Factors Determining Performance of Banks in Foreign Markets - Report Example

Factors determining performance of banks in foreign markets TABLE OF CONTENTS 1.0 Introduction 3 2.0 Study findings 5 2.1 Foreign country location 5 2.2 Origin of banks 6 2.3 Profit realized 7 2.4 Turnover of banks 9 2.5 Correlations tests for variables 10 2.6 Investigation of the relationship between origin of bank and the foreign country location 12 3.0 Limitation of study and recommendations for further study 18 1.0 Introduction There are several factors that have been found to influence the decision of banks entering foreign countries. One of the reasons is the degree of economic interaction taking place between the host country and the foreign country. Entry requirements and tax regulations also affect the entry of foreign participants in host countries. According to Ali, (2005), there is a preference of foreign banks to invest in host countries which have few banking activities restrictions. Cross-country evidence has shown that whenever there is high restrictions into banking there will be higher net interest margins as well as overhead costs. There is also high chances for major banking crisis having a positive association with limiting foreign bank participation. Foreign countries will be attracted to host countries where they feel there is opportunities. Foreign banks will enter host countries with high per capita income and low taxes (Parkhe, 1998). Greater foreign banks entry will be realized in host countries where there is high economic growth with averagely less efficient banking system. A conducive host country will be found to have initial GDP per capita and inflation having a negative association with the presence of foreign banks but a the host country having a positive stock market capitalization Ali (2005). Inefficiency in the host country local banks is manifested by high average costs, very high cash flows and existence of low net interest margin less charge offs. The host countries also found to have small banks that can easily be acquired by the foreign banks. Foreign competition in home countries also is a reason why domestic banks compelled to invest in foreign countries. There is overwhelming evidence that the reasons foreign banks invest in developing world is not the same reasons for investing in developed ones. Following the customer appears to be not a reason when investment is being made in the developing country meaning that there is genuine desire to exploit opportunities in the host countries. With such investment motive foreign banks are likely to have substantial benefits in host countries provided some market segments such as SMEs that are in dire need of financial services are not sidelined. Culture may affect the ability to enter and the performance of banks in foreign markets. A good example to illustrate this is given by Berger, Klapper, and Udell (2000) who note that foreign banks with their headquarters in South America nations had a tendency of lending to small Argentine businesses in comparison to other foreign banks with headquarters in other countries. The most likely reason for this being that similarity of culture and language offered them advantages in comparison to other institutions based in other places. The expansion of the foreign banks in the host countries provides indicators of the banks participation in the destination market. It is believed that large banks are more likely to expand in foreign countries and research has found that there is a positive correlation between bank sizes and their extent of internationalization. According to the findings of Tschoegel (1983) 100 large banks were found to have large presence worldwide. A positive correlation has been found to exist between the asset size of banks and their number of branches (Vertinsky, 1992). The foreign banks are also found to be more efficient. Home country regulation also plays a role in determining way banks enter foreign markets. The home country may affect the banks ability to expand to foreign countries by having a restriction on foreign country investments or through other general regulations that affect the banks competitiveness in foreign countries. Frankel and Morgan points out that cross-country regulation could have reduced foreign banks costs relative to U.S. banks thereby making them more competitive. 2.0 Study findings The findings of this study has been given under the following subheadings Foreign country location Origin of banks Turnover of banks Correlations tests for variables Investigation of the relationship between origin of bank and the foreign country location 2.1 Foreign country location A study on the location of the foreign countries in which the banks that were under study were located was as shown in figure 1. From the figure it can be seen that the highest number of the the banks which were being studied were located in the in Africa with 26% of the foreign banks being in this region. From the figure it can also be seen that 16%, 18% and 22% of the foreign banks were located in Europe, Asia and North America respectively. The fact that there is a hign number of the banks in Africa could because of the inefficiencies in the domestic banks in Africa which the foreign banks sees as an opportunity of establishing more efficient banks in this region. There is also a high number of foreign banks in Europe. Europe being a developed region the high number of banks could be due to lack of barriers of entry into the market. The number of foreign banks in the Middle East is the least and this could be due to cultural diffrence of the Middle East and other regions with high potential for