Economic Determinants and Entry Modes of
Foreign Banks into Central Europe
Aneta Hryckiewicz
Goethe University Frankfurt
Oskar Kowalewski
Warsaw School of Economics (SGH)
WNE Research Seminar
Warsaw, 28th, February 2008
1
Agenda

Motivation

Methodology

Results

Conclusions
2
Motivation

Recent trend towards financial liberalization as well as globalization of the financial markets
have resulted in an increase of foreign banking operations.

There is a growing literature on merits/pitfalls of extensive foreign-bank presence in the
developed as well as developing countries, for example:
 efficiency of the domestic banking sector: Hasan and Merton (2003); Barajas et al. (2000)
or Claessens et al. (2000)
 implications for stability: Demigrüc-Kunt et al. (1998); Levine (1999); Barth (2001)
 lending to small and medium-size enterprises: Clarke et al. (2002); Berger et al. (2001)

There are also some contributions about motivations of foreign banks to enter other markets:
 Buch, 2000
 Focarelli and Pozzolo, 2001
 Buch and DeLong, 2003
 Magri et al., 2005
 Claessens et al., 2007
3
Motivation

However, most studies….
– come from the US or Western European countries;
– use linear approaches; small samples;
– either time-series or cross-section structure of data;
– focus on entries via M&As or branches (mostly US) and treat each type of organizational
form in isolation;
– many studies neglect the importance of local market opportunities and economics or
structural characteristics of the host countries;
– especially, the variables measuring profit market opportunities mentioned in the theory is
either omitted in empirical analysis due to limited data availability or found to be non
significant;
→ All of these might cause some sort of biasness in the results and underestimate or limit the
potential implications for policy makers or in some cases may lead even to the impropriate
conclusions for developing countries.
4
Motivation

The developing countries differ in many respects from the developed economies:
 information asymmetries
 underdeveloped institutional structure
 different macroeconomic environment
 weak financial regulatory and supervisory framework
→ Hence, the motives driving the foreign banks to enter the developed countries must be
different from the motives for the developing countries, as well as the entry modes chosen
by the banks.

