1. 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

2. Agenda Goal and Motivation Literature review Data Empirical methodology Results Conclusions 2

3. 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

4. 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

5. 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

6. 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

7. 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

8. Data 8 Dependent variables VariableDefinitionSource Business freedom Measures the efficiency of government regulation of business, and is derived from an array of measurements of the difficulty of starting, operating, and closing a business. Heritage dataset Freedom to trade internationally Measures a wide variety of restraints that affect international exchange: tariffs, quotas, hidden administrative restraints, and controls on exchange rates and capital. Fraser dataset Regulations 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).

9. Dependent variables’ characteristics 9 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 freedom 1.00 Freedom to trade internationally 0.571.00 Regulations 0.510.561.00 Property rights 0.690.600.581.00 Business regulations 0.630.580.740.73 VariableObs.MeanSt. Dev.Min.Max. Business freedom2,18865.66815.01510100 Freedom to trade internationally 1,5277.2261.261.1039.723 Regulations1,5666.6791.0332.7019.3 Property rights1,5355.7161.7641.49.6 Business regulations1,3905.9571.1512.29.5

10. Data (cont’d) 10 Explanatory variables (Main model) VariableDefinitionSource Foreign bank presence (log) Ratio of foreign banks to total banks. A foreign bank is a bank where 50% percent or more of its shares are owned by foreigners (Claessens and van Horen, 2013). Global Financial Development database GDP per capita (log) Purchasing Power Parity (PPP) adjusted Gross Domestic Product (GDP) per capita at 2005 constant international $ prices (Chain Series) Penn World Tables 7.1 GDP growthGDP growth (%) World Development Indicators InflationInflation, GDP deflator (%) Bank credit to bank deposits Bank credit to bank deposits (%) Global Financial Development database Inward FDI flowsInward direct investment flows, as a share of GDP United Nations Conference on Trade and Development (UNCTAD) statistics OpennessOpenness at 2005 constant prices, as a share of GDPPenn World Tables 7.1

11. Data (cont’d) 11 Additional explanatory variables (Enhanced model) VariableDefinitionSource DemocracyPolity2 measure of democracyPolity IV database Sound money Measures the consistency of monetary policy with long-term price stability, and the ease with which other currencies can be used via domestic and foreign bank accounts. Fraser dataset Size of government Measures the size of government interference with the economy (government consumption, transfers and subsidies, government 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) Chief executive party orientation 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 when party position can best be described as centrist (e.g. party advocates strengthening private enterprise in a social-liberal context) (value assigned=2); Left, for parties that are defined as communist, socialist, social democratic, or left-wing (value assigned=3). Database of Political Institutions Plurality Dummy variable that takes the value of 1 if legislators are elected using a winner-take-all / first past the post rule and 0 otherwise. Legal origin and religion dummiesDjankov et al., 2007

12. Explanatory variables’ characteristics Obs.MeanSt. Dev.Min.Max. (log) Foreign bank presence1,8253.360.91504.605 (log) GDP per capita2,1608.7231.3215.6211.822 GDP growth2,2760.0420.046-0.180.89 Inflation2,2750.141.251-0.32853.995 Bank credit to bank deposits2,18399.32363.9418.612898.048 Inward FDI flows2,23600.001-0.0060.007 Openness2,1600.8270.5170.0884.33 Democracy2,1994.0456.42-1010 Sound money1,5327.9431.68909.9 Chief executive party orientation 2,261-8.40398.223-9993 Plurality2,239-77.057267.68-9991 12 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

13. Empirical Methodology Three estimation techniques 1.Pooled OLS  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)  X j : array of variables that may affect business regulations  Legal origin and religion dummies included ε t : time dummies  Two models:  Main model: X j includes main macroeconomic variables  Enhanced model: X j 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 underlying economic, political and social forces. 13

14. 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

15. 3.Treatment effects model (two stage IV model) First stage: FBx it 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% z it is the instrument used in the panel GMM case Second stage: It models the response of the countries’ business regulations to foreign bank presence (i.e., the “treatment”) relative to the countries with non- foreign bank presence, which serve as the control group n takes values 1, 2 and 3 Busreg it-1 accounts for the possible differences in the trend of the dependent variable between the treated and control groups before the treatment System estimation 15 Empirical Methodology