foreign banking. Figure 1: Location of foreign country 2.2 Origin of banks The results in Figure 2 gives the foreign banks origin. From the figue it can be seen that the region with the list number of foreign banks is Africa. Asia and Europe had the highest number of banks in foreign countries with each contributing 20% of the banks under study. North America region and Latin America contributed each 18% of the foreign banks under study, Middle East had 18% while Africa had 8%. Figure 2: Bank origin 2.3 Profit realized The range of profit realized by the banks was as shown in Table 1. From the table it is observed that 14 banks which represents 28.0% of all the banks had a profit of more than 6m dollars, 8 banks (16.0%) had a profit margin of 2 to 4m dollars while the 1 to 2m and 5 to 6m dollar profit margin had 12 banks each. The profit margin is presented diagrammatically in Figure 3. Table 1: Profit realized in $ Figure 3: Profit margins of the foreign banks 2.4 Turnover of banks The turnover of the banks was as shown in Table 2. From the table it is observed that11 banks which represents 22.0% of all the banks had a turnover of more than 20 million dollars, 13 banks (26.0%) had a turnover of 16 to 20 million dollars while 12 banks (24% of the total number of banks) had a turnover 11 to 15 million. The turnover range is presented diagrammatically in Figure 4. Table 2 Turnover of banks Frequency Percent Less than 1m 1 2.0 1 to 5m 6 12.0 6 to 10m 7 14.0 11 to 15m 12 24.0 16 to 20m 13 26.0 More than 20m 11 22.0 Total 50 100.0 Figure 4: Turnover for the foreign banks 2.5 Correlations tests for variables Correlation test was done to establish the relation between the variables: age of the mother bank, foreign ban age, profit realized and the turnover with the result being as in Table 3. From the results it can be seen that there is a strong correlation between the turnover of the banks and the profits realized with a Pearson correlation of 0.912 at p=0.000. The correlation of turnover and profit is an indication that the higher the activities of the banks the higher the profits being realized. This is also an indication that the banks are running efficiently and therefore making profit that is proportional to the turnover. There is a positive significant correlation between the profit realized and the foreign bank age with a Pearson correlation of 0.651 with p= 0.000. This could be explained by the fact that banks which have been in the markets for longer have more experience and therefore are more efficient. The other reason could be that the banks have been expanding with time and this has seen the increase in the profit. From the table it can also be seen that there is a moderate positive and significant correlation between age of the mother bank and the foreign bank age with a Pearson correlation value of 0.593 and p = 0.000. The explanation to this could be that banks expand with time and with time they exhaust the local market and thus they are compelled to invest in foreign countries. Therefore banks which are old in their home country are likely to have old branches in foreign countries. The correlation is not strong due to the fact that there are some restrictions by home countries and these acts as a hindrance of the banks venturing in foreign markets. Some of the banks may not be efficient enough to be able to venture into foreign markets as soon as possible or lack of competition in the local country may make the Age of the mother bank Foreign bank age Profit realized Turnover Age of the mother bank Pearson Correlation 1 .593** .234 .138 Sig. (2-tailed) .000 .101 .340 N 50 50 50 50 Foreign bank age Pearson Correlation .593** 1 .651** .507** Sig. (2-tailed) .000 .000 .000 N 50 50 50 50 Profit realized Pearson Correlation .234 .651** 1 .912** Sig. (2-tailed) .101 .000 .000 N 50 50 50 50 Turnover Pearson Correlation .138 .507** .912** 1 Sig. (2-tailed) .340 .000 .000 N 50 50 50 50 **. Correlation is significant at the 0.01 level (2-tailed). banks not to be under pressure to go beyond borders. Table 3: Correlations 2.6 Investigation of the relationship between origin of bank and the foreign country location In order to find out if there was any relationship between the origin of the bank and the foreign country in which the banks operate a cross tabulation and chi-square analysis were performed with results being as in Table 2 and Table 3. From table 2 looking closely at North America row it can be seen that there was no bank of African origin operating in North America as a foreign bank. This can be explained by the facts that banking services in North America is very competitive and banks originating in Africa might not survive the competition. Latin America, Asia and Middle East had each one bank having their operation in North America. The presence of a bank of Middle East origin can be due to the fact that non of the other banks operating in the region are able to fulfill the banking requirement of the people with origin from Middle East who may be living in North America. This therefore has brought about some demand for some banking services fulfilling unique cultural and religious requirements. The existence of some banks of Latin America and Asian origin in North America is due to the fact that the banks are following their clients in diaspora. Europe had the highest number of foreign banks in North America with 3 banks in operation. The presence of high number of European banks in North America could be due to cultural agreement of the two regions. The European is a region with very high competition in banking and therefore there is need to look for market abroad. Banks of European may be