Global Banking and Financial Regulation - Banks Motivation for Going International - Literature review Example

GLOBAL BANKING AND FINANCIAL REGULATION Essay on Banks’ motivation for going international It has been the recent phenomenon in the world’s economy that global integration, which was thought to be the phenomenon of real sectors, but has happened in the financial sector as well. The financial institution’s endowment of their financial services to the foreign countries is not the only way to the world’s economy integration, but there is an upsurge in the internationalisation of banks as well (Zhang, 2008). It is considered not to be the new occurrence, rather it has been started in the middle ages, when some Italian banks started operations across the borders (Jones, 1990). However, the globalisation of banks and multinational banking has taken pace in contemporary years with a different way to enter into the foreign market, as by investing directly in abroad. The reason behind this phenomenon is that there has been the financial deregulation and liberalization in the financial sector across the globe. The decrease in the information cost due to high development in the technology side has resulted in the internationalisation of the real sectors as well as the banking sectors. Meanwhile, it is also seen in the banking sector that there is a growing number of mergers as well as acquisitions happened in the bank (Soussa, 2004; Gunu & Olabisi, 2011). Due to this upsurge in the globalisation, some concerns are being important to banks and also the governments, where the governments are trying to find the impacts of financial integration on their economy, and on the other hand, the banks are trying to find the best ways to make their expansion into foreign markets strategically sound. Such worries are due to the fact that the banking industry is of high significance in terms of the strategic funding to the other sectors (Mullineux & Murinde, 2003). But the question arises here is that what are the main motives of the banks in order to enter into the foreign markets. The purpose of this essay is to critically examine the banks’ motivation for diversifying internationally and also to evaluate the risks involved in the banking globalisation with reference to the 2007-2009 global financial crisis. The essay has two major sections, first for the bank’s motivations where the motives are critically evaluated, and second for the risks being faced by global banks, which are evaluated with respect to the global financial crisis. The literature suggested different point of views with regard to the potential motives of the banks to go abroad. The major motivation for a bank to enter into foreign markets can be said as to maximize the profits. It is the same motive as the real sector organisations have. How a bank can maximize profits by investing in the foreign markets are the main debated areas in the literature. According to the Hryckiewicz and Kowalewski (2010), the banks are motivated to enter into the foreign markets due to the host country’s economic features, which are sound with respect to the risk and return. They argued that banks invest mainly in the countries, where there is an expectation of greater economic development and more potential is there to advance by avoiding the inadequacies of domestic banks (Hryckiewicz & Kowalewski, 2010). In line with this argument, Bhattacharya (1994) has highlighted that the banks may go international to capture the business opportunities. It is explained in a way that when the banking industry in the foreign market is not much competitive and technologically developed, then the banks can enter into the market and explore more opportunities with the employment of new technological advancements and marketing techniques (Bhattacharya, 1994). It is obvious in today’s market environment, there is much technological advancement with regard to the banking system, such as information technology systems, online banking, etc. This has also resulted in the lowering of transaction cost. In contrary to the Hryckiewicz and Kowalewski (2010)’s argument, the Berger and de Young (2001) have suggested that the economic growth of the host country may not be the reason for profit maximization in the foreign markets, rather there could be the same return rates in the host country. The only thing which motivates is the risk diversification, where more profits are realized due to the diversification effect of investing in the lager portfolio (Berger & De Young, 2001). While Bhattacharya (1994) mentioned in his study about the bank internationalisation that the combined risk from the domestic and foreign portfolio is much lower than the risk of investment only in domestic portfolio. The study also concluded that there is much decrease in the risk of the portfolio with the global expansion of banks, as evidenced by the Canadian banks (Bhattacharya, 1994). The efficiency gain is also discussed in literature, as the multinationals gain efficiency through the synergistic relationships. In the same regard, banks entering into the foreign markets can have the efficiency gain motive. As Sabi (1988) has argued that when the banks have economies of scale with its large size, then they can enter into foreign markets in order to capture the scale efficiency with lowering the costs. The bank can better