Foreign bank ownership and business regulations Manthos D. Delis Surrey Business School Georgios P. Kouretas Athens University of Economics and Business Chris Tsoumas University of Piraeus Centre for Financial Risk Analysis-EM Lyon Business School, Thursday 27 March 2014 Agenda Goal and Motivation Literature review Data Empirical methodology Results Conclusions 2 Goal and motivation Motivation ◦ Entry of foreign banks into local banking markets, a worldwide phenomenon during the last decades that has attracted much attention in the literature. ◦ The depth of this entry has potentially important implications for financial and macroeconomic stability in host countries. ◦ But, what about institutions? Goal To examine empirically the impact of foreign bank presence on host countries institutions, specifically business regulations Question of increased importance due to its: Importance for long-run growth Permanent nature Issue not addressed so far in the literature 3 Literature Review Lehner and Schnitzer (2008, JCE) study the impact that foreign bank entry has on local banks in two ways: (a) spillover effects for local banks and (b) increasing competition in the local banking market. Findings: An increase in competition has positive welfare effects. Spillovers are less likely to have positive welfare effects the stronger bank competition is. Clarke, Cull and Peria (2006, JCE) use survey data of firms operating in 35 developing and transition economies.They find that all firms of 4 Literature Review any size report that they face lower financing obstacles in countries with higher levels of foreign bank presence. Giannetti and Ongena (2012) argue that capital inflows and entry of foreign banks can contribute to the development of a country’s financial system (investment and financial expertise). They find that firms have the same access to credit and ability to invest whether they borrow from a foreign bank or not. Foreign banks benefit all firms indirectly since they increase credit access. 5 Literature Review Sytse, Rejie and Rezaul (SMJ, 2006) they provide evidence that it is important to disaggregate foreign ownership into foreign institutional and foreign corporate shareholders. The main finding show that the impact of institutional investors on firm performance is not-clear. 6 Data Large (unbalanced) panel dataset ◦ ◦ ◦ ◦ ◦ ◦ 8 large databases employed Annual data 114 countries (both advanced and emerging) 1995-2011 period 5 distinct dependent variables Large array of control variables 7 Data Dependent variables Variable Business freedom Freedom to trade internationally Regulations Definition Source Measures the efficiency of government regulation of business, and is derived from an array of measurements of Heritage dataset the difficulty of starting, operating, and closing a business. Measures a wide variety of restraints that affect international exchange: tariffs, quotas, hidden administrative restraints, and controls on exchange rates and capital. Measures the regulatory environment for a country regarding credit market, labor market and business regulations. Property rights Measures the degree to which a country’s laws protect private property rights, the quality of enforcement of such laws by the state, and the quality of contract enforcement. Business regulations Sub-component of the regulations index, measures the efficiency of government regulation of business (administrative requirements