1. The impact of foreign bank entry on the domestic financial system: Do distance, culture and geography matter?
Tianshu Zhao, Department of Finance, University of Birmingham
ESRC Reference - ES/N013344/1: Delivering Inclusive Financial Development and Growth
Research Project Workshop
SOAS University of London 3rd – 4th March, 2017

2. Outline The main research questions
A brief review of the literature : European literature influence
Empirical consideration

3. Research questions
The impact of foreign direct investment, taking the form of physical presence, i.e. foreign bank entry
on the financial intermediation behaviour of domestic banks,
on the access to external finance for domestic borrowers, and
on the financial inclusion, the economic growth and stability of the host countries.
We ask: Whether, how and when?

4. Policy initiatives and expectations
To gain the benefit from the globalization and integration of world financial market, allowing foreign financial institutions to set up subsidiaries is a proposal
The desirable ends: stimulate competition, increase access to financial services, enhance financial and economic performance of borrowers, and bring greater financial stability in the banking system
Whether, how and when: these depend on some conditions

5. The liability of being a foreigner
Foreign banks have funding cost advantage but face informational disadvantages.
The informational disadvantage is more serious in soft information-based relational loans, compared to arm's length or "transaction loans" based on hard information

6. Unintended outcomes in LICs
Foreign banks “cherry pick” informational transparent borrowers and show stronger preference toward asset-based loans
Leads to the market segmentation, and no anticipated competition result
Adverse impact on financial inclusion
Uncertain consequence on the industry structure and aggregate net output

7. Market segmentation
Foreign banks are more likely to demand collateral and grant shorter maturity loans than domestic banks.
Foreign banks also base their pricing on internal credit ratings and collateral pledges, while domestic banks price according to the length, depth and breadth of their relationship with a firm (Beck et al., 2016)
Lower lending rates charged by foreign banks does not stem from superior efficiency of foreign entrants but rather result from borrower transparency, loan maturity and currency (Degresy et al, 2012)

8. Outreach
Foreign banks finance only a small set of very profitable and big corporates
The decline in loans is greater among smaller firms, firms with fewer tangible assets (Gormley, 2010).
The positive impact of the increase in foreign bank participation in developing countries on the number of deposit and loan accounts only appears in rich and urban municipalities (Allen et al., 2016)
Foreign banks cherry-pick financially transparent households: formal employment, having personal assets, and are richer (Beck and Brown, 2015)
Financial inclusion—defined as the use of formal accounts—the individual and country characteristics associated with financial inclusion and the policies that are effective among those most likely to be excluded: poor, rural, female or young individuals.
Overall, we find that greater financial inclusion is associated with lower account costs, greater proximity to financial intermediaries, stronger legal rights, and more politically stable environments. However, the effectiveness of policies to promote inclusion varies depending on the characteristics of the individuals considered. (allen et al., 2016)

9. The variations regarding impact
Distance-related information frictions (Mian, 2006)
physical distance
cultural distance
intrabank hierarchical distance
institutional (legal) distance
regulatory environment distance

10. The variations….. (cont’d)
The mode of entry determines how information is distributed between foreign and domestic banks (Claeys and Hainz, 2014)
Foreign banks entry materialized via acquiring domestic lenders would have better capacity in handling information problem (Gormley, 2014)

11. The variations….. (cont’d)
Institutional environment and legal system: the enabling channels in improving informational environment and enforcing financial contract
The costs of contract enforcement
The availability and the quality of credit information
The quality of creditor protection

12. The variations….. (cont’d)
Regulatory arbitrage and exploitation: lower barriers to entry, tighter restrictions on bank activities, and to a lesser degree higher minimum capital requirements in domestic markets are associated with lower bank lending standards abroad (Ongena et al., 2013).
The effects are stronger when:
banks are less efficiently supervised at home,
exist independently from the impact of host-country regulation

13. The variations….. (cont’d)
The comparative position of domestic banks and banking system
The relative funding costs advantage of foreign banks
The market structure of domestic banks prior to the physical presence of multinational banks (Balmaceda et al., 2014)
The funding structure of foreign banks matters
Increased competition for funds lead to a reduction in lending of domestic banks to less wealthy firms
The lending technology of domestic banks prior to foreign entry and the enabling channel to handle soft-information intensive lending products

14. The variations….. (cont’d)
Segmented markets might induce declines in credit access (Detragiache et al., 2008) and negatively affect the economy in the host countries (Gormley, 2014).
The overall impact on a larger foreign bank presence on credit to the private sector and on the net output depends on the distribution of firms and the distribution of the sectors (Gormley, 2014)

15. The variations…….: The time dimension
Learning by doing by foreign banks: short term impact vs long term impact
Learning by example of domestic banks: Within a credit market, firms appear to have the same access to financial loans and ability to invest whether they borrow from a foreign bank or not, while foreign banks benefit all firms by indirectly enhancing credit access (Giannetti and Ongena, 2012)

16. The variations…….: The time dimension (cont’d)
The cross-border transmission of economic shocks (policy-induced/no) through the banking system
Global banks support their foreign affiliates during times of financial stress through internal capital markets with (possible) positive consequence for their lending
The negative supply shock to parent banks (or in other markets) can be transmitted to their foreign subsidiaries and branches with (possible) negative consequences for their lending
The positive (negative) impact varies according to the importance (and/or the commitment) of the foreign markets for the global banks (different dimensions of periphery): flight to quality and flight to home

17. Empirical considerations
Cross-locality within one country, across country study
Identification is achieved via the variation of the branches of foreign banks within one nation
Financial consequence is measured via the survey questions regarding experience of the borrowers, and rejection/acceptance of loan applications , price and non-price terms and conditions and the ex-post default at loan contract level (field work will be needed)
Data will be matched at either locality-level or at the level of bank-borrower relationship

18. Going Forward Research fieldwork in Uganda and possibly Kenya
Data challenges: Secondary and well as primary data
Mixed methods approach, combining quantitative and qualitative methods
Policy and stakeholder engagement in Uganda and possibly Kenya

19. End
Questions and comments welcome
Thank you!