UBC Theses and Dissertations

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UBC Theses and Dissertations

Towards the development of an optimal comprehensive retirement preparation model Crockett, Herbert Ralph 1975

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A THEORY OF INTERNATIONAL BANKING EXPANSION  by  JAMES H. CLEAVE B.Comm., University of B r i t i s h Columbia, 1974  A THESIS SUBMITTED IN PARTIAL FULFILMENT OF THE REQUIREMENTS FOR THE DEGREE OF MASTER OF SCIENCE IN BUSINESS ADMINISTRATION  in the Faculty of Commerce and Business Administration  We accept this thesis as conforming to the required standard  THE UNIVERSITY OF BRITISH COLUMBIA May, 1975  In presenting  t h i s thesis i n p a r t i a l fulfilment of the requirements for  an advanced degree at the University of B r i t i s h Columbia, I agree that the Library s h a l l make i t f r e e l y available for reference  and  study.  I further agree that permission for extensive copying of t h i s thesis for scholarly purposes may by his representatives.  be granted by the Head of my Department or  It i s understood that copying or publication  of t h i s thesis for f i n a n c i a l gain s h a l l not be allowed without my written permission.  J . H. Cleave  Department of Commerce and Business The University of B r i t i s h Columbia Vancouver, Canada V6T 1W5  Date  May Ju_,  1975  Administration  ABSTRACT  T h i s s t u d y r e p r e s e n t s an attempt t o d e v e l o p a t h e o r y t o e x p l a i n t h e r a p i d growth o f i n t e r n a t i o n a l b a n k i n g w i t n e s s e d d u r i n g t h e p a s t decade.  The f o c u s i s on two major b a n k i n g n a t i o n s : Canada and t h e  United States. The d e f i n i t i o n o f i n t e r n a t i o n a l b a n k i n g adopted f o r t h e purposes of t h i s s t u d y i s v e r y broad i n n a t u r e and i n c l u d e s s e v e r a l t y p e s o f financial activities.  I n a d d i t i o n t o u s u a l commercial b a n k i n g a c t i v i t i e s  we i n c l u d e t h e s o - c a l l e d c o n g e n e r i c s e r v i c e s a s s o c i a t e d w i t h merchant banking. The r e s e a r c h p r o c e s s i n v o l v e d a comprehensive  review of banking  j o u r n a l s , sundry p e r i o d i c a l s , and t h e a n n u a l r e p o r t s o f major and American banks.  Canadian  T h i s m a t e r i a l p r o v i d e d d e s c r i p t i v e i n f o r m a t i o n on  t h e i n t e r n a t i o n a l a c t i v i t i e s o f t h e banks. A f t e r i n t e r n a t i o n a l b a n k i n g i s d e f i n e d a c h a p t e r i s devoted t o a d i s c u s s i o n o f t h e importance o f b a n k i n g t o v a r i o u s w o r l d  economies.  I n t h i s a r e a , much r e l i a n c e i s p l a c e d on t h e w r i t i n g s o f R. W. G o l d s m i t h who developed a measure o f t h e l e v e l o f f i n a n c i a l s o p h i s t i c a t i o n f o r a country. Two c h a p t e r s a r e t h e n devoted t o a d e s c r i p t i o n o f t h e r e c e n t r a p i d growth o f t h e i n t e r n a t i o n a l a c t i v i t i e s o f Canadian and American banks.  One c o n c l u s i o n i s t h a t i n t e r n a t i o n a l growth has proceeded a t a  c o n s i d e r a b l y f a s t e r pace than domestic  growth.  S e v e r a l o b s e r v e r s o f t h e i n t e r n a t i o n a l b a n k i n g scene have o f f e r e d  ii  iii  e x p l a n a t i o n s f o r the r a p i d growth.  The most p o p u l a r e x p l a n a t i o n i s t h a t  the growth of w o r l d t r a d e has caused or a t l e a s t h e a v i l y i n f l u e n c e d t h e growth of i n t e r n a t i o n a l b a n k i n g .  I t i s a t t h i s p o i n t t h a t we  some f l a w s i n t h e ' f o l l o w i n g t r a d e ' argument. p o p u l a r e x p l a n a t i o n p r o v i d e s the 'jumping our t h e o r y of i n t e r n a t i o n a l b a n k i n g  identify  Dissatisfaction with this  o f f p o i n t ' f o r development of  expansion.  I n o r d e r t o l a y the f o u n d a t i o n f o r development of a t h e o r y o f i n t e r n a t i o n a l b a n k i n g e x p a n s i o n , the l i t e r a t u r e on t h e t h e o r y of the f i r m and on t h e t h e o r y of f o r e i g n d i r e c t investment  i s surveyed.  Based on t h e above m a t e r i a l , a model has been developed  which  b u i l d s upon the s c h o o l of d i r e c t investment t h e o r y t h a t f o c u s e s on g o p o l i s t i c i n d u s t r y s t r u c t u r e and m a x i m i z a t i o n of growth.  The banks  a r e seen t o have an almost i n n a t e need f o r growth which i s t h e v a r i a b l e i n f l u e n c i n g i n t e r n a t i o n a l expansion.  critical  Several environmental  v a r i a b l e s a r e i d e n t i f i e d t h a t tend t o r e t a r d growth i n t h e sector.  