Interesting questions:
 what have driven foreign banks to establish their operations in the developing economies?
 what factors they have taken into account and have played the most important role in the
decision making process?
 which entry modes they have preferred given they have decided to enter a foreign market?
5
What has driven foreign banks into developing countries?
Foreign bank entry occurred in almost all developing
countries at the beginning of 1990s, however its pattern
was not uniform
Venezuela
Turkey
Peru
Poland
Mexico
1994
1994
1999
Chile
1999
Hungary
Brazil
Czech Republic
Argentina
0%
20%
40%
60%
80%
0%
100%
20%
40%
60%
80%
100%
Thailand
1994
Malaysia
1999
Korea
0%
20%
40%
60%
80%
100%
6
Source: IMF 2000, for 1994 ratio of assets of banks where foreign owners own more than 50% (in case of 1999 – 40%) of total equity to total bank assets
What has driven foreign banks into developing countries?
There is also no obvious pattern based on the level of
development
Share of foreign credit institutions as % of total assets of CIs
120
1998
2004
100
80
60
The foreign ownership assets is
high in Luxemburg, Finland
and United Kingdom,
while low in Germany,
France or Italy.
In developing countries, the
foreign banking ownership
is high in Slovakia, Czech
Republic and Lithuania,
while significantly lower in
Cyprus or Slovenia.
40
20
Source: ECB
nia
Lithu
a
La tv
ia
bu rg
Ne th
erlan
ds
Port
uga l
Spa
in
Swe
d en
Un it
ed K
ingd
on
Malt
a
Cy p
ru s
Cz e
ch R
epu b
lic
Pola
nd
Hu n
gar y
Slov
a kia
Slov
e nia
Esto
nia
Ita ly
Lu xe
m
Aust
ria
Belg
ium
De n
mark
Finla
nd
Fra n
ce
Ger m
any
Gre e
ce
Irela
nd
0
7
What has driven foreign banks into developing countries?
There is also no obvious pattern based on the level of
development
The differences are more meaningful when we compare the countries worldwide
Share of foreign credit institutions in the developed
countries, as % of total assets of CIs
100%
80%
60%
40%
20%
0%
Germany
Sw eden
United States
Luxemburg
New Zealand
Share of foreign credit institutions in the developing
countries, as % of total assets of CIs
100%
80%
60%
40%
20%
0%
Bangladesh
Source: Barth and others 2001; data for 1998
Egypt
India
Hungary
Cambodia
Macedonia 8
What has driven foreign banks into developing countries?
There are also no uniform entry modes of foreign banks
based on the financial development
Number of subsidiaries and branches in the EU
200
branches
subsidiaries
180
160
140
120
100
80
60
40
20
Lu It
xe al y
N mb
et
he urg
rl a
n
Po ds
rtu
U
Sw ga
l
ni
te ed
d
e
Ki n
ng
do
Po m
la
C
ze Hun nd
ch ga
R ry
ep
ub
l
Sl i c
ov
ak
Au
st
r
Be ia
lg
D iu m
en
m
a
Fi rk
nl
G and
er
m
a
G ny
re
ec
e
Sp
a
Fr in
an
c
Ire e
la
nd
0
There are no uniform entry modes in the banking internationalization. France, Luxemburg
have high number of foreign subsidiaries, while Greece, Italy or Germany have more foreign branches.
9
Source: ECB; data at 2004
What has driven foreign banks into developing countries?
There are also differences in entry modes of foreign
banks between developing countries
The differences are more meaningful when we compare developing countries
worldwide
Number of subsidiaries and branches
subsidiary
branch
ru
gu
ay
U
Tu
rk
ey
ep
ub
li c
H
un
Sl
ga
ov
ry
ak
R
ep
ub
lic
Ec
ua
do
r
R
Br
az
il
C
ze
ch
ia
Bo
l iv
Ar
ge
nt
in
a
70
60
50
40
30
20
10
0
High number of branches in Argentina, Turkey, while in Hungary until 2004 there was none.
10
Source: Barth and others 2001; data for 2002
What has driven foreign banks into developing countries?
There are also differences in banking internationalization
within a bank
PL
HU
CZ
SK
SL
EE
LT
LI
BG
RO
HR
AL
CS
CG
BH
Raiffeisen
UniCredit
Erste Bank
Banca Intensa
SocGen
KBC
GE Money
EFG
ING
Citigroup
Swedbank/
Hansabank
Volksbank
Alpha Bank
Commerzbank
Source: RZB Group Research Report; majority stakes only; data as at 31 December, reflecting ownership structure as at August 2006
11
UA
What has driven foreign banks into developing countries?
There are also differences in entry modes within a bank
PL
HU
CZ
SK
SL
Raiffeisen
B
A
B,A
A
A
UniCredit
A
A
A
Erste Bank
A
A
A
Banca Intensa
A
A
A
LT
LI
B,A
B
KBC
A
A
A
A
A
A
A
A
Citigroup
HR
AL
CS
S
S,A
S
A
A
A
A
A
A
A
A
A
A
S
S
A
CG
BH
UA
A
AS
A
A
A
A
A
A
A
B,A
B
B
B
S
B
S
B,A
S
S
S
S
S
S
Swedbank/
Hansabank
A
A
Volksbank
A
A
Alpha Bank
Commerzbank
RO
A
EFG
ING
BG
S
A
SocGen
GE Money
EE
A
A
A
A
B
A
S
B
S
A
A
B
A
B
B
Source: RZB Group Research Report; ECB, national banks supervision reports; A- Acquisition; B-Branch; S-Subsidiary
12
The Importance of a Foreign Bank‘s Entry Mode

may affect competitive structure of local banking systems:
 threatening profits and market share of domestic banks
 affecting price and quality of bank services in host country

may affect banking structure in general through specialization
 promoting one entry mode may cause neglecting some banking segments

involves different levels of parent bank responsibility and financial support with
implications of:
 the parent banks who care about their exposure (can be affected by a failure or great losses
of a parent‘s bank institution in a host country)
 local regulators who care about domestic stability (may prevent country from a crisis or at
least attenuate their effects)
 local depositors who care about safety of their savings
13
Related Literature on Developing Countries