16. 16 Panel A: Pooled OLSPanel B: GMM Lagged dependent 0.876***0.862***0.921***0.919*** (64.557)(65.514)(18.687)(18.592) Foreign bank presence t-2 0.524***1.516** (2.849)(2.372) Foreign bank presence t-1 0.635***1.324* (3.722)(1.810) GDP per capita t-1 1.094***1.156***0.964*0.880* (6.674)(7.116)(1.886)(1.864) GDP growth t-1 -2.348-2.546-1.603-2.373 (-0.756)(-0.784)(-0.343)(-0.562) Inflation t-1 -0.090**-0.092***-0.037**-0.027* (-2.357)(-2.783)(-2.171)(-1.666) Bank credit/Deposits t-1 0.003* 0.010***0.009* (1.892)(1.900)(2.676)(1.932) Inward FDI flow t-1 -236.696-321.710306.430276.806 (-0.923)(-1.187)(0.506)(0.410) Openness t-1 0.2160.369-0.735-0.494 (0.837)(1.439)(-1.277)(-0.700) Diagnostics Obs.1,5071,4851,5431,517 No. of countries110 114 Adj-Rsq.0.900.89 No of GMM instruments47 AR2 (p-value) -0.24-0.55 (0.81)(0.58) Legal origin and religion dummies not reported for pooled OLS Main model – Heritage’s business freedom

17. 17 Enhanced model – Heritage’s business freedom Panel A: Pooled OLSPanel B: GMM Lagged dependent0.860***0.844***0.916***0.922*** Foreign bank presence t-2 0.447**1.682** Foreign bank presence t-1 0.560***1.414 GDP per capita t-1 0.847***0.883***0.859**0.718** GDP growth t-1 -2.629-2.6660.859-0.186 Inflation t-1 0.0060.024-0.041-0.021 Bank credit/Deposits t-1 0.003**0.004**0.012***0.011** Inward FDI flow t-1 -359.220-411.763618.835717.980 Openness t-1 0.1060.255-0.873-0.862 Democracy t-1 0.0190.0210.0510.040 Size of government t-1 0.0150.037-0.149-0.131 Property rights t-1 0.1350.161*-0.023-0.026 Sound money t-1 0.0790.097-0.070-0.037 Freedom to trade intern. t-1 0.021-0.007-0.271-0.270 Regulations t-1 0.438**0.466**0.571*0.528* Government party orientation t-1 0.000 -0.002-0.003 Plurality t-1 0.000 -0.0000.000 Diagnostics Obs. 1,4401,4181,4901,464 No. of countries 107 111 Adj-Rsq. 0.890.88 No of GMM instruments 55 AR2 (p-value) -0.26-0.63 (0.79)(0.53) Legal origin and religion dummies not reported for pooled OLS

18. 18 Treatment effects model – Heritage’s business freedom Panel A: 1 year aheadPanel B: 2 years aheadPanel C: 3 years ahead Dependent at t-1 0.75***0.74*** 0.65***0.63*** 0.54***0.52*** FB dummy 10 at t -8.04-22.71-29.89 FB dummy 20 at t 12.5516.29*17.48* FB dummy 30 at t 6.598.61*9.20** FB dummy 40 at t 4.536.056.38* GDP per capita 1.76***1.92***1.87***1.93***2.51***2.74***2.68***2.80***3.27***3.56***3.49***3.61*** GDP growth -7.91-6.17-7.90-8.16*-13.97*-11.87**-14.08**-14.43**-22.44**-19.28***-21.71***-22.81*** Inflation -1.04** -0.95*-0.98**-3.19***-3.14***-3.12***-3.22***-3.82**-3.81***-3.82***-3.97*** Bank credit/Deposits 0.00*0.01** 0.01*0.01***0.01**0.01***0.010.01***0.01** Inward FDI flow 667.13*483.33450.96461.66971.60*724.63699.07710.321205.37*910.94*897.67*910.98* Openness 0.530.360.450.440.540.300.410.360.640.380.500.41 First stage probit Foreign ownership- Investment restrictions -0.04*0.04**0.07*** -0.030.05**0.08***0.09***-0.020.05***0.09***0.10*** Constant1.43***0.24*-0.29**-0.70***1.36***0.15-0.42***-0.82***1.30***0.09-0.52***-0.95*** Obs. 1,330 1,228 1,127 Pseudo-Rsq.0.00 0.01 0.000.01 0.000.01 0.02 Legal origin and religion dummies not reported

