Foreign Banks Entry into Developing Countries - Dissertation Example

? Foreign Banks Entry into Developing Countries: Impact on Lending to Small and Medium Enterprises (SME's The Ghanaian Experience Presented by: Presented to: Introduction The 21st century transformed the pattern of trade. It may seem cliched that the world has turned into a global village. The newer means of communication and the prospects of modern technology changed everyone’s life. The facilities available today have marked great changes in the world of business and commerce. One of the most appropriate examples is “outsourcing” to India by U.S companies. This has two fold effects; cost saving by the American companies and a source of income for the Indians. Modern technology and Internet have led to a canopy of network all the world. This has increased the number of foreign banks entering the lesser developed markets. The banks have an added advantage in those markets due to the lack of competitiveness. Lesser Developed countries are mainly agrarian. The main source of income is working in the fields. The dependency ratio is quite high. However, one of the major sources of employment in these countries is the cottage and SMEs. This is especially true for people living in remote or rural areas. According to Clark, Cull and Peria (2002) small and medium scaled enterprise comprises of more than 50% of employment for some of the lesser developed countries. They are the dynamic sectors of the economy and their success could serve as a predecessor towards industrialization. However, they lack proper financing which usually hinders their growth prospects. Objectives With the advent and increased number of foreign banks dominating the market the situation has worsened. It is believed that the entry of foreign banks into the market of a less developed country would raise the competition and thus, there would be an easy and an efficient provision of loans. However, it is a fact that market asymmetries occur and the greater competition leads to a reduction is the access of credit to local firms (Petersen and Rajan, 1995). The foreign are risk averse and therefore, in order to minimize cost and maximize benefits loan only to the profitable firms that are highly credit worthy. The purpose of this study is to investigate the impact of the entrance of foreign banks into local markets. An assessment on their effects on granting loans would be prepared. Special emphasis would be laid upon SMEs. Lending behavior towards the SMEs would be analyzed and it would be assessed that whether the volume has increased or decreased with the entry of foreign banks. Moreover, changes in the services and products offered to SMEs would be identified. In addition the credit policy, credit process and characteristics of loans offered to SMEs would be appraised. Thus, the focus of the study is to deeply emphasize on the position of finances of SMEs with the prevalence of foreign banks. Basically the existence of foreign banks would be weighed upon the benefits and disadvantages to the SMEs. The research would work upon the following null hypothesis against the alternate hypothesis: H0: The existence of foreign banks provide higher provision of loans for SMEs H1: The existence of foreign banks do not provide higher provision of loans for SMEs This hypothesis would be tested by focusing upon the following questions: 1) What is the impact of Foreign Banks on Domestic Bank Lending? 2) Has credit to SME’s increased or decreased following the entry of Foreign Banks? 3) What are the different types of loans offered to SMEs and how are they delivered? 4) What are the credit policies and the criteria for assessing SMEs loan application? 5) What are terms and conditions of providing loans? 6) What possible steps do SMEs need to take in order to get financed by banks? Literature Review The backbone of all businesses is finance. The industries are heavily dependent on the lending institutions for the availability of finances. The loan market works somewhat, similar to a product market. Interest rates are the main determinants. High interest rates encourage savings which result in credit creation. The banking industry is a competitive industry with no barriers to entry and exit. Due to this, the entry of foreign banks have risen in the lesser developed countries over the past few years. The entrance of foreign banks is seen as both a favor and a threat to the domestic market. Thus, two opposing views are observed. According to one view, the domestic bank markets in lesser developed countries are not very competitive and therefore, they are inefficient and provide loans at a higher interest rate. Thus, the entrance of foreign banks would increase the competition in the domestic market and the borrowers would be better off. Opponents believe that the entry of foreign banks create an atmosphere of competition which leads to a decline in loans provided to the borrowers. Moreover, asymmetric information prevail and the cost of acquiring the information about local firms is quite high (Gormley, 2007; Petersen and Rajan, 1995). Thus, according to Sengupta (2006) the foreign banks indulge in ‘cream-skimming’, where they lend only to the most profitable local firms. Gormley’s paper (2007) identifies the