oli-  domestic  I t i s argued t h a t t h e l o g i c a l consequence of t h i s i s t h a t the  banks t u r n e d t o i n t e r n a t i o n a l markets i n o r d e r t o a c h i e v e t h e i r growth objectives. F o r e i g n growth does not proceed w i t h o u t l i m i t however. c o n s t r a i n t (drawing from the w r i t i n g s of W.  A profit  J . Baumol) i s i d e n t i f i e d  and  i n c o r p o r a t e d i n t o the t h e o r e t i c a l model. Some of the o t h e r t h e o r i e s of d i r e c t investment p o p u l a r Hymer/Kindleberger  ( i n c l u d i n g the  ' s u p e r i o r knowledge' t h e o r y ) have o n l y l i m i t e d  e x p l a n a t o r y power i n i n t e r n a t i o n a l b a n k i n g . A f t e r a p r e l i m i n a r y t h e o r e t i c a l model was  developed, i n t e r v i e w s  iv were arranged with senior executives i n the international d i v i s i o n s of the f i v e major chartered banks.  Their reactions to the model are d i s -  cussed (where appropriate) i n chapters seven and eight. The study closes with a discussion of recent events that have tended to shake up international banking. and various types of governmental  Inadequate  capitalization  interference are currently having a  retarding effect on international growth.  F i n a l l y , a chapter i s devoted  to a prediction of the future of international banking.  It i s concluded  that, while many problems w i l l be present, the need for growth w i l l continue to be the major factor i n explaining the development of i n t e r national banking.  TABLE OF CONTENTS Page LIST OF TABLES  ?  . viii  LIST OF FIGURES  ix  Chapter 1.  INTRODUCTION  1  O b j e c t i v e s o f Study  1  Research Methodology  . . . .  O r g a n i z a t i o n o f Study 2.  3.  5  INTERNATIONAL BANKING  8  Definition  8  Correspondent Banks  9  Resident Representatives  12  Agencies  14  F o r e i g n Branches  16  S u b s i d i a r i e s and A f f i l i a t e s  18  J o i n t Ventures or C o n s o r t i a  19  Summary  21  IMPORTANCE OF INTERNATIONAL BANKING Summary  4.  2  25 31  GROWTH OF INTERNATIONAL BANKING Growth o f U.S. I n t e r n a t i o n a l B a n k i n g  v  34 44  vi Chapter  5.  6.  Page Canadian Growth  55  Summary  66  EXISTING EXPLANATIONS FOR THE GROWTH OF INTERNATIONAL BANKING .  70  THEORIES OF THE CAUSES OF DIRECT FOREIGN INVESTMENT A l i b e r ' s Theory  7.  79 .  Imperfect C a p i t a l Markets  88  M o n o p o l i s t i c Advantage  90  O l i g o p o l y and Need f o r Growth  94  Summary  97  TOWARD A THEORY OF INTERNATIONAL BANKING EXPANSION B a n k i n g : An O l i g o p o l i s t i c I n d u s t r y  . . .  102  . 102  Need f o r Growth  105  P r o f i t Constraint  112  Maintenance o f Market Share  8.  84  H3  Government I n t e r f e r e n c e  115  S u p e r i o r Knowledge Theory  123  P r e f e r e n c e f o r D i r e c t Investment  129  Cross Hauling  131  A l i b e r ' s Theory  133  Summary  134  A THEORY OF INTERNATIONAL BANKING EXPANSION  138  vii Chapter  Page Results of Interviews  . . . .  Summary 9. 10.  154 155  CURRENT EVENTS AND THE THEORETICAL MODEL  157  THE FUTURE  169  BIBLIOGRAPHY  181  APPENDIXES  186  I.  I n t e r v i e w Guide f o r F i e l d Study  187  11.  The F o r e i g n Investment D e c i s i o n  193  LIST OF TABLES Table  Page  1-1.  R e l a t i v e S i z e o f Canadian and American Banks  4-1.  The World's Major Banks - 1973  35  4-2.  Comparative Growth Rates o f Major Banks  40  4-3.  Money E x p r e s s e d as a P e r c e n t a g e o f Gross N a t i o n a l Expenditure ( R e l a t i v e to the U.K. i n b r a c k e t s ) E s t i m a t e d L e v e l a t June 1973  42  4-4.  A d j u s t e d Ranking o f Top Ten Banks  43  4-5.  F o r e i g n Branches o f N a t i o n a l Banks By Region and By C o u n t r y , March 31, 1965  45  A s s e t s and L i a b i l i t i e s o f F o r e i g n Branches of N a t i o n a l Banks, December 31, 1964  46  4-6. 4-7.  A s s e t s o f F o r e i g n Branches o f U.S.  Banks  1971-1974  47  4-8.  F o r e i g n Branches o f U.S.  4-9.  Worldwide I n t e r n a t i o n a l N e t w o r k — C h a s e Manhattan Bank E x p a n s i o n o f Branch B a n k i n g Overseas Compared w i t h F o r e i g n Trade and U.S. D i r e c t I n v e s t ment Abroad 1967-1972  4-10.  4  Banks 1973  48  53  54  4-11.  Growth i n A s s e t s o f C h a r t e r e d Banks  56  4-12.  Bank B r a n c h e s , A g e n c i e s , S u b s i d i a r i e s and A f f i l i a t e s - December 1973  57  4-13.  C h a r t e r e d Banks: T o t a l F o r e i g n C u r r e n c y A s s e t s and L i a b i l i t i e s , 1963-1974  60  4-14.  A s s e t s o f Banks i n the U n i t e d Kingdom  63  7-1.  P r o f i t R a t i o s By S i z e o f U.S.  7-2.  P r o f i t R a t i o s of S e l e c t e d Banks viii  Banks  109 11°  LIST OF FIGURES  Figure 2-1.  