5 2.0 2.2 .9 1.7 13.0 % within Foreign country location 30.8% 15.4% .0% 38.5% .0% 15.4% 100.0% Africa Count 4 1 3 2 4 1 15 Expected Count 3.3 4.0 2.3 2.5 1.0 2.0 15.0 % within Foreign country location 26.7% 6.7% 20.0% 13.3% 26.7% 6.7% 100.0% Middle East Count 0 0 0 1 0 4 5 Expected Count 1.1 1.3 .8 .8 .3 .7 5.0 % within Foreign country location .0% .0% .0% 20.0% .0% 80.0% 100.0% Total Count 13 16 9 10 4 8 60 Expected Count 13.0 16.0 9.0 10.0 4.0 8.0 60.0 % within Foreign country location 21.7% 26.7% 15.0% 16.7% 6.7% 13.3% 100.0% Table 5 Chi-Square Tests Chi-Square Tests Value df Asymp. Sig. (2-sided) Pearson Chi-Square 64.665a 25 .000 Likelihood Ratio 57.459 25 .000 Linear-by-Linear Association 10.593 1 .001 N of Valid Cases 60 a. 36 cells (100.0%) have expected count less than 5. The minimum expected count is .27. 3.0 Limitation of study and recommendation for further study further study This study may generally pass as a success but there some limitations in it. The study did not put into consideration some important factors like the banks participation in corporate activities. The study did not give the amount of the tax that the banks pay to exchequer in their country of operation. The report did not give details on the mode of operation of the banks in the foreign market. This study opens up possibilities of other studies that are directly related to it. One of the studies that could be of important is the level of technology used in the different banks. 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