for running a business, bureaucracy costs, procedures for starting a business, bribes and favoritism, licensing restrictions and cost of tax compliance). Fraser dataset 8 Dependent variables’ characteristics Variable Business freedom Freedom to trade internationally Regulations Property rights Business regulations Obs. 2,188 Mean 65.668 St. Dev. 15.015 Min. 10 Max. 100 1,527 7.226 1.26 1.103 9.723 1,566 1,535 1,390 6.679 5.716 5.957 1.033 1.764 1.151 2.701 1.4 2.2 9.3 9.6 9.5 Heritage’s business freedom: Sample period: 1995-2011 Range: 10 to 100 Fraser’s variables: Sample period: 1995 and 2000-2011 Range: 0 to 10 Higher values indicate more efficient regulations Correlations Business freedom Freedom to trade internationally Regulations Property rights Business regulations Business freedom 1.00 Freedom to trade internationally 0.57 1.00 0.51 0.69 0.63 0.56 0.60 0.58 Regulations 1.00 0.58 0.74 Property rights 1.00 0.73 9 Data (cont’d) Explanatory variables (Main model) Variable Definition Source Foreign bank presence (log) Ratio of foreign banks to total banks. A foreign bank is a bank where 50% percent or more of its Global Financial shares are owned by foreigners (Claessens and van Development database Horen, 2013). GDP per capita (log) Purchasing Power Parity (PPP) adjusted Gross Domestic Product (GDP) per capita at 2005 constant Penn World Tables 7.1 international $ prices (Chain Series) GDP growth GDP growth (%) Inflation Inflation, GDP deflator (%) Bank credit to bank deposits Bank credit to bank deposits (%) Inward FDI flows Inward direct investment flows, as a share of GDP Openness World Development Indicators Global Financial Development database United Nations Conference on Trade and Development (UNCTAD) statistics Openness at 2005 constant prices, as a share of GDP Penn World Tables 7.1 10 Data (cont’d) Additional explanatory variables (Enhanced model) Variable Definition Source Democracy Polity2 measure of democracy Polity IV database Measures the consistency of monetary policy with long-term Sound money price stability, and the ease with which other currencies can be used via domestic and foreign bank accounts. Measures the size of government interference with the economy Size of government (government consumption, transfers and subsidies, government Fraser dataset enterprises and investment, top marginal tax rate) Institutional variables employed as dependent in other econometric specifications (i.e., freedom to trade internationally, property rights, regulations) Measures the chief executive party's orientation with respect to economic policy: Right, for parties that are defined as conservative, Christian democratic, or right-wing (value assigned =1); Center, for parties that are defined as centrist or Chief executive when party position can best be described as centrist (e.g. party party orientation advocates strengthening private enterprise in a social-liberal Database of Political context) (value assigned=2); Left, for parties that are defined as Institutions communist, socialist, social democratic, or left-wing (value assigned=3). Dummy variable that takes the value of 1 if legislators are Plurality elected using a winner-take-all / first past the post rule and 0 otherwise. Legal origin and religion dummies Djankov et al., 200711 Explanatory variables’ characteristics (log) Foreign bank presence (log) GDP per capita GDP growth Inflation Bank credit to bank deposits Inward