Page O r g a n i z a t i o n a l S t r u c t u r e of the Foreign A c t i v i t i e s o f a L a r g e U.S. Bank  23  8-1.  Model o f F o r e i g n E x p a n s i o n  139  8-2.  Model o f P r o f i t C o n s t r a i n t  142  8- 3.  N u m e r i c a l Example o f t h e S t a t i c D e t e r m i n a t i o n o f Bank S i z e  9- 1. AI-1.  144  C a p i t a l / A s s e t R a t i o s o f U.S. B a n k i n g I n d u s t r y  159  Schematic o f Bank E x p a n s i o n Abroad  192  ix  ACKNOWLEDGMENT  A s p e c i a l v o t e o f thanks i s extended t o my f r i e n d , mentor, and t h e s i s a d v i s o r , P r o f e s s o r Whatarangi W i n i a t a , who encouraged me t o pursue t h e s t u d y . H i s h e l p f u l guidance and g e n t l e ' p r o d d i n g ' has no doubt improved t h e q u a l i t y o f the work you a r e about t o r e a d . The w r i t e r remains s o l e l y r e s p o n s i b l e f o r any errors or omissions.  x  DEDICATION  T h i s t h e s i s i s d e d i c a t e d t o my w i f e S h i r l e y  who  (almost always) c h e e r f u l l y t o l e r a t e d t h e l o n g hours of p l a y i n g  'second f i d d l e ' t o a s t a c k of  books.  xi  A THEORY OF INTERNATIONAL BANKING EXPANSION  xii  Chapter One INTRODUCTION OBJECTIVES OF STUDY The primary objective of t h i s study i s to develop a theory to explain the rapid growth of international banking witnessed during the past decade.  The United  States i s the world leader i n international  banking and Canada ranks as the t h i r d largest international banking nation.  Accordingly,  the main focus of our research w i l l be on the  Canadian and American banks. There has been much written on the theory of foreign d i r e c t i n vestment and considerable  study of multinational enterprise.  However,  every serious study which t h i s writer has been able to locate deals with manufacturing and/or resource based industries v i r t u a l l y exclusively and pays scant attention to the service industries.  I t may be because  the service industries are not amenable to analysis that they are neglected.  Raymond Vernon, f o r example, dismissed  the service industries as  follows:  The banks, insurance companies, a i r l i n e s , shipping companies, and t o u r i s t agencies that s e l l their services across international boundaries generally find themselves obliged to develop highly s p e c i a l ized business s k i l l s and to adapt to s p e c i a l l y t a i l o r e d national laws and national i n s t i t u t i o n s . Accordingly, the problems of the international service industries w i l l not be explored i n depth i n the pages ahead.1 Vernon has a good point for very early on i n the research this writer became somewhat frustrated by the 'messiness' of the  1  stages  2 e x p a n s i o n p r o c e s s e x h i b i t e d by the b a n k i n g i n d u s t r y .  In t h i s  connection  an o b s e r v e r of the i n t e r n a t i o n a l b a n k i n g scene has w r i t t e n :  The e x p a n s i o n now t a k i n g p l a c e does not amount t o any movement p r o c e e d i n g on some g r a n d , d e l i b e r a t e d e s i g n . The p r o c e s s i s an u n t i d y one, m o t i v a t e d by c o n s i d e r a t i o n s v a r y i n g from bank t o bank and count r y t o c o u n t r y , and t a k i n g p l a c e p i e c e m e a l by a v a r i e t y of methods. Yet however amorphous, i t f e e d s on i t s e l f , a c q u i r i n g a d r i v e of i t s own. 2  A B r i t i s h banker warned r e c e n t l y t h a t those who  seek t o f i n d  o r d e r and make some sense out of the development of i n t e r n a t i o n a l b a n k i n g w i l l meet w i t h d e s p a i r .  However t h i s w r i t e r f i n d s no a. p r i o r i r e a s o n t o  assume t h a t t h e r e a r e not some common u n d e r l y i n g the development of m u l t i n a t i o n a l e n t e r p r i s e — b e f a c t u r e of farm equipment.  f a c t o r s that  influence  i t b a n k i n g or the manu-  W i t h t h i s i n mind we w i l l e x p l o r e the more  p o p u l a r t h e o r i e s of f o r e i g n d i r e c t i n v e s t m e n t — t h e o r i e s e x p l a i n the e x p a n s i o n of i n d u s t r i a l e n t e r p r i s e s — a n d  developed t o  attempt t o  identify  some a s p e c t s of t h a t phenomenon t h a t might be a p p l i c a b l e t o the e x p l a n a t i o n of i n t e r n a t i o n a l b a n k i n g e x p a n s i o n . Once t h e s e common a s p e c t s are l o c a t e d , an attempt w i l l be made t o p u l l the s t r a n d s  together  i n t o a t h e o r y of i n t e r n a t i o n a l b a n k i n g expan-  sion that i s able to withstand t e n t and  i n conformity  the d u a l t e s t s of b e i n g l o g i c a l l y  consis-  w i t h the major f a c t s .  