having favorable regulations of banking sectors in their home countries which make it favorable to invest in the foreign countries. Long banking experience for European means high efficiency making it possible for the banks to survive high competition in North America. The 3 banks with Europe origin comprised of 37.5% of banks within foreign country location and 30.0% banks with origin of bank. In the Europe row it is observed that the highest number of banks in the regions had their origin in the same region with a total of 7. The banks of Latin America operating in Europe were 2, North America and Asia had each one bank while Africa and Middle East had no banks operating in this regions. The high number of the banks operating in their home area can be linked to cultural compatibility and the competitiveness of the European banks. The banking regulation in Europe may be another reason why there are few banks from other regions investing in Europe. Asia region had a total of 9 banks operating in the region, five of which operated within the same region, 2 having North America origin and 2 originating from Middle East. North America venture into Asian markets may simply due to the fact that there economic growth in the region which attracts American multinationals. The Middle East presence in Asia may be simply of supplying unique services required by the diaspora of Middle East origin. The 5 banks comprised of 55.6% with the foreign country location and 50.0% within the origin of bank. The 5 banks that operate in the same region can be explained by cultural compatibility and geographical distance. The presence of foreign banks of Asian origin in North America can be due to the facts that the banks are in pursuit of their clients abroad. The Asian banks presence in Middle East may be explained as being due geographical proximity. The table 5 also shows 5 International banks under study were operating in Middle East 4 of which originate from the same region with one being of Asian origin. The Africa row shows that 13 of the banks are based in Africa 4 of which have their origin in the same region, Latin America and North America each contributing 3 of the 13 banks operating in Africa as foreign banks. The high number of foreign banks operating in Africa can be partly be explained by the fact that the region has domestic banks with very high in efficiency. some of the investors all could be seeing a lot of growth opportunities in Africa. In most Africa countries there may be no strict regulation that may be bar foreign investors from undertaking their activities in the region. From the table 5 it is clear that most of the foreign banks have their origin being the same region. The foreign banks which have their mother banks being outside their region of operation also seem to be biased in the regions they operate in. from he table it is seen that there is no banks of North American or Europe origin operating in the Middle East. There are many foreign banks operating in Africa but foreign banks of African origin only operate in the same region (Africa). 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 64.877 at p=0.000. Table 4: Foreign country location * Origin of bank Cross-tabulation Table 5 Chi-Square Tests Value df Asymp. Sig. (2-sided) Pearson Chi-Square 64.877a 25 .000 Likelihood Ratio 61.937 25 .000 Linear-by-Linear Association 11.535 1 .001 N of Valid Cases 50 a. 36 cells (100.0%) have expected count less than 5. The minimum expected count is .32. 3.0 Limitation of study and recommendation for further study further study There are some limitations of these in this study that can be pointed out. In the study the performance of the banks has been limited to profit and turnover without putting into consideration the total assets of banks. The amount of tax paid by the banks has not also been put into consideration. The mode of entry of the foreign banks in the foreign market has not been identified for the banks that have been studied. This is a limitation as mode of entry into foreign markets may have considerable effect on the performance of the banks. Some further studies can be done that are related to this study. It is recommended that a study be done on level of technology use for different banks and the effect on reduction on cost. The level of use of local labor in the foreign market is important on performance of the banks and a study need to be conducted on the same. Political stability of the countries in which the foreign banks are operating has effect on performance and a study on the level of effects is important. References Ali, A. (2005), Domestic banks and foreign banks profitability and differences and their determinants.Case business school city of London. Parkhe, A. and S. R. Miller, 1999, “Is There a Liability of Foreignness in Global Banking? An Empirical Test of U.S. Banks’ X-Efficiency,” Michigan State University, Mimeo. Nigh, D., Kang R. C., and S. Krishnan, 1986, “The Role of Location-Related Factors in U.S. Banking Involvement Abroad: An Empirical Analysis,” Journal of International Business Studies (Fall): 59-72. Berger, A. N., L. F. Klapper, and G. F. Udell, 2000, “The Ability of Banks to Lend to Informationally Opaque Small Businesses.” Mimeo. Tschoegl, A. E., 1983, “Size, Growth, and Transnationality among the World’s Largest Banks,” Journal of Business, 187-201. Ursacki, T. and I. Vertinsky, 1992, “Choice of Entry, Timing, and Scale by Foreign Banks in Japan and Korea,” Journal of Banking and Finance, 16, 405-21. Janek, U. (2004), “Effect of foreign banks entry on bank performance in the CEE Countries”. Tartu University Press, ISBN 9985-04-0416-5, order No.569. Read More