There is a limited literature on the determinants of location choices of foreign banks
among developing countries, mostly because of data unavailability:
 Focarelli and Pozzolo, 2001
 van Horen, 2006
 Claessens and van Horen, 2007

Some recent papers started focusing on the entry modes of foreign banks in the
developing countries; however, again, the number of studies limits to a few papers…
 Cerlutti et al. (2007)
14
Our Sample


based on the four Eastern European markets: Poland, Czech Republic, Hungary and Slovak
„a wave“ of foreign bank entries
100%
1995
2006
80%
60%
40%
20%
0%
Czech Republic





Hungary
Poland
Slovak
different policies towards foreign banking and types of banking operations
initially underdeveloped financial systems and poor macroeconomic environment; however there were
significant discrepancies between the countries;
taking time-series‘ approach we can take into account the changes occurring in these countries,
starting from the improvement of the macroeconomic environment, regulatory structure, ending up
with the development of financial structure and joining the EU;
we have unique dataset for foreign entry modes for each of this country also in the time-series‘ context
finally, we take non-linear approach to take advantage from higher number of observations; in totally
we have 1212 observations.
15
Our Model (1)
Analyzing the entry determinants

to analyze entry decisions into CE countries, we consider a Poisson regression where the
number of entries of foreign banks at time t from a country i (29 OECD countries) into one of
the CEE countries - Poland, Hungary, Czech Republic and Slovak:
exp  iht  iht
Pr(Yiht  y ) 
y!
y


an entry is defined to be followed by three modes: branch, subsidiary or M&As
y = number of entering banks from country i to country k at time t and Y 1ht, Y2ht, Y3ht,… Y29ht
have independent Poisson distribution with parameters λ1ht, λ2ht, λ3ht,… λ29ht.

it is used to assuming that
iht are log-linearly dependent on the explanatory variables. Thus:
ln iht  0  1Kht  2 H hit  3 Bit   iht
h = host countries (Hungary, Poland, Czech Republic and Slovak)
i = entries from the sample (29 OECD countries) defined together as home countries
Kht = a vector of variables specific for the host country
Hhit = a vector of variables specific for relationship between host and home country
Bit = a vector of variables specific for the home countries
16
Our Model (1)
Analyzing the entry determinants

moreover, we control for some unobserved host-country and time-specific effects. Hence, our
error term has one or two component, depending on the specification:
iht   iht   h



or
iht   iht   h  t
both components are iid distributed with zero mean
clustering the standard errors on the home country‘s level
Pearson test is higly insignificant suggesting that our data are Poisson distributed and our model
specificantion is appriopriate
17
Our Model (2)
Analyzing the determinants of entry modes

to model the changes between the determinants affecting particular organizational forms we
have chosen seemingly unrelated bivariate probit estimation (SURB), which allows us to control
for the correlation between entry modes within a one country:
Pr(Yiht  1)  f ( K ht , H iht , Bit )
Pr(Yiht  1)  f ( K ht , H iht , Bit )

where Yiht = 1 when an entry via a particular form (M&A, branch or subsidiary) from country i
into country h occurs at time t versus an entry through another form from country i into country h
occurs at time t, otherwise 0
h = host countries (Hungary, Poland, Czech Republic and Slovak)
i = entries from the sample (29 OECD countries) defined together as home countries
Kht = a vector of variables specific for the host country
Hhit = a vector of variables specific for relationship between host and home country
Bit = a vector of variables specific for the home countries