RESEARCH METHODOLOGY  The tics,  r e s e a r c h p r o c e s s i n v o l v e d a comprehensive s u r v e y of  statis-  a n n u a l r e p o r t s , and v a r i o u s p u b l i c a t i o n s (newspapers, magazines,  b a n k i n g j o u r n a l s ) t h a t c o n t a i n a r t i c l e s on the s u b j e c t of i n t e r n a t i o n a l  3 banking.  Information from these sources coupled with the writer's per-  sonal banking experience (eleven years i n Canada and one year i n the United States) led to the development of a theory of international banking expansion. After a preliminary t h e o r e t i c a l model had been developed, we then conducted interviews with senior executives i n the international d i v i s i o n s of the f i v e major chartered banks.  The objective of the i n t e r -  views was to obtain insights into the major concepts upon which our model rests.  We were also interested i n obtaining reaction to the model de-  veloped.  The guide questionnaire and model u t i l i z e d i n the f i e l d study  are included as Appendix I. It i s f a i r to say that the reaction to our preliminary model was mixed.  Some areas of general agreement were i d e n t i f i e d .  some areas of general disagreement.  So too, were  In areas where general disagreement  was i d e n t i f i e d we reconsidered our position and i n some cases altered our approach. Problems were encountered however i n cases where the responses to s p e c i f i c questions or reaction to c e r t a i n variables i n the model were mixed.  In these cases the writer has searched for outside information  that tends to point i n one d i r e c t i o n or the other. The following table i s presented to give the reader a f e e l for  3 the size and economic power of the major Canadian and American banks. The big f i v e Canadian banks control about 92 per cent of the Canadian banking industry, while the big f i v e American banks control about 25 per cent of the U.S.  industry. These ten banks dominate their domestic compe-  t i t o r s i n the international banking scene.  4 Table  1-1  RELATIVE SIZE OF CANADIAN AND  AMERICAN BANKS  1973 A s s e t s (millions)  1973 World Rank  1964 World Rank  $49,404  1st  1st  Citicorp  44,019  2nd  3rd  The Chase Manhattan Corp.  36,790  3rd  2nd  J . P. Morgan & Co. I n c .  20,375  17th  9th  M a n u f a c t u r e r s Hanover Corp.  19,850  18th  4th  $18,381  28th  8th  16,117  35 t h  10th  Bank of M o n t r e a l  14,409  41st  16th  The Bank of Nova S c o t i a  10,328  55th  38th  9,422  71st  47th  UNITED STATES BankAmerica C o r p o r a t i o n  CANADA The R o y a l Bank of Canada Canadian Imp.  B. of Commerce  The Toronto-Dominion  Bank  I t i s q u i t e apparent from t h e above t a b l e t h a t Canadian banks have s l i p p e d c o n s i d e r a b l y over the p a s t t e n y e a r s i n s i z e r e l a t i v e t o o t h e r major i n t e r n a t i o n a l banks.  The t h r e e l a r g e s t U.S.  o t h e r hand have m a i n t a i n e d t h e i r w o r l d dominance.  banks on t h e  I t would seem t h a t  t h i s f a c t might i n d i c a t e t h a t Canadian banks have t a k e n a l e s s a g g r e s s i v e approach t o t h e p u r s u i t of growth than the o t h e r major w o r l d banks. w i l l e x p l o r e t h i s p o s s i b i l i t y f u r t h e r below.  We  I t can be p o i n t e d out a t  t h i s time however t h a t o v e r t h e p a s t few y e a r s t h e r e have been a number of b a n k i n g mergers i n b o t h Europe and Japan.  These mergers have  5 catapulted some moderate-sized i n s t i t u t i o n s into world prominence i n banking.  An example i s the merger of the National P r o v i n c i a l Bank Ltd.  and Westminster Bank Ltd., both of London, to form the National Westminster Bank Ltd..which i s now the seventh largest i n the world. An important motivating factor behind at least some of the mergers i s thought to be the widely held European view that firms must be encouraged to merge i n order to reap economies of scale and meet the challenge of large American firms.  The chief proponent of t h i s view i s  the French j o u r n a l i s t , Jean-Jacques Servan-Schreiber. His book, The American Challenge, outlines h i s view of the problems facing European  4 business and the measures necessary to overcome them.  Recently, the  v a l i d i t y of Servan-Schreiber's views have been questioned by R. Rowthorn (International Big Business 1957-67: A Study of Comparative Growth)~* and Stephen Hymer (Multinational Corporations and International Oligopoly: 6 The Non American Challenge).  A more detailed examination of the issues  involved w i l l be included below when we discuss the size and the apparent need or desire for growth of the banking industry. ORGANIZATION OF THE STUDY Chapter two i s devoted to the development international banking.  