19. 19 Main model – Fraser’s variables Dependent variable is Freedom to trade internationally Panel A: Pooled OLSPanel B: GMM Foreign bank presence t-2 0.0170.376** (1.544)(2.076) Foreign bank presence t-1 0.026**0.448** (2.168)(2.068) Diagnostics Obs.1,0609671,094997 No. of countries109107114111 Adj-Rsq.0.92 No of GMM instruments3734 AR2 (p-value) -0.58 (0.56) -0.72 (0.47) Dependent variable is Regulations Panel A: Pooled OLSPanel B: GMM Foreign bank presence t-2 0.020-0.074 (1.306)(-0.969) Foreign bank presence t-1 0.021-0.056 (1.278)(-0.597) Diagnostics Obs.1,0899951,1231,025 No. of countries109107114111 Adj-Rsq.0.890.88 No of GMM instruments4541 AR2 (p-value) 0.53 (0.60) 0.62 (0.54)

20. 20 Main model – Fraser’s variables (cont’d) Dependent variable is Property rights Panel A: Pooled OLSPanel B: GMM Foreign bank presence t-2 0.0100.144 (0.755)(0.943) Foreign bank presence t-1 0.0100.177 (0.658)(1.140) Diagnostics Obs.1,0639691,097999 No. of countries109108114112 Adj-Rsq.0.95 No of GMM instruments3734 AR2 (p-value) 1.16 (0.24) 1.24 (0.22)

21. 21 Treatment effects model – Fraser’s Freedom to trade internationally Panel A: 1 year aheadPanel B: 2 years aheadPanel C: 3 years ahead FB dummy 10 at t -1.90-2.85-5.29 (-1.57)(-1.24)(-0.91) FB dummy 20 at t 1.98*1.52**1.61** (1.91)(2.12)(2.31) FB dummy 30 at t 1.37***1.05***1.09*** (2.58)(2.73)(3.00) FB dummy 40 at t 0.88***0.74***0.76*** (3.00)(2.84)(3.08) First stage probit Foreign ownership- Investment restrictions -0.08**0.08**0.10***0.14***-0.060.10***0.13***0.17***-0.040.11***0.15***0.20*** (-2.03)(2.30)(3.20)(4.50)(-1.44)(2.66)(3.72)(4.80)(-0.98)(2.82)(4.01)(5.17) Constant 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)(0.56)(-1.95)(-4.60)(5.52)(-0.15)(-2.72)(-5.00)(4.67)(-0.64)(-3.24)(-5.44) Obs.828 727 626 Pseudo-Rsq.0.01 0.020.000.010.02 0.000.010.020.03

22. Panel A: Pooled OLSPanel B: GMM Foreign bank presence t-2 0.034*0.254 (1.870)(1.501) Foreign bank presence t-1 0.034*0.729** (1.736)(2.002) Diagnostics Obs.1,0049111,038941 No. of countries109107114111 Adj-Rsq.0.840.83 No of GMM instruments3936 AR2 (p-value) -1.04-0.31 (0.29)(0.76) 22 Main model – Fraser’s Business regulations Treatment effects model – Fraser’s Business regulations Panel A: 1 year aheadPanel B: 2 years aheadPanel C: 3 years ahead FB dummy 10 at t -4.32**-5.35*-7.87 (-2.18)(-1.68)(-1.22) FB dummy 20 at t 6.174.543.73* (1.24)(1.52)(1.69) FB dummy 30 at t 3.99*2.95**2.25** (1.78)(2.12)(2.31) B dummy 40 at t 2.37***1.83***1.35*** (2.75)(2.99)(2.91) First stage probit Foreign ownership- Investment restrictions -0.11**0.050.07**0.11***-0.09*0.07*0.09**0.14***-0.070.08*0.12***0.19*** (-2.46)(1.39)(2.12)(3.40)(-1.85)(1.71)(2.55)(3.83)(-1.31)(1.92)(2.91)(4.39) Constant 1.97***0.28-0.24-0.83***1.81***0.14-0.44*-1.07***1.65***-0.01-0.67**-1.43*** (6.14)(1.16)(-1.05)(-3.61)(5.19)(0.53)(-1.70)(-4.12)(4.27)(-0.03)(-2.29)(-4.76) Obs.783 682 580 Pseudo-Rsq. 0.010.000.01 0.000.010.020.000.01 0.02

23. 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

24. Thank you for your attention! 24