The Internationalisation Of Banking

Published Date: 02 Nov 2017

According to Grubel ,the international banking market is marked by intensive branch and subsidiary networks, few joint ventures and rare contractual arrangements. As such, High control entry modes are by far the most common (Grubel 1989, Huertas 1990).

One way to enter a new overseas market is foreign direct investment of banks. As a matter of fact, it has been argued that banks may prefer to engage in cross border lending without setting up an overseas physical presence. (Buch, Why... 1999, p. 22).

Therefore, the only way to do that is through a correspondent bank. It is suitable for already executes transactions, but not for expanding business opportunities. According to Khoury 1988, it is a poor way to serve existing clients even if the relationship is considered strong and permanent, and to internationalize operations (Khoury 1998, pp. 154-155).

There are two forms of entry on a foreign market:

Greenfield investment,which involves setting up an institution from scratch. It mainly requires a capital infusion from the beginning or in some cases such as a branch or a representative office, a limited capital infusion or the transfer of human capital.

According to Konopielko 1999, the benefits of having operations which is limited to representative services is the risk is lower and therefore regulation is not burdensome

Also, according to Buch 1997, it offers the bank a low cost entry mode, helping it to establish its name without requiring the capital cost and the risk of setting up a branch or subsidiary. This is useful where the domestic market’s worth needs to be ascertained. Further as per Clegg and Scot-Green 1998,if the market development is encouraging or sizeable and remunerative deals is being granted only to firms present in the region, a representative office is a foothold.

Acquisition of a control position from a local banking institution or a full acquisition of the institution.

According to Root (1983), the benefits of acquiring a local bank in its entirety or through majority or minority shareholdings, are: an established presence, existing relationships and functioning branch networks. However, the demerits may include a poor balance sheet, the existing management and an inefficient workforce.

When banks want to expand abroad they use the following strategies:

1) Follow the customer strategy,

2) Leading the customer strategy,

3) Market-seeking strategy,

4) Follow the leader strategy.

‘Follow the customer’ strategy is the common reason for the growth in multinational banking, due to foreign direct investment and foreign trade abroad by corporations. (Walter 1988)As such, these banks react to the expansion of their clients abroad by following them in order to protect their client-bank relationship. They are capable of offering to their clients the same financial products as in the home countries, on account of their developed relationship. There are also considerable costs in assessing the banking requirements of a particular firm. As such; the banking relationship consists of flow information, which due to market failure cannot be traded. Thus, it should be exploited by the bank. (Grubel, 1977) For example, it enables the bank to assess any new loan proposal at low marginal cost, as it had in the past carried most of its assessment. The lower cost gives the bank’s offshore unit a competitive advantage over its rivals. In addition, the bank by and large holds an important position in the trading operations of the client, thus making the change in banker improbable. According to Khoury (1998),in the US, the non-universality of the US banking industry makes it more difficult for American banks to hold on to clients, still they are able on the basis of substantial information costs.

‘Leading the customer’ strategy was another strategy pursued by banks in their quest for overseas expansion (Buch 1997, p. 344). Sometimes, a bank may act as an agent of its current customers from the home country via newly developed contacts established abroad. This for example helps small- and medium-size companies, who are customers of the international banks, to consult and obtain information such as current political and economic situation about the foreign markets. These information and consulting services are known under the "consulting banking" or "informational banking". This advantage enables an international bank to not only improve and broaden its scope of products and services and to strengthen its client ties, but also to gain new clients and to improve its market position. (Stephan 1998, pp. 131-133).

‘Market-seeking’ strategy entails that for some reasons a bank need to penetrate newinternational markets (Hellman 1996, p. 31). Through this strategy, the bank feels it possesses certain financial products which are superior or inexistent to its rivals, or it seeks to exploit a new segment which it perceives is lacking competition and innovation but is potentially profitable in the international market .Generally, when going international, the need to expand in new markets exists. According to Mohanty et al. (1998, p. 3), only a few strong international banks employs this strategy as market seeking is linked with higher risks and uncertainty. Their objective is to attain a geographically wide service network and to penetrate through home-country loyalties to draw other customers.

The "Follow your leader" strategy explains why international banks may choose to open overseas branches despite have no client base or ties. It is a phenomenon which is linked to oligopolistic reaction according to Caves 1982, whereby banks invest overseas as a response to actions by other competitors out of fear of losing clients.As Aliber 1984 puts it, "The ‘follow the leader’ explanation leads to an identification problem,for the factors that explain why firms headquartered in one country set up foreign subsidiaries might also explain why banks headquartered in this same country also set up branches abroad, quite independent of whether domestic firms are investing abroad."

According to Bouteller and Marois 1999, if a bank wants to expand in emerging countries it usually follows two different strategies:

• By obtaining a foreign bank status, it can devote itself to its international client or to the local segment of the domestic market such as the local conglomerates who may need corporate banking, share listing or bonds issue .Another reason for staying to this basic position is competition is tough or the bank is targeting a niche market.

• It can make the most of its status as a local bank particularly in countries which allows foreign banks to obtain a domestic license and, receiving the same treatment as other domestic banks. Normally, only few international banks are active in the retail banking segment, due to high barriers to entry.

Cost is another factor accounting for the overseas expansions of banks. (Caliber 1984, Ramsler, 1982) The actual reason in this case is capital cost. International banking activities helps banks to gain access to the cheapest source of capital; consequently, it leads to a transfer of these funds to areas where the return on investment will be higher.

According to Buch 1999, most explanations of FDI of banks have omitted the fact that foreign banks FDI’s decisions are irreversible and are formed under circumstances of uncertainty. As Buch points out," entry and exit into non-traditional markets are potentially subject to hysteresis."

In banking, investments made cannot be undone as a network of branches or establishing a subsidiary is important in attracting deposits or business, and making lending or building long lasting relationships with customers.

The optimal investment policy of a representative bank must thus consider the value of the real investment option: as information about the economic environment improves over time,

it pays to wait and to postpone investment.

A representative bank’s main investment policy should henceforth take into account the worth of the actual investment option because just as the facts about the economic condition advances, it delays the investment by paying for it.

When deciding whether or not to penetrate a new market, banks needs to consider three cost components namely the fixed costs of entry, the costs of exit and operating costs.

The presence of entry and exit costs thus creates a range of inaction: revenues has to increase sufficiently before banks move into the non-traditional market but once having entered the new market, they do not leave unless revenues fall substantially (Buch, Why... 1999, pp. 8-10).

However, a delay can be caused due to the existence of entry and exit charges, for instance the revenues that these banks generate have to be high so that these banks can push themselves into the non-traditional market. The only time that banks can leave the new market is when they are not able to generate significant revenues (Buch, Why… 1999,pp. 8-10).

According to Dale (1986), in all banking systems worldwide, ,when penetrating a market at the initial stage, international banks are subject to the banking laws or rules and regulations prevailing in the market they wish to enter, particularly in regard to their organizational structure or the type of activity they wish to provide. For instance, some countries may impose on foreign banks that they either operate as subsidiary or as branch.

Hellman (1996) and Uiboupin (2005) describe the three basic strategies that establish and implement the foreign banks for expanding international: "customer following strategy", "market seeking strategy" and "follow the leader strategy".

Hellman, P. 1996, "Internationalization of the Finnish Financial

Service Companies", International Business Review vol.5 no.2

pp.191-208

Uiboupin J. 2005," Short-term effects of foreign bank entry On

bank performance in selected CEE countries", Working Papers of

Eesti Pank No 4.