of a d e f i n i t i o n of  I t i s important for the reader to be clear about  what we mean when we use the term 'international banking' since the d e f i n i t i o n has a bearing on our t h e o r e t i c a l model. Chapter three represents an attempt to give the reader some understanding of the contribution that international banking can make to v a r i ous world  economies.  6 Chapters f o u r and f i v e t r a c e t h e r e c e n t growth o f i n t e r n a t i o n a l b a n k i n g and d i s c u s s t h e a t t e m p t s t h a t have been made t o e x p l a i n t h e phenomenon observed. C h a p t e r s s i x , seven and e i g h t form t h e h e a r t o f t h e t h e s i s . Chapter s i x s u r v e y s t h e v a r i o u s t h e o r i e s o f d i r e c t i n v e s t m e n t and Chapt e r s seven and e i g h t r e p r e s e n t our attempt t o develop a t h e o r y o f i n t e r n a t i o n a l banking expansion. I n Chapter n i n e we d i s c u s s some r e c e n t events a f f e c t i n g t h e i n t e r n a t i o n a l b a n k i n g environment w h i c h might c a l l f o r some minor a l t e r a t i o n s to our model. F i n a l l y , i t would seem t h a t no paper d e a l i n g w i t h an  institu-  t i o n a l problem i s complete w i t h o u t some t r e a t m e n t o f t h e f u t u r e . d i n g l y , we w i l l c l o s e out t h e s t u d y by a t t e m p t i n g t o u t i l i z e  Accor-  the concepts  developed t o make some p r e d i c t i o n s about what might l i e i n s t o r e f o r i n t e r n a t i o n a l b a n k i n g over t h e next decade.  7 Notes f o r Chapter One ^ Raymond Vernon, The Economic Environment o f I n t e r n a t i o n a l ness (Englewood C l i f f s , N.J.: P r e n t i c e - H a l l , 1972), p. 7.  Busi-  2 Quoted i n The Economist (November 21, 1964), p. 845.  3 The Banker (June 1974) and Banks o f t h e World (1964). 4 J . J . S e r v a n - S c h r e i b e r , The American C h a l l e n g e (New Y o r k : Atheneum, 1968). S. Hymer and R. Rowthorn. I n t e r n a t i o n a l B i g B u s i n e s s 1957-67: A Study o f Comparative Growth (Cambridge: Cambridge U n i v e r s i t y P r e s s , 1971). ^ Hymer and Rowthorn, " M u l t i n a t i o n a l C o r p o r a t i o n s and I n t e r n a t i o n a l O l i g o p o l y : The Non American C h a l l e n g e , " i n The I n t e r n a t i o n a l C o r p o r a t i o n s : A Symposium, C. K i n d l e b e r g e r (ed.) (Cambridge, Mass.: M.I.T. P r e s s , 1970).  Chapter  Two  INTERNATIONAL BANKING  Definition International banking i s a term that i s commonly used to describe a wide range of banking a c t i v i t i e s — f r o m f a c i l i t a t i n g a simple foreign remittance to mobilizing Euro dollars throughout the world. There i s however no widely accepted 'tidy' d e f i n i t i o n of the term 'international banking.'  This i s not r e a l l y surprising.  Experts have long  ago given up the attempt to set out a reasonable d e f i n i t i o n of domestic banking. The Canadian Bank Act contains no d e f i n i t i o n of banking.  Sec-  tion 2 of the Act contains a c l a s s i c d e f i n i t i o n that a bank "means a bank to which this Act applies.""'' the  Section 75 of the Act contains a l i s t of  general powers of a bank and sets out types of business that may  undertaken.  be  The 'out' used by the Act to avoid a d e f i n i t i o n i s the r e -  s t r i c t i o n that prohibits the use of the words 'bank' or 'bankers' i n the corporate t i t l e of any company unless i t i s chartered under the Act. For  the purposes of this paper we w i l l assert that a bank be-  comes international when i t makes a foreign direct investment i n a company engaged i n f i n a n c i a l services.  These f i n a n c i a l services w i l l i n -  clude issuing demand and notice l i a b i l i t i e s and granting loans (usual commercial banking) but also w i l l include the wide range of f i n a n c i a l services offered by merchant banking. w i l l be discussed l a t e r i n the chapter.  8  The nature of merchant banking  9  The key to the d e f i n i t i o n i s that a_ d i r e c t investment must be made. We w i l l now  enter into a discussion of the various operating  forms employed by the banks i n their international operations.  Those  operating forms that f i t within our d e f i n i t i o n of international banking w i l l then be i d e n t i f i e d at the conclusion of the chapter. A.  Correspondent  Banks  Correspondent  banking i s a system whereby banks maintain a de-  posit relationship with each other.  U.S. banks have used the system  domestically for years to help i n overcoming l e g i s l a t i o n that prohibits branching.  