28 January 2012

VoxEU: Foreign banks - Trends and impact on financial development

This column presents a newly-collected, comprehensive database on bank ownership for 137 countries over the period 1995–2009. It shows that current market shares of foreign banks average 20 per cent in OECD countries and 50 per cent elsewhere.

Although interrupted by the recent financial crisis, the past two decades have seen an unprecedented degree of globalisation, especially in financial services. Cross-border bank and other capital flows have increased dramatically. Many banks have ventured abroad and established a presence in other countries. This has happened among EU countries, but especially in emerging markets and developing countries. While western banking groups were most active as investors, also many banks from emerging economies have ventured abroad.

Trends in foreign bank investment

Recently, a new, comprehensive database on bank ownership, identifying also the home country of foreign banks, for 137 countries over the period 1995–2009, has been completed, with key facts summarised in the overview paper (Claessens and van Horen 2012). The data show some salient trends. The paper documents that, albeit interrupted by the global financial crisis, foreign bank presence, in terms of number and share among domestic banks, has increased substantially in most countries over the past three decades.

State of affairs

Taking stock as of end 2007 – just before the crisis – foreign banks capture on average about 20 per cent of market shares, in terms of loans, deposits and profits, in OECD countries and close to 50 per cent in emerging markets and developing countries.

Differences between domestic and foreign banks

Foreign banks differ from domestic banks in key balance-sheet variables. Notably, foreign banks have higher capital and more liquidity. In terms of performance, foreign banks underperform domestic banks in emerging markets and developing countries, but do not perform differently in high-income countries.

Impact of foreign banks on financial sector development

Before the crisis, the general consensus was that the benefits greatly outweigh the costs in many dimensions. It was generally considered that foreign banks add to domestic competition, improve the quality of financial intermediation, increase access to financial services, enhance financial and economic performance of their borrowers, and bring greater financial stability. Using the newly-assembled data, cross-country analysis shows that the relationship between foreign bank presence and financial sector development indeed differs by host country. Specifically, in emerging markets and high-income countries, foreign bank presence tends to have an insignificant relationship with credit extended. In developing countries however, foreign bank presence is associated with less overall credit extended. Indeed, in these countries a one standard deviation increase in the foreign-bank share is associated with a decline in private credit–to-GDP of 5 percentage points, economically very large, since the mean of private credit–to-GDP in this group of countries is only 19 per cent. Of course, this is not necessarily a causal relationship.

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