clustering the observations on the home country‘s level
18
Testing Hypothesis – Explanatory Variables
Determinants of the Model
„Follow the Customer“
Non-financial FDIs to GDP (lag)
Trade (export+import) to GDP
„Location-Specific
Factors“
net interest margin
„Economic Crises“
exchange rate of a host country
towards EUR
„Ownership-Specific
Factors“
liquid liabilities to GDP
bank deposits to GDP
differences in the growth rates
concentration ratio
distance to the host country
bank freedom index
legal origin of a home country
creditor rights
differences in efficiencies
between host and home banking
markets
stock market capitalization
country risk
inflation (log)
differences in overheads between
home and host banking markets
corporate tax rate
EU-dummy
19
Results – Model (1)
Exchange rate
Inflation
Tax rate
Bank freedom index
Creditor rights
Liquid liabilities
Bank deposits
Concentration ratio
Net margin
Diff. in growth rates
Diff. in overheads
Distance
(1)
(2)
(3)
(4)
-0.0276***
0.0850
0.1049
0.1178***
(0.0087)
(0.0538)
(0.0704)
(0.0400)
0.3402***
0.7829***
1.0510**
1.1431**
(0.1203)
(0.2712)
(0.3446)
(0.4703)
-0.0453
0.0501
-0.0438
-0.0845
(0.0449)
(0.0576)
(0.0522)
(0.1031)
-0.4225
-1.4793**
-1.2986
-2.0571
(0.4072)
(0.6660)
(1.1241)
(1.2678)
-1.6585***
-1.4742***
-1.3578**
-1.4094***
(0.4902)
(0.4902)
(0.6600)
(0.4286)
-0.4307**
-0.8816***
-0.9110***
-0.8652**
(0.1741)
(0.2748)
(0.3439)
(0.4001)
0.3948
0.9087***
0.9070**
0.9320**
(0.2117)
(0.3092)
(0.3962)
(0.4601)
-0.0527**
-0.0123
-0.0104
-0.0614
(0.0263)
(0.0351)
(0.0726)
(0.0835)
-0.4232***
-0.6221**
-0.8631**
-0.4954
(0.1623)
(0.2530)
(0.4023)
(0.3440)
-0.0822
-0.1290***
-0.1260***
-0.1297**
(0.0574)
(0.0484)
(0.0477)
(0.0508)
-0.0891
-0.1004
-0.0979
-0.1254
(0.1105)
(0.1160)
(0.1264)
(0.1388)
-0.7091***
-0.7617***
-0.7525***
-0.7358***
(0.2191)
(0.2486)
(0.2476)
(0.2448)
20
Results – Model (1)
Non-financial FDI (lag)
English legal origin
German legal origin
French legal origin
Scandinavian legal origin
EU dummy
(1)
(2)
(3)
(4)
-
0.0984
0.1453
0.9345**
(0.0940)
(0.1063)
(0.4605)
2.1870***
2.2097***
2.1933***
2.1283***
(0.7380)
(0.6934)
(0.7011)
(0.6897)
2.5333***
2.1406***
2.1377***
2.0718***
(0.5538)
(0.5493)
(0.5589)
(0.5599)
1.6339***
1.4131***
1.4150***
1.3744***
(0.5448)
(0.5358)
(0.5378)
(0.5301)
0.9189
0.8723
0.8725
0.8262
(0.7941)
(0.7701)
(0.7801)
(0.7705)
-0.9172**
-0.2890
-1.9321
-1.0557
(0.5098)
(0.7489)
(1.7070)
(9.7948)
Fdinonlag*y2000
-0.6200*
(0.3355)
Fdinonlag*y2001
-0.7548**
(0.2976)
Fdinonlag*y2003
-0.8561**
(0.3846)
No. of observations
1212
973
973
973
Log likelihood value