compete with local banks in the foreign market on the basis of economies of scale and hence, the efficiency (Sabi, 1988). While, Ursacki and Vertinsky (1992) have argued that the efficiency is achieved with the lowering of transaction costs, as with higher extent of globalisation, there are huge and various customer source, which will in turn, lower the transaction cost. Additionally, the efficiency can be resulted from the consistent and efficient distribution channel in the foreign market, especially in case of developing countries, as they do not have such efficient distribution system (Ursacki & Vertinsky, 1992). Another motive to enter into the foreign markets is to gain more market share, or in other words, to gain more customers of the host country or to retain the domestic corporate customers to improve the scale of business (Beermann, 2008). In this regard, Bhattacharya (1994) has pointed out this theory of “Follow-your-customer”, where the banks enter into foreign markets to provide superior foreign services to the local clients. Due to the follow-the-customer strategy, a comparative advantage can also be gained by the foreign investments, where it is considered as the investment in the information asset and building strong relationships with the clients (Bhattacharya, 1994). It is also known as “gravitational pull effect”, as De Paula (2002) has suggested. This is important in order to reduce the costs of “credit rating”, which is much greater in other cases. Or it can also be pointed out that if follow-the-customer strategy for any corporate client is not pursued then this could be availed by the competitor. Thus, it provides a competitive advantage as well (Bhattacharya, 1994; Beermann, 2008; De Paula, 2002). The increasing concern with the information asset in today’s environment, the follow-the-customers strategy has great importance, as argued by the Mody, et al., (2003). They also suggested that this strategy gives an edge over competitors, as the information is the crucial asset and it is significant for the banks to operate with a small pool of clients to protect their delicate information. Additionally, the regulatory framework can also be another motivation for the banks to enter into the foreign markets. When the banks in the domestic market have to follow the strict regulations, then they opt for going international, especially in those countries where the regulations are bit relaxed (Bhattacharya, 1994). The question here is that why the governments would relax the regulations. Here, it can be argued that the purpose of this would be to enhance competition among the banking institutions, as it was done in Europe in 90’s because of the inefficiency and ineffectiveness of the state owned banks (Van Horen, 2007). Consequently, the regulatory differences with respect to the prudential regulations or the structural regulations can also be the bank’s motivation for entering into foreign markets. Apart from the host country perspectives, Qian and Delios (2007) have conducted a study from home country’s perspective. They suggested that the motivation of the bank for internationalisation would also be to augment the home country’s market position with the foreign operations (Qian & Delios, 2007). Bhattacharya (1994) also mentioned another motive as the “pull factor”, where the banks go into foreign markets due to their lower price-to-earnings ratio. As with lower P/E ratio, the banks have to recompense fewer for one dollar of income. But the condition for this is that the banks can purchase the shares of foreign banks, and cannot enter through foreign direct investment. This can be caused by the currency levels’ volatility. Moreover, there are some other motives, which can also be important consideration while entering into foreign markets, such as due to easy access to limited resources, lower costs of input in the foreign market, capture new markets, lower regulatory restrictions, and source of competitive edge (Mariotti & Piscitello, 2010; Mullineux & Murinde, 2003). Furthermore, De Paula (2002) has argued that there can be potential barriers as well, which can pose a real threat while entering into the foreign market, such as the local market advantage may be lost, the issue of cultural differences, diseconomies in functioning, and inability to control operations from a distance. However, it is suggested that if these barriers and problems are overcome by the bank management, then the foreign investment advantages of increasing efficiencies, lowering costs and risk diversification can be achieved (De Paula, 2002). Moreover, in contrary to the above discussion of foreign banks’ advantages, Slager (2005) has provided evidence that commonly the globalisation of banks does not add to increase the profit and shareholders’ value through internationalisation (Slager, 2005). And also a recent study by Liu (2013) has suggested that it is not the special motives that motivates the banks to invest in foreign markets, rather the bank globalisation is evolved in the course of the economic deregulation and other conditions. Most of the researchers have applied the Multinational Companies’ theory for internationalisation in the context of the banking industry (Liu, 2013). So, it entails further research and evidence needed to be provided in this regard. In the above given discussion, the literature has suggested