FDI flows Openness Democracy Sound money Chief executive party orientation Plurality Obs. 1,825 2,160 2,276 2,275 2,183 2,236 2,160 2,199 1,532 Mean 3.36 8.723 0.042 0.14 99.323 0 0.827 4.045 7.943 St. Dev. 0.915 1.321 0.046 1.251 63.941 0.001 0.517 6.42 1.689 Min. 0 5.62 -0.18 -0.328 8.612 -0.006 0.088 -10 0 Max. 4.605 11.822 0.89 53.995 898.048 0.007 4.33 10 9.9 2,261 -8.403 98.223 -999 3 2,239 -77.057 267.68 -999 1 Sample period dictated by foreign bank presence availability (1995-2009) Foreign bank assets to total bank assets not used because of much shorter time period availability (2004-2009) No collinearities detected 12 Empirical Methodology Three estimation techniques 1. Pooled OLS Busreg it a Busreg it1 FBitn j X jit1 t uit j Busreg: measure of business regulations in country i at time t Lagged dependent included to account for possible persistence FB: foreign bank presence (n takes the values 1 or 2) Xj: array of variables that may affect business regulations Legal origin and religion dummies included • εt: time dummies Two models: Main model: Xj includes main macroeconomic variables Enhanced model: Xj adds institutional and political characteristics Yet, pooled OLS may not be appropriate when both business regulations and foreign bank presence are driven by some other 13 underlying economic, political and social forces. Empirical Methodology 2. Panel GMM (Arellano – Bover / Blundel – Bond) To account for: Endogeneity issues (i.e., reverse causation from business regulations to foreign bank presence) Countries’ fixed effects Ideal method for large N - small T, as in our case Xj’s instrumented with their lagged values (i.e., L2; L3) FB instrumented with: Fraser’s Foreign ownership/investment restrictions index Sub-component of the Freedom to trade internationally index, based on the following two Global Competitiveness Report questions: “How prevalent is foreign ownership of companies in your country?”; and “How restrictive are regulations in your country relating to international capital flows?” Two models (main, enhanced), as in pooled OLS 14 Empirical Methodology 3. Treatment effects model (two stage IV model) • First stage: FBxit b0 b1zit eit • FBxit is a dummy with 1 for foreign bank presence and 0 otherwise • Four distinct dummies employed: 1. FB10: 1 if foreign bank presence >=10% 2. FB20: 1 if foreign bank presence >=20% 3. FB30: 1 if foreign bank presence >=30% 4. FB40: 1 if foreign bank presence >=40% • zit is the instrument used in the panel GMM case • Second stage: Busreg itn a0 a1Busreg it1 a2 FˆBxit a3 X jitn t n uitn j • It models the response of the countries’ business regulations to foreign bank presence (i.e., the “treatment”) relative to the countries with nonforeign bank presence, which serve as the control group • n takes values 1, 2 and 3 • Busregit-1 accounts for the possible differences in the trend of the dependent variable between the treated and control groups before the treatment 15 • System estimation Main model – Heritage’s business freedom Panel A: Pooled OLS 0.876*** 0.862*** Lagged dependent (64.557) (65.514) 0.524*** Foreign bank presencet-2 (2.849) 0.635*** Foreign bank presencet-1 (3.722) 1.094*** 1.156*** GDP per capita t-1 (6.674) (7.116) -2.348 -2.546 GDP growth t-1 Legal origin and religion(-0.756) (-0.784) dummies not reported-0.090** -0.092*** Inflation t-1 (-2.783) for pooled OLS (-2.357) 0.003* 0.003* Bank credit/Deposits t-1 (1.892) (1.900) -236.696 -321.710 Inward FDI flow t-1 (-0.923) (-1.187) 0.216 0.369 Openness t-1 (0.837) (1.439) Diagnostics Obs. 1,507 1,485 No. of countries 110 110 Adj-Rsq. 0.90 0.89 No of GMM instruments AR2 Panel B: GMM 0.921*** 0.919*** (18.687) (18.592) 1.516** (2.372) 1.324* (1.810) 0.964* 0.880* (1.886) (1.864) -1.603 -2.373 (-0.343) (-0.562) -0.037** -0.027* (-2.171) (-1.666) 0.010*** 0.009* (2.676) (1.932) 306.430 276.806 (0.506) (0.410) -0.735 -0.494 (-1.277) (-0.700) 1,543 114 1,517 114 47 -0.24 47 -0.55 16 Enhanced model – Heritage’s business freedom Panel A: Pooled OLS Lagged dependent 0.860*** 0.844*** Foreign bank presencet-2 0.447** Foreign bank presencet-1 0.560*** GDP per capita t-1 0.847*** 0.883*** GDP growth t-1 -2.629 -2.666 Inflation t-1 0.006 0.024 Bank credit/Deposits t-1 0.003** 0.004** Inward FDI flow t-1 -359.220 -411.763 Openness t-1 0.106 0.255 Legal origin and religion Democracy t-1 0.019 0.021 dummies not reported Size of government t-1 0.015 0.037 for pooled OLS Property rights t-1 0.135 0.161* Sound money t-1 0.079 0.097 Freedom to trade intern. t-1 0.021 -0.007 Regulations t-1 0.438** 0.466** Government party orientation t-1 0.000 0.000 Plurality t-1 0.000 0.000 Diagnostics Obs. 1,440 1,418 No. of countries 107 107 Adj-Rsq. 0.89 0.88 No of GMM instruments AR2 (p-value) Panel B: GMM 0.916*** 0.922*** 1.682** 1.414 0.859** 0.718** 0.859 -0.186 -0.041 -0.021 0.012*** 0.011** 618.835 717.980 -0.873 -0.862 0.051 0.040 -0.149 -0.131 -0.023 -0.026 -0.070 -0.037 -0.271 -0.270 0.571* 0.528* -0.002 -0.003 -0.000 0.000 1,490 111 1,464 111 55 -0.26 (0.79) 55 -0.63 17 (0.53) Treatment effects model – Heritage’s business freedom Panel A: 1 year ahead Dependent at t-1 FB dummy 10 at t 0.75*** 0.74*** 0.74*** 12.55 Bank credit/Deposits Inward FDI flow Openness Foreign ownershipInvestment restrictions Constant Obs. Pseudo-Rsq. 0.63*** 0.63*** -7.91 -1.04** 1.87*** 0.52*** 8.61* 1.93*** 0.52*** 9.20** 6.05 2.51*** 0.52*** 17.48* 4.53 1.92*** 0.54*** -29.89 6.59 1.76*** 0.63*** 16.29* FB dummy 40 at t Inflation 0.65*** Panel C: 3 years ahead -22.71 FB dummy 30 at t GDP growth 0.74*** -8.04 FB dummy 20 at t GDP per capita Panel B: 2 years ahead 6.38* 2.74*** 2.68*** 2.80*** 3.27*** -13.97* -11.87** Legal -7.90 origin-8.16* and religion dummies reported -1.04** -0.95* not -0.98** -3.19*** -3.14*** -14.08** -14.43** -3.12*** -6.17 3.56*** 3.49*** 3.61*** -22.44** -19.28*** -21.71*** -22.81*** -3.22*** -3.82** -3.81*** -3.82*** -3.97*** 0.00* 0.01** 0.01** 0.01** 0.01* 0.01*** 0.01** 0.01*** 0.01 0.01*** 0.01** 0.01** 667.13* 483.33 450.96 461.66 971.60* 724.63 699.07 710.32 1205.37* 910.94* 897.67* 910.98* 0.53 0.36 0.45 0.44 0.41 0.36 0.64 0.38 0.50 0.41 -0.04* 0.04** 0.07*** 0.07*** 1.43*** 0.24* -0.29** -0.70*** 1,330 0.00 1,330 0.00 1,330 0.01 1,330 0.01 0.54 0.30 First stage probit -0.03 0.05** 0.08*** 0.09*** -0.02 0.05*** 0.09*** 0.10*** 1.36*** 0.15 -0.42*** -0.82*** 1.30*** 0.09 -0.52*** -0.95*** 1,228 0.00 1,228 0.01 1,228 0.01 1,228 0.01 1,127 0.00 1,127 0.01 1,127 0.01 1,127 18 0.02 Main model – Fraser’s variables Foreign bank presencet-2 Foreign bank presence t-1 Diagnostics Obs. No. of countries Adj-Rsq. No of GMM instruments AR2 (p-value) Dependent variable is Freedom to trade internationally Panel A: Pooled OLS Panel B: GMM 0.017 0.376** (1.544) (2.076) 0.026** 0.448** (2.168) (2.068) 1,060 109 0.92 967 107 0.92 1,094 114 997 111 37 -0.58 (0.56) 34 -0.72 (0.47) Dependent variable is