-360.0716
-282.1786
-278.2254
-273.9627
0.0535
0.1823
0.0132/0.0010*
0.0007
Wald test
21
Results – Model (2)
Bank freedom index
Creditor rights
Liquid liabilities
Bank deposits
Net margin
Distance
Concentration ratio
Market Cap.
Country risk
Tax rate
Trade
Diff. in growth rates
Income per capita
Wald test
Branch
Subsidiary
M&A
-3.6800**
-0.2572
-0.5330**
(1.4437)
(0.3892)
(0.2147)
-6.0274***
-3.0948***
-0.8189***
(0.8260)
(0.7198)
(0.2336)
-0.6791**
0.3266***
-0.0304
(0.2918)
(0.1182)
(0.0611)
-2.9354***
-0.4692***
0.1062*
(1.0028)
(0.1278)
(0.0610)
-9.0712***
-0.4191*
-0.0234
(3.4256)
(0.2339)
(0.1205)
-0.4266**
-0.0083
-0.1292
(0.2006)
(0.1410)
(0.1337)
3.1794***
0.0856
-0.1017***
(1.2115)
(0.0810)
(0.0305)
0.1304**
-0.0171
-0.0224
(0.0659)
(0.0145)
(0.0099)
0.4802***
0.0711
-0.0714***
(0.1424)
(0.0712)
(0.0279)
0.3908***
-0.0469***
-0.0233*
(0.1505)
(0.0168)
(0.0136)
-0.0045
0.0141***
0.0109
(0.0062)
(0.0024)
(0.0021)
-0.0499
-0.0595**
-0.0093
(0.0344)
(0.0258)
(0.0307)
0.0050***
0.0001
-0.0003***
(0.0018)
(0.0001)
(0.0001)
0.3179
0.2702
0.1752
22
Results – Model (2)
(1)
Branch/
Subsidiary
(2)
Branch/
Subsidiary
(3)
Branch/
M&A
-0.2600
-6.1753
(4)
Branch/
M&A
Bank free index
-3.5805***
(1.2670)
(0.3906)
(6.2767)
(0.2146)
Creditor rights
-5.9824***
-3.0971***
-8.5927***
-0.8269***
(0.9302)
(0.7156)
(2.4903)
(0.2358)
-0.6776
0.3299***
-0.8109***
-0.0350
(0.2988)
(0.1180)
(0.1605)
(0.0598)
-2.9569***
-0.4737***
-3.7757***
0.1109*
(1.0746)
(0.1276)
(0.9332)
(0.0597)
-9.1258**
-0.4230*
-11.2538***
-0.0238
(3.6072)
(0.2319)
(1.6624)
(0.1202)
-0.4231**
-0.0082
-0.4877***
-0.1293
(0.1967)
(0.1404)
(0.1883)
(0.1343)
3.2009**
0.0855
3.9711***
-0.0999***
(1.2751)
(0.0810)
(0.7180)
(0.0303)
0.1316
-0.0173
0.1637***
-0.0221**
(0.0696)
(0.0143)
(0.0415)
(0.0099)
0.4825***
0.0704
0.6393***
-0.0699**
(0.1506)
(0.0715)
(0.1315)
(0.0276)
0.3943**
-0.0468***
0.4736***
-0.0231*
(0.1590)
(0.0168)
(0.0892)
(0.0136)
-0.0036
0.0141***
-0.0114
0.0109
(0.0058)
(0.0024)
(0.0071)
(0.0021)
-0.0493
-0.0597**
-0.0247
-0.0090
(0.0339)
(0.0257)
(0.0397)
(0.0306)
0.0050***
0.0001
0.0062***
-0.0003***
(0.0019)
(0.0001)
(0.0010)
(0.0001)
0.3651
0.3651
0.0992
0.0992
Liquid liabilities
Bank deposits
Net margin
Distance
Concentration ratio
Market capitalization
Country risk
Tax rate
Trade
-0.5328**
Non-financial FDIs
Diff. growth rates
Income per capita
Wald test
23
Results – Model (2)
(1)
Bank free index
Creditor rights
Liquid liabilities
Bank deposits
Net margin
Distance
Concentration ratio
Market Cap.
Country risk
Tax rate
Trade
(2)
Subsidiary/
M&A
Subsidiary/
M&A
Income per capita