question in his study that whether the entry of foreign banks improve credit access for domestic firms and if so, which firms? The study has been conducted using the data on Indi when the entrance of foreign banks started to happen around 1990. This was mainly the result of the 1994 agreement signed by India with the World Trade Organization to allow the entry of foreign banks. The research subject has been dealt very carefully and a deep analysis of the effects of the foreign banks onto the access of credit to local firm has been conducted. Geographical location has been the main variable used by Gormley (2007). Gormley (2007) compares the changes in the in the borrowing patterns of domestic firms located geographically near the new banks to changes in the borrowing patterns of firms located further from the new banks. He also took into account the changes in the access to credit to different firms as a control for any differences in the types of firms located in areas with a new foreign bank. Further the study of Gormley(2007) revealed that the 10% profitable firms located near the foreign banks received large loans whereas, the access to credit decreased by 7.6% for an average firm. This decrease has been accredited purely to the supply side as discussed earlier. The reduction in loans has been accredited to the lack of supply by the domestic banks. Data has been collected on a firm level and regression analysis has been used. The OLS regression has been used in order to obtain consistent estimates. Firm level Outcome of a particular district and in a particular time period has been regressed over Foreign Banks in a particular district over a particular time period. The data of a particular country has been used rather than the use of cross-sectional data. This provides very useful results pertaining to the nature of the development of the country and the impacts of the foreign banks. Moreover, the time elapsed between the emergence of new banks and the old banks have been catered to as well. Overall the study focused upon the reduced access of loans to the firms due to the emergence of foreign banks. Moreover, the increased access of credit to profitable firms has been proved as well. However, Gormley (2007) emphasizes that the main cause of this disturbance is due to the asymmetry of information in the LDCs. A paper by the Development Research Group by the World Bank focuses upon the penetration of the foreign banks into the market of LDCs. This paper makes use of cross sectional data over different countries and concludes that the existence of foreign banks result in the provision of finances for the enterprises at all level. According to the studies taken into account it has been assessed that the foreign banks reduce domestic lending. A study by Clark, Cull & Peria (2002) states that the evidence on this claim is limited and hence, does a deep analysis of this issue. Studies from USA (Clark, Cull & Peria ,2002) reveal that large organizations do not find it very feasible to lend to small scale and opaque firms. Thus, this is a statement in favor of the above stated claim that the entrance of foreign banks indeed lowers the credit access and availability. Berger et al. [2001] finds that small businesses in Argentina were less likely than larger ones to receive credit both from large banks and from foreign banks (Clark, Cull & Peria ,2002). Another study on Argentina by Argentina, Escude et al. [2001] revealed that the share of loans to the SMEs was considerably small but in the year 2000 they were granted half of the credit (Clark, Cull & Peria ,2002). It is also been noted, although very rarely, that some foreign banks have lent a greater amount to SMEs that the domestic bank (Clarke,2002 ; Clark, Cull & Peria ,2002). The paper also highlights an important finding of Jenkins(2000) that 44% of the 78 banks surveyed which lent to SMEs reasoned it on the competitiveness of these loans which changed the market conditions. The research methodology is applied in this paper is different from that of Gormley’s (2007). The data deals mainly with the degree of penetration of the foreign banks and how it impacts the availability of credit to the SMEs. OLS regression analysis is carried out in this case as well. The control variables include macro, institutional and some micro factors. The study tends to focus on the correlation between the presence of foreign banks and the interest rates and long term credit. The study by Clark, Cull & Peria (2002) includes data from the World Business Environment Survey (WBES The World Bank’s World Development Indicators and political data from Beck et al. (2001). The study investigates and finds that the penetration of foreign banks in the LCDs do not serve as a hindrance to SMEs. Instead it suggests that small businesses also benefit from the presence of foreign banks. This is because the concentration of foreign banks is towards the high profiting firms. Therefore the domestic firms might shift to niche market that is the small scale market such as SMEs. Thus, it could be said that the foreign banks’ entry into the LCDs result in segmentation of the banking sector. This idea has been presented by Gormley (2006) as well. Clark, Cull & Peria (2002) reveal that countries that have high foreign