Small unit banks i n towns and v i l l a g e s maintain deposits  with large c i t y banks who centre banks.  In this way  i n turn maintain accounts with large money surplus funds from r u r a l areas could be put  to productive use i n the larger i n d u s t r i a l i z e d areas. Correspondent  relationships with foreign banks serve a somewhat  d i f f e r e n t purpose: the settlement of international clearings.  In foreign  centres where a Canadian or U.S. bank i s not d i r e c t l y represented, an account with a foreign correspondent can serve as a vehicle through which payments or c o l l e c t i o n s can be made on behalf of importers and exporters. The foreign exchange market, which i s the l i n k between the domest i c f i n a n c i a l system and the f i n a n c i a l system of other countries, can be operated e n t i r e l y through a system of correspondent banks.  While i t  i s true that some foreign transactions can become f a i r l y complex, i n the f i n a l analysis there i s v i r t u a l l y no f i n a n c i a l transaction involving  10 f o r e i g n t r a d e o r c a p i t a l f l o w s t h a t cannot be handled through dents.  correspon-  To c l a r i f y the concept o f c o r r e s p o n d e n t b a n k i n g an example o f a  rather t y p i c a l transaction follows: a)  assume The R o y a l Bank o f Canada m a i n t a i n s a Canadian d o l l a r account w i t h t h e T o k a i Bank o f Japan;  b)  assume a Canadian e x p o r t e r e n t e r s i n t o a c o n t r a c t t o s e l l $1,000,000 i r o n ore t o a Japanese i m p o r t e r on terms o f t h i r t y days a f t e r  c)  acceptance;  The R o y a l would f o r w a r d t h e b i l l o f exchange and s u p p o r t i n g documents t o the T o k a i Bank;  d)  T o k a i would n o t i f y t h e Japanese i m p o r t e r ;  e)  when shipment a r r i v e s i n p o r t the i m p o r t e r would 'accept' t h e b i l l from t h e T o k a i Bank who would h o l d i t f o r t h i r t y  f)  days;  on the due date the T o k a i Bank would c o l l e c t t h e b i l l and c r e d i t the Canadian d o l l a r account m a i n t a i n e d by the R o y a l Bank;  g)  The R o y a l would then s i m p l y d e b i t t h e Canadian d o l l a r  account  and c r e d i t t h e account o f the e x p o r t e r . B a l a n c e s w i t h f o r e i g n banks c o n s t i t u t e a s i g n i f i c a n t p r o p o r t i o n of  t o t a l f o r e i g n a s s e t s and l i a b i l i t i e s o f t h e c h a r t e r e d banks.  As a t  June 30, 1974, t h e c h a r t e r e d banks had $15,898 m i l l i o n on d e p o s i t w i t h f o r e i g n banks.  I n t u r n , f o r e i g n banks had $14,410 m i l l i o n on d e p o s i t  w i t h Canadian banks.  These f i g u r e s r e p r e s e n t e d r e s p e c t i v e l y 61.8 per  c e n t and 50.2 per c e n t o f t o t a l f o r e i g n a s s e t s and l i a b i l i t i e s . I t appears t h a t the magnitude o f c o r r e s p o n d e n t b a l a n c e s i s w e l l  11  i n excess of the t r a n s a c t i o n s b a l a n c e s r e q u i r e d t o f a c i l i t a t e the of t r a d e and  c a p i t a l and  t h a t , i n p a r t , they r e f l e c t i n t e r - b a n k  flows  lending.  Some a n a l y s t s , i n n o t i n g the r a p i d b u i l d up of i n t e r n a t i o n a l bank d e p o s i t s — e s p e c i a l l y Euro d o l l a r s — h a v e warned t h a t l o s s e s w i l l occur.  likely  D. R. Mandich, S e n i o r V i c e - P r e s i d e n t , D e t r o i t Bank and  Company, warned i n  Trust  1972:  o v e r l y l a r g e Euro d o l l a r d e p o s i t s have been and a r e b e i n g g r a n t e d t o f o r e i g n banks i n r e l a t i o n t o t h e i r i n d i v i d u a l c a p i t a l s and f i n a n c i a l p r o p o r t i o n s , w i t h v e r y l i t t l e r e a l knowledge of the p e o p l e of t h e i r f i n a n c i a l engagements. The t h e o r y r e p o r t e d l y i s t h a t the d e p o s i t s a r e s h o r t term ones and t h e r e f o r e s a f e , but t h e r e i s c l e a r l y a p r o c e s s of c r e d i t b e i n g extended w i t h o u t normal c r e d i t s t u d i e s and safeguards. Obviously, t h i s i s a p r a c t i s e which i n v i t e s misfortune a t some f u t u r e time.2 The  s e v e r a l bank f a i l u r e s of 1974  statement.  have c e r t a i n l y s u p p o r t e d the  foregoing  I t i s known t h a t most major banks a r e l o o k i n g v e r y c l o s e l y  at t h e i r correspondent r e l a t i o n s h i p s . Bank r e p o r t e d l y e l i m i n a t e d $100  B r i t a i n ' s N a t i o n a l Westminster  m i l l i o n w o r t h of c r e d i t l i n e s w i t h A m e r i -  can banks as a r e s u l t of b e i n g burned by the f a i l u r e of the  U.S.  3 N a t i o n a l Bank of San D i e g o .  