Wald test
Subsidiary/
M&A
Subsidiary/
M&A
Subsidiary/
M&A
-0.3376
-0.5491***
0.4846
-0.8223**
0.8016
-0.4249
(0.3669)
(0.2131)
(0.7726)
(0.3402)
(1.5960)
(0.4262)
-2.9704***
-0.8210***
-6.0261*
-0.9175***
-17.8308**
-0.9668***
(0.7292)
(0.2340)
(3.4881)
(0.2731)
(8.2145)
(0.3050)
0.3050**
-0.0323
1.2992
-0.3524***
2.0305
-0.3012***
(0.1197)
(0.0611)
(1.4516)
(0.1334)
(2.0066)
(0.0973)
-0.4326***
0.1100
-1.3996
0.4141***
-2.1860
0.3480***
(0.1278)
(0.0618)
(1.4499)
(0.1370)
(1.8188)
(0.1217)
-0.3742*
-0.0224
-0.1041
-0.0456
-0.2176
-0.0802
(0.2225)
(0.1212)
(0.2447)
(0.1062)
(0.4224)
(0.0997)
-0.0024
-0.1309
-0.0086
-0.1725
-0.0015
-0.1707
(0.1427)
(0.1346)
(0.1725)
(0.1396)
(0.1708)
(0.1386)
0.0746
-0.1042***
0.1290
-0.0894**
0.0405
-0.0970*
(0.0789)
(0.0307)
(0.0848)
(0.0421)
(0.0613)
(0.0518)
-0.0182
-0.0223**
0.0192
-0.0016
-0.1113
-0.0165
(0.0137)
(0.0097)
(0.0568)
(0.0188)
(0.0880)
(0.0452)
0.0571
-0.0718***
0.0246
-0.0591**
-0.0443
-0.0537
(0.0644)
(0.0276)
(0.0822)
(0.0301)
(0.0487)
(0.0318)
-0.0443**
-0.0237*
-0.1488
0.0098
-0.4040
-0.0551
(0.0185)
(0.0137)
(0.1837)
(0.0210)
(0.3345)
(0.0336)
0.0137***
0.0110***
0.0131***
0.0084***
0.0156***
0.0087***
(0.0026)
(0.0022)
(0.0026)
(0.0022)
(0.0029)
(0.0022)
-0.0428
0.0981**
-0.1090
0.0774*
(0.0895)
(0.0423)
(0.2275)
(0.0447)
Non-financial FDIs
Diff in growth rates
Subsidiary/
M&A
(3)
-0.0611**
-0.0090
-0.1111***
-0.0327
-0.1030***
-0.0311
(0.0260)
(0.0311)
(0.0348)
(0.0336)
(0.0389)
(0.0346)
0.0001
-0.0003***
-0.0002
-0.0002
-0.0009
-0.0004*
(0.0001)
(0.0001)
(0.0006)
(0.0001)
(0.0011)
(0.0002)
0.0066
0.0066
0.0184
0.0184
0.0293
0.0293
24
Conclusions









macroeconomic and institutional determinants had significant influence on the
foreign banking
our results suggest that the foreign banks were mostly encouraged by potential of the
CE banking markets and low degree of financial sophistication
our findings present that in the course of time and financial development, the
motivations of foreign banks have changed
the legal origin of the home country mattered
most of the foreign bank entries were cross-border transactions
choice of the organizational form mattered
besides the economic characteristics of a host country, we showed that the entry
mode is also determined by the type of activity a foreign bank is going to render in a
host country as well as by a type of client followed
finally, we showed that the factors affecting the location choice in the developing
country differ from the developed countries
our results are robust to several variables used by relevant literature on foreign
banking
25