bank penetration do not consider interest rates and long-terms loans as constraints as compared to those that are without the foreign banks. Clark, Cull & Peria (2002) further introduces the reasons that contribute towards the idea of foreign banks lending to SMEs. This is because usually it is considered that the portfolio shares of SMEs in the foreign banks are quite small as compared to domestic banks. However, Clark, Cull & Peria (2002), suggest two reasons for the reverse scenario. One of the reasons is that the foreign banks enter the market with a small interest rate margin and lower overhead cost. This has been concluded from the evidence of the study conducted. Thus, this scenario might encourage the foreign banks to lend to SMEs. The second reason that contributes is the atmosphere of competition that would prevail due to the entry of foreign banks. This might trigger the domestic banks to transform their lending behavior and concentrate on the alternative potential lenders that are the SMEs. Some of the LDCs have a huge contribution of SMEs in their Industrial Sector. Due to this they employ sometimes more than 50% of the population. Thus, their financing is an utmost crucial factor for LDCs. They can deeply affect the economic situation of these countries. Therefore, this is an area of high concern for the policy makers. The papers discussed have emphasized on both the positive and negative impacts of the foreign banks. Moreover, they have also conducted research and in light of empirical evidence justify their findings. Such works are of great importance for the policy makers of lesser developed countries who attain an expert guide line. . Methodology and Data Collection The means of conducting research would be both quantitative and qualitative. Different research works would be reviewed. The critical points would be highlighted and a deep analysis would be conducted. Some of the works that would be used include: Banking Competition in Developing Countries: Does Foreign Bank Entry Improve Credit Access? Does Foreign Bank Penetration Reduce Access to Credit in Developing Innovative Approach to SME Financing in Nigeria: A Review of Small and Medium Industries Equity Investment Scheme (SMIEIS) These would be critically reviewed and a detailed literature would be provided. Moreover, newspaper and journal articles would be consulted for a better understanding of the subject. The qualitative data would be assessed and all crucial factors would be highlighted in identifying the impacts of foreign aid on the SMEs. Quantitative data would be gathered from Ghana. A field visit would be made in May-June 2011. First hand data would be collected by various sources. The main sources for the collection of data would be: i. Participating Banks Annual Reports ii. Ghana Banking Survey Reports by Price Waterhouse Coopers iii. Bank of Ghana Annual Reports iv. National Board for Small and Medium Sized Industries (NBSSI) For a detailed study, quantitative data for both foreign banks and SMEs would be obtained. Currently there are 14 foreign banks operating Ghana. Till 1983 the banking system in Ghana was heavily nationalized with the exception of two banks Standard Chartered and Barclays operating then. Using the Participating Banks Annual Reports and the Ghana Banking Survey Reports by Price Waterhouse Coopers, we can obtain the amount of loans granted by banks in respective years. For instance if the Standard Chartered has been operating for more than thirty years, the loans granted for 30 years would be obtained. The research methodology would comprise of two different steps. The first step would include the following: 1) Collection of data of the aggregate loan provided by foreign banks in Ghana. The arrangement of long term loans since the time they have been operational. The data should be of preferably 30 years. Collection of data of long-term loans at least two local banks in Ghana. The arrangement would be done in the similar manner. The data should be of preferably 30 years. 2) The aggregate amount of loans provided by domestic commercial banks in Ghana. 3) The impact of loans given by domestic firms due to the existence of foreign firms would be analyzed. Regression by Ordinary Least Square Y = B0 + B1 foreign bank loans + u In order to establish a relationship or identify the impact the above regression equation can be used. A time series model would be developed with data of two local and two foreign banks. Y in the above equation represents Domestic Loans which are dependent on the foreign loans. The value of the B1 would be used to assess the impact that an additional amount of foreign bank loan would have on the Domestic Bank loan. Moreover, the elasticity could be checked by the following equation : logY = B0 + B1log( foreign bank loans) + u However, the analysis could be refined by adding a variable “distance” and the number of foreign banks operating in Ghana. This could be used as dummy variable. If the foreign bank is in the range of 5 km than it could have a value of 0 and if it is farther away it could be given a value of 1. This could assess the impact that distances between banks have upon the domestic loans due to the existence of foreign banks. The new equation would be: Y = B0 + B1 foreign banks + B2distance + u B2 measures the impact of distance between banks on domestic bank loans. The step two of this methodology would require two steps: 1) Collection of the data on the aggregate data over a period of 30 years of the loans granted to SMEs. 2) Determinants of the granting of loans to the SMEs. 3) Impact of the existence of foreign banks on SME loans. Regression by OLS Z = C0 + C1 foreign banks + C2domestic banks + u Foreign Banks would be the number of foreign banks and Domestic banks would be the number of domestic banks in the period of 30 years. Z is the aggregate amount of loans over the 30 years that have been obtained by the SMEs. This would be a very simple model to analyze. For a refinement of this equation, two more variables can be included. Number of people employed could be an added factor. There might be a possibility that the greater number of people employed by an SME may serve as a positive factor towards the granting of loans by the foreign banks. Moreover, credit rating of the firm could have an impact too. The new model would be: Z = C0 + C1 foreign bank + C2domestic banks + C3 people employed + C4 credit rating + C5competition + u Here, credit rating would be a dummy variable: 0 = low rating, 1 = high rating Data on the number of people employed over the time span would be required as well. In order to further enhance the analysis “competition” has been an added factor to the equation. As competition cannot be measured directly a proxy variable would be used to measure the extent of competition between the local and foreign banks. Thus, the above regression equations make use of the possible determinants that could account for the granting of loans to the SMEs. The analysis of the data would be further enhanced by time series plot and other summary statistic measures. Moreover, graphical representations would be provided in order to aid the research methodology. Implications The study would have implication for the policy makers of the lesser developed countries. They might view this study as a useful instrument in settling the issue of financing of SMEs. Research studies show that the increased competition from foreign banks result in high competition and pressure which results is a reduced amount of loans. Therefore, the government needs to regulate its policy. Foreign banks should be allowed to enter the market but the government needs to organize a mechanism so as to protect the foreign banks from the increased competition so that they do not decrease their amount of lending. Limitations The study would have certain limitations. The errors in data collection and arrangement might prevail. The time span considered might not represent the true and most appropriate form of research. However, due to the unavailability of data the time span would have to be restricted to 30 years. The analytical interpretations of the data might not be universally accurate. In calculating the models there might be factors that would have been ignored or not included in the model. The error term “u” would include the unobserved variable. There might be an existence of statistical bias or inconsistency in the method applied. Conclusion Economic growth of any country is related to the amount of business and trade being conducted by the economy. The lesser developed countries like Ghana are not apt at manufacturing. However, the existence of small scale industries is a great benefit to them as an income generator. The entrance of foreign banks poses a threat to the local industries as the provision of credit is reduced. SMEs are undoubtedly a very important segment of the economy for lesser developed countries. Therefore, they need to be financed well and protected from the competition enforced by the foreign banks. The role of government needs to be vitalized and regulations need to be strengthened in order to protect the domestic industry. References Gormley, T.A. (2007), Banking Competition in Developing Countries: Does Foreign Bank Entry Improve Credit Access?. Available from: Washington University in St. Louis, Finance Department Web site: http://fic.wharton.upenn.edu/fic/india/11gormley.pdf [Accessed: March 27, 2011]. Clarke, G.R., Cull, R. & Peria, S.M. (2002), DOES FOREIGN BANK PENETRATION REDUCE ACCESS TO CREDIT IN DEVELOPING COUNTRIES? EVIDENCE FROM ASKING BORROWERS. Available from: The World Bank, Development Research Group Web site: http://siteresources.worldbank.org/INTFR/Resources/foreign_bank_penetration.pdf [Accessed: March 27, 2011]. Abereijo, I.O. & Fayomi, A.O. (2005), Innovative Approach to SME Financing in Nigeria: A Review of Small and Medium Industries Equity Investment Scheme (SMIEIS). J. Soc. Sci.,11(3). Available from: Obafemi Awolowo University, Centre for Industrial Research & Development Web site: http://www.krepublishers.com/02-Journals/JSS/JSS-11-0-000-000-2005-Web/JSS-11-3-173-258-2005-Abst-PDF/JSS-11-3-219-227-2005-265-Abereijo-I-O/JSS-11-3-219-227-2005-265-Abereijo-I-O-Full-Text.pdf [Accessed: March 27, 2011]. Petersen, Mitchell A. & Raghuram G. Rajan (1995) “The Effect of Credit Market Competition on Lending Relationships,” Quarterly Journal of Economics, 110(2), 407-443. Sengupta & Rajdeep (2006) “Foreign Entry and Bank Competition,” Journal of Financial Economics. Read More

 

Read More