F u r t h e r m o r e , N a t i o n a l W e s t m i n s t e r Bank  has adopted the p o l i c y o f r e f u s i n g t o h a n d l e l e t t e r s o f c r e d i t from banks u n l e s s  they have a s s e t s i n B r i t a i n .  Thus because of  U.S.  carelessness  i n i n t e r bank d e a l i n g an impediment t o f o r e i g n t r a d e has been e r e c t e d . I t was  o r i g i n a l l y intended  t h a t the p r i m a r y f u n c t i o n of  inter  bank d e p o s i t s would be t o f a c i l i t a t e the r e v e r s e f l o w s of funds t h a t accompany a l l t r a n s a c t i o n i n r e a l goods and  services.  I t now  seems  t h a t i n t e r bank d e p o s i t s c o n s t i t u t e an i m p o r t a n t i n v e s t m e n t o u t l e t as well.  An i n t e r e s t i n g and  i m p o r t a n t i s s u e w h i c h a r i s e s i s whether o r  not  12 these a c t i v i t i e s can be adequately supervised  from a domestic base.  T r a d i t i o n a l functions of correspondents also include the exchange of information on economic conditions, p o l i t i c a l events and reports on commercial enterprises.  In addition the correspondent bank  can be thought of as the Canadian or U.S. It i s reported  credit  window to a foreign market.  that Canadian banks have at least 5,000 corres-  pondent banks throughout the world and, while no figures could located, i t i s very l i k e l y that U.S.  be  banks have s u b s t a n t i a l l y more  correspondents. B.  Resident Representatives The representative o f f i c e i s used by both Canadian and  U.S.  banks, primarily i n areas where f u l l service banking i s prohibited. This operating form has been described as the weak l i n k i n the banking structure of any country because the function i s i l l - d e f i n e d and i s not r e a d i l y susceptible to control by the monetary a u t h o r i t i e s . function of a resident representative of a Canadian or U.S. "hunt down business and make money for us."^  The  bank i s to  This function however i s  subject to the constraint that normal banking a c t i v i t i e s (acceptance of deposits, granting loans) are prohibited. representative  In several countries  i s also prohibited from entering into a contract.  business obtained i n the foreign country i s supposed to be  the Any  contracted  for and booked at head o f f i c e . The representative i s e s s e n t i a l l y a roving marketing o f f i c e r for the head o f f i c e .  He v i s i t s correspondent banks, maintains l i a i s o n with  l o c a l o f f i c e r s of multinational c l i e n t s of head o f f i c e , and attempts to  13 c o n t a c t p o t e n t i a l customers. The banks o f t e n r e g a r d s t e p toward a f u l l b r a n c h .  the r e p r e s e n t a t i v e o f f i c e as the  I n some markets i t i s thought a d v i s a b l e  t e s t the w a t e r s i n a r e l a t i v e l y i n e x p e n s i v e way sentative office.  first to  by s e t t i n g up a r e p r e -  I n the m a j o r i t y of cases however the  representative  i s used i n a r e a s t h a t p r o h i b i t f u l l s e r v i c e b a n k i n g by f o r e i g n e r s . Canada i s a good example.  The  1967  f o r e i g n c o r p o r a t i o n c a r r y i n g on b u s i n e s s  Bank A c t s t a t e s t h a t  i n Canada may  bank, banker, or b a n k i n g t o d e s c r i b e i t s a c t i v i t i e s .  no  use the word Despite  t h i s at  l e a s t t h i r t y f o r e i g n banks have, w i t h immunity, e s t a b l i s h e d o f f i c e s i n Canada u s i n g the name of the bank above the door.  Canadian•officials  have t u r n e d a b l i n d eye toward the r e p r e s e n t a t i v e , o f f i c e . The  importance of a r e s i d e n t r e p r e s e n t a t i v e t o the i n t e r n a t i o n a l  a c t i v i t i e s of a bank i s d i f f i c u l t t o a s s e s s because a s e p a r a t e c e n t r e cannot be c r e a t e d .  profit  I t appears u n l i k e l y however t h a t the  contri-  b u t i o n of the r e p r e s e n t a t i v e i s s i g n i f i c a n t i n r e l a t i o n t o o t h e r a t i n g forms.  The  oper-  r e p r e s e n t a t i v e o f f i c e appears t o be used more e x t e n -  s i v e l y by those banks t h a t a r e l e s s committed t o i n t e r n a t i o n a l a c t i v i t i e s . For example, Bankers T r u s t New the U.S.  Y o r k C o r p o r a t i o n , s i x t h l a r g e s t bank i n  w i t h a s s e t s of $21 b i l l i o n , had  ( a t December 31, 1973)  r e p r e s e n t a t i v e o f f i c e s around the w o r l d and o n l y seven f u l l branches."'  nineteen  service  On the o t h e r hand BankAmerica C o r p o r a t i o n m a i n t a i n e d  t w e l v e r e p r e s e n t a t i v e o f f i c e s w h i l e i t s f o r e i g n branches t o t a l l e d in  1973.  