Regulations Foreign bank presencet-2 Foreign bank presence t-1 Diagnostics Obs. No. of countries Adj-Rsq. No of GMM instruments AR2 (p-value) Panel A: Pooled OLS 0.020 (1.306) 0.021 (1.278) 1,089 109 0.89 995 107 0.88 Panel B: GMM -0.074 (-0.969) -0.056 (-0.597) 1,123 114 1,025 111 45 0.53 (0.60) 41 0.62 (0.54) 19 Main model – Fraser’s variables (cont’d) Foreign bank presencet-2 Foreign bank presence t-1 Diagnostics Obs. No. of countries Adj-Rsq. No of GMM instruments AR2 (p-value) Dependent variable is Property rights Panel A: Pooled OLS Panel B: GMM 0.010 0.144 (0.755) (0.943) 0.010 0.177 (0.658) 1,063 109 0.95 969 108 0.95 (1.140) 1,097 114 999 112 37 1.16 (0.24) 34 1.24 (0.22) 20 Treatment effects model – Fraser’s Freedom to trade internationally Panel A: 1 year ahead FB dummy 10 at t -1.90 (-1.57) 1.52** (2.12) 1.61** (2.31) 1.05*** (2.73) 0.88*** (3.00) FB dummy 40 at t Obs. Pseudo-Rsq. -5.29 (-0.91) 1.37*** (2.58) FB dummy 30 at t Constant Panel C: 3 years ahead -2.85 (-1.24) 1.98* (1.91) FB dummy 20 at t Foreign ownershipInvestment restrictions Panel B: 2 years ahead 1.09*** (3.00) 0.74*** (2.84) 0.76*** (3.08) -0.08** (-2.03) 0.08** (2.30) 0.10*** (3.20) 0.14*** (4.50) First stage probit -0.06 0.10*** (-1.44) (2.66) 1.77*** 0.13 -0.41* -0.99*** 1.63*** -0.04 -0.65*** -1.22*** 1.51*** -0.18 -0.88*** -1.52*** (6.48) 828 0.01 (0.56) 828 0.01 (-1.95) 828 0.01 (-4.60) 828 0.02 (5.52) 727 0.00 (-0.15) 727 0.01 (-2.72) 727 0.02 (-5.00) 727 0.02 (4.67) 626 0.00 (-0.64) 626 0.01 (-3.24) 626 0.02 (-5.44) 626 0.03 0.13*** (3.72) 0.17*** (4.80) -0.04 (-0.98) 0.11*** (2.82) 0.15*** (4.01) 0.20*** (5.17) 21 Main model – Fraser’s Business regulations Panel A: Pooled OLS 0.034* (1.870) 0.034* (1.736) Foreign bank presencet-2 Foreign bank presencet-1 Diagnostics Obs. No. of countries Adj-Rsq. No of GMM instruments AR2 (p-value) 1,004 109 0.84 Panel B: GMM 0.254 (1.501) 0.729** (2.002) 911 107 0.83 1,038 114 941 111 39 -1.04 (0.29) 36 -0.31 (0.76) Treatment effects model – Fraser’s Business regulations Panel A: 1 year ahead FB dummy 10 at t -4.32** (-2.18) 4.54 (1.52) 3.73* (1.69) 2.95** (2.12) 2.37*** (2.75) B dummy 40 at t Obs. Pseudo-Rsq. -7.87 (-1.22) 3.99* (1.78) FB dummy 30 at t Constant Panel C: 3 years ahead -5.35* (-1.68) 6.17 (1.24) FB dummy 20 at t Foreign ownershipInvestment restrictions Panel B: 2 years ahead -0.11** (-2.46) 1.97*** (6.14) 783 0.05 (1.39) 0.28 (1.16) 783 0.07** (2.12) -0.24 (-1.05) 783 0.01 0.00 0.01 1.83*** (2.99) First stage probit 0.11*** -0.09* 0.07* (3.40) (-1.85) (1.71) -0.83*** 1.81*** 0.14 (-3.61) (5.19) (0.53) 783 682 682 0.01 2.25** (2.31) 0.01 0.00 1.35*** (2.91) 0.09** (2.55) -0.44* (-1.70) 682 0.14*** (3.83) -1.07*** (-4.12) 682 -0.07 (-1.31) 1.65*** (4.27) 580 0.08* (1.92) -0.01 (-0.03) 580 0.12*** (2.91) -0.67** (-2.29) 580 0.19*** (4.39) -1.43*** (-4.76) 580 0.01 0.02 0.00 0.01 0.01 0.02 22 Conclusions Foreign bank presence does affect business regulations, measured by ◦ Business freedom (difficulty of starting, operating, and closing a business) ◦ Business regulations (administrative requirements for running a business, bureaucracy costs, procedures for starting a business, bribes and favoritism, licensing restrictions and cost of tax compliance) ◦ Freedom to trade internationally Evidence for impact 2 and 3 years ahead Impact for foreign bank presence larger than 30% ◦ Larger than 20% for freedom to trade internationally 23 Thank you for your attention! 24