a number of evidences and concepts to support or reject the arguments with respect to the bank’s motivation of going abroad. But the effects of this banking industry’s globalisation have not been discussed until now. Here, it is time to move towards the evaluation of the risks, which are being faced by the global banks with reference to the financial crisis of 2007-2009. The risks of banking integration can be seen in context of the financial crisis of 2008. Buch and Neugebauer (2011) have provided a theory with the evidence that the integration of banking industry on the globe can pose some big risks. They have also provided some inferences in this regard that the integration has a higher contagious risk, where they postulated that the financial shocks become contagious when the banks are integrated. The little shocks at the start of the financial crisis were spread through one region to the other due to the integration of banks in these regions. They argued that the extent of the liquidity catastrophe in financial crisis highly depends on the extent of markets’ integration (Buch & Neugebauer, 2007). When the banks are not properly integrated or are roughly collaborating financial setups or their operations, then the contagious risk is lower. The contagion risk grows with the moderate levels of integration among banks. But it is surprising that when the banking systems or financial structures are fully integrated, then the risk of contagious crisis becomes lower again (Hryckiewicz & Kowalewski, 2010). Another postulation given by Buch and Neugebauer (2011) is that the banks also have liquidity cushions to save them from the liquidity risk, which is also impacted by the extent of financial crises. Moreover, the financial crises can also pose the risk of depreciation of the asset prices that can result in the worsening of their financial situations (Buch & Neugebauer, 2007). The above theoretical inferences were seen in the financial crises of 2007-2009, when even the large scale banks were also non-resistant to the liquidity shocks in the economy and they faced huge consequences from an extensive liquidity crisis. On the other hand, the governments, even from the developed economies countries has to deliver some support and funding to their international banks, in order to recollect assurance in them as well as to bring their financial structure to a satisfactory level. There was huge weakening of financial circumstances among a great number of international banks and severe amendments in the valuing of risk. These two factors of weak financial conditions and wrong assessments of risks resulted in the increase in the likelihood of having a setback in their operations in foreign countries, particularly with regard to advancing. Undeniably, there were also many international banks who tried to reassess their operations abroad, and set back by closing out or selling their disappointing subsidiaries (Buch & Neugebauer, 2007). Consequently, it can be the risk that the international financial crisis may alter the whole configuration of the financial sector in Central Europe in addition to the other evolving economies. Though, it is evident that still the bank integration over the globe is not stopped at all. And no other bank except the AIG bank has closed its operations in the Central Europe. However, in the financial crisis time, many of the local banks were also closed out such as in Ukraine and Russia. And also some of the local banks and local financial institutes are considered to be working on their own risks, while they are the possible targets of the international banks for the purpose of acquisitions (Hryckiewicz & Kowalewski, 2010). However, there is a need to develop proper integration between the banks to make them resistible to the financial risks and contagious risks, as suggested by (Buch & Neugebauer, 2007). In support of this argument, Jang (2013) has given an evidence about the diversification benefits. In his evidence, he argued that global business diversification expands the easy access to resources, particularly in overseas countries. There is an important implication here that the international banks are less impacted by the capital market disruptions in the domestic country in comparison to the other local banks, as they have easy access to the capital and resources. In reference to the 2007-2009 financial crisis, when there was a resource crisis as well, US companies get more funding from the banks abroad, rather than the local banks (Jang, 2013). In conclusion, it can be said that a number of motivations are critically evaluated with the help of studying literature, where there are many motives of banks highlighted in order to go international. Though, some are also rejected and approved from different studies, but it entails that there is need to conduct the further research over the issue. Moreover, the financial crisis of 2007-2009 has impacted on the bank integration with its contagious effect and deterioration of the financial structures. It is a fear that this crisis will change the financial structure, if there is no full integration when the crisis effects are lower. Bibliography Beermann, P., 2008. Topics in Multinational Banking and international Industrial Organization, M¨unchen: Ludwig-Maximilians-Universitat. Berger, A. 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