Foreign Entry and Banking Efficiency in Asia

1. Foreign Entry and Banking Efficiency in Asia Bayu Kariastanto, GRIPS Wako Watanabe, Keio University May 24, 2012 International Conference, “International Competition in Banking: Theory and Practice” Ukrainian Academy of Banking, Sumy, Ukraine

2. Outline of the Presentation • Introduction to foreign banks in Asia • Background theories and hypotheses • Data • Empirical methodology • Results and interpretations

3. Overview of the Results In Asia, • Foreign banks are more cost efficient than private domestic banks but not more profitable. • State owned banks are less profitable than private banks. • Mode of entry (greenfield/JV/acquiring) does not affect profitability but greenfield banks are less cost efficient than local bank acquirers.

4. The Presence of Foreign Banks by Region The share of assets held by foreign banks within bank assets by region（%） Note: the number of countries inside the blaket Source: Domanski (2005) 4

5. Ownership Type and Bank Performance • Foreign banks vs. domestic banks • Foreign banks bring new lending technology and their governance is more disciplined. • Private banks vs. state owned banks • State owned banks engage in political (“connected”) lending. • Minority foreign/state shares • Minority shares may influence bank performance as majority shares do?

6. Ownership Type and Bank PerformanceEvidence • Foreign banks vs. domestic banks • Foreign banks more profitable in developing/transitional countries (Bonin et al., 2004; Claessent, et al., 2000; Micco et al., 2004) • Private banks vs. state owned banks • State owned banks as efficient as private banks (Bonin et al., 2004) • Minority shares (foreign/state) • Minority foreign ownership improves state-owened banks’ efficiency (Berger et al., 2008)

7. Mode of Entry and Bank Performance • Greenfield • Open branches only in regional major cities • Specialized on wholesale lending • Utilize “hard” information ( = private & verifiable) • Local bank Acquirers • Acquire a local branch network. • Utilize “soft information” ( = unverifiable) • Joint Ventures • Hybrids of greenfield and retail banks

8. De Novo Banks, Retail Banks or Joint Ventures • Theoretically, it is hard to predict which mode of foreign entry is more profitable/efficient. • Empirically… • Lending rates are higher when foreign lenders are greenfield than they are local bank acquirers (Claeys & Hainz, 2007)

9. Soft Information and Relationship Lending Soft (qualitative) information Relationship lender (a loan officer) Relationship SMEs Hard (quantitative) information Asymmetric information Other banks 9

10. Backgrounds: SME Lending and Soft Information • Local domestic lenders may be more profitable. • A relationship lender who has exclusive access to certain information about a borrower’s credit quality is able to earn a rent so that relationship lenders are more profitable than hard information based transaction lenders. (ex. Rajan, 1992) • Local lenders are able to select better credit risks whereas entrants are forced to lend to poor credit risks that local lenders choose not to lend to (Dell'Ariccia et al, 1999) • But more technologically advanced foreign lenders may be more cost efficient and more profitable. 10

11. Soft Information and A Bank’s Organizational Structure Loan review function of the headquarters Documenting soft information is hard so it is difficult to deliver soft information from a bank’s branch to its headquarters. Hard info The more delegated a bank’s branch is, the more incentive to gather soft information the branch has (because soft information is utilized for decision making). Branch manager Loan officer Soft info Hard info Soft info Relationship SMEs Hard info 11

12. Organizational Structure and Bank Lending Hypothesis Loan officers at a bank with a decentralized decision making structure has more incentive to collect soft information than those at a bank with a centralized structure. Evidence: Liberti & Mian (2009), Agarwal & Hauswald (2010) 12

13. Operation Type and Foreign Bank Performance Our question Is a presumably more independent foreign subsidiary more efficient/profitable than a branch? Evidence? • Very few papers look at foreign banks’ operation types. • A branch/subsidiary choice is made based on institutional environments (Cerutti et al., 2007). 13

14. Data • The primary source of our data is Bankscope (Fitch IBCA & Bureau van Dijk) as well as banks’ homepages • Our data are the unbalanced panel of 980 banks from 33 countries in Asia (East, Southeast, South and Central Asia/Caucasus.) over the period of 1996 through 2011.

15. Trends of Ownership Types in Asia, Shares in terms of Total Assets

16. Descriptive Statistics: Ownership Types and Operation Types • Sample banks are divided into four ownership types, majority STATE (23%), majority private DOMESTIC (40%), majority FOREIGN (30%) and “no majority” (7%). • State, domestic, foreign and “no majority” represent 48%, 27%, 11% and 14% of total bank assets in Asia, respectively. • Only 6% of foreign banks operate as branches. • This may be due to underepresentation of branches in Bankscope.

17. Empirical Methodology: SFA Approach • The two step estimation approach is employed. • At the first step, running the regression of the profit/cost function, each sample bank’s efficiency is estimated. • At the second step, the estimated efficiency (level/rank) is regressed on variables to measure a bank’s attributes such as ownership types as well as control variables. • The profit efficiency is more complete concept than the cost efficiency (Berger & Mester, 1997)

18. The Cost/Profit Function • The profit/cost function follows the specification employed by Bonin et al. (2004). • Assumed to be a function of four outputs (total loans, total deposits, liquid assets, other earning assets) and two input prices (ratios of interest expenses to total deposits and non-interest expenses to fixed assets). • Year and country dummies are included.

19. Ownership Type RegressionsProfit Efficiency

20. Ownership Type RegressionsCost Efficiency

21. The Ownership Type Regressions • Banks are profit efficient in the following order, Domestic > Foreign > State • Domestic banks have better access to the soft information (Mian, 2003; Claeys and Heinz, 2003) • State-owned banks are often engaged in policy oriented loans or politically motivated loans (Sapienza, 2004; Dobson and Kashyap, 2006; Berger, et al, 2008) • Foreign banks are more cost efficient than domestic banks. • Foreign banks are more technologically advanced.

22. Foreign Bank RegressionsProfit Efficiency

23. Foreign Bank RegressionsCost Efficiency

24. Foreign Bank Regressions • Mode of entry does not affect profit efficiency. • Minority state ownership decreases greenfield banks’ profit efficiency. • The ex-post government’s stake in a bank established as a greenfield bank reduces the bank’s profitability. • Greenfield banks are less cost efficient than local bank acquirers. • Branches are generally more efficient than subsidiaries. • Only successful branches may be in the data…

25. THANK YOU!!