6  only 103  14 C•  Agencies The P o r t e r Commission d e s c r i b e d an agency as an o f f i c e f r e e t o  conduct a l l phases of b a n k i n g b u s i n e s s o t h e r than the a c c e p t a n c e of deposits.^  The b e s t known, and o l d e s t , Canadian a g e n c i e s a r e l o c a t e d  i n New Y o r k .  P r i o r t o the development of Canadian f i n a n c i a l  markets  the c h a r t e r e d banks c a r r i e d the b u l k o f t h e i r secondary r e s e r v e s i n t h e form of c a l l l o a n s t o New Y o r k b r o k e r s .  The New  York agencies  f a c i l i t a t e d these t r a n s a c t i o n s .  C a l l l o a n s have r e c e n t l y d e c l i n e d b o t h  i n a b s o l u t e and r e l a t i v e terms.  As a t June 3 0 t h , 1974, c a l l l o a n s i n a  f o r e i g n c u r r e n c y t o t a l l e d $225 m i l l i o n compared t o $1,017 m i l l i o n i n g 1964.  I n r e l a t i v e terms f o r e i g n c a l l l o a n s have d e c l i n e d from 24 per  cent of t o t a l f o r e i g n c u r r e n c y a s s e t s i n 1964 t o l e s s than 1 per cent in  1974. I n a d d i t i o n t o g r a n t i n g l o a n s , t h e a g e n c i e s a l s o p r o v i d e a wide  range of ' f r i n g e ' b a n k i n g s e r v i c e s i n c l u d i n g b u y i n g and s e l l i n g s e c u r i t i e s and h a n d l i n g f o r e i g n exchange t r a n s a c t i o n s . There i s a s i g n i f i c a n t advantage  i n o p t i n g f o r agency r a t h e r  than b r a n c h s t a t u s s i n c e an agency i s n o t u s u a l l y s u b j e c t t o r e s e r v e requirements.  I t can borrow funds from t h e l o c a l p u b l i c , book them a t  head o f f i c e , and then borrow a l i k e amount from head o f f i c e f o r placement i n the l o c a l m a r k e t s . who  The advantage  of t h e a g e n c i e s over l o c a l banks  a r e s u b j e c t t o r e s e r v e r e q u i r e m e n t s can be s u b s t a n t i a l as t h e f o l l o w -  i n g h y p o t h e t i c a l example i l l u s t r a t e s :  15  assume:  loan rate 10%  deposit rate 8%  reserve requirement 10% - customer deposits $1,000,000 New York Agency of Canadian Bank unproductive  assets (reserves)  productive loan  0  deposit  $1,000,000 $1,000,000  revenue (10%)  $1,000,000  $100,000  interest expense (8%) net revenue  $1,000,000  80,000 $ 20,000  The Chase Manhattan Bank unproductive  assets (reserves)  productive loan  $  100,000  deposits $1,000,000  900,000 $1,000,000  revenue (10%) interest expense net revenue  $1,000,000  $ 90,000 80,000 $ 10,000  In a highly competitive market i t i s easy to see that the agency could, i f i t desired, cut the loan rate or bid up the deposit rate to make i t unattractive for the U.S. bank to enter the market. Another advantage of agency status i n the United States i s that an agency can avoid Regulation "Q," which r e s t r i c t s U.S. banks i n the rate of interest they can pay on time deposits.  16 The above advantages have n o t gone u n n o t i c e d i n t h e U n i t e d  States  and we appear t o be h e a d i n g i n t o "a new e r a o f s u p e r v i s i o n and c o n s t r a i n t s 9  f o r t h e o p e r a t i o n s o f Canadian banks i n t h e U.S."  There i s c u r r e n t l y  b e f o r e Congress a p i e c e o f l e g i s l a t i o n aimed a t e s t a b l i s h i n g a n a t i o n a l p o l i c y c o v e r i n g t h e o p e r a t i o n s o f f o r e i g n banks i n t h e U.S.  Some a r e a s  of t h e l e g i s l a t i o n would d i r e c t l y a f f e c t agency o p e r a t i o n s .  Membership  i n t h e F e d e r a l Reserve System would be compulsory and would mean t h a t a g e n c i e s would have t o c a r r y r e s e r v e s and be s u b j e c t t o v a r i o u s F e d e r a l regulations, i n c l u d i n g the i n t e r e s t r a t e c e i l i n g . I f p a s s e d , t h i s l e g i s l a t i o n c o u l d w e l l s i g n a l t h e end o f t h e agencies.  I t appears l i k e l y t h a t t h e c h a r t e r e d banks would o p t i n s t e a d  f o r f u l l s e r v i c e branches. D.  F o r e i g n Branches The most p o p u l a r method o f e s t a b l i s h i n g i n t h e i n t e r n a t i o n a l  arena i s v i a the f o r e i g n branch.  F u l l s e r v i c e banking  offers several  advantages over t h e t h r e e o p e r a t i n g forms mentioned above.  A branch  oper-  a t i o n a l l o w s t h e bank t o compete d i r e c t l y f o r i n d i g e n o u s b u s i n e s s i f i t so d e s i r e s .  The e s t a b l i s h m e n t o f a d e p o s i t base i n t h e l o c a l  currency  can enable an i n t e r n a t i o n a l bank t o s e r v e l o c a l f i n a n c i n g needs as w e l l as t h e needs o f m u l t i n a t i o n a l c l i e n t s . Canadian banks i n t h e C a r i b b e a n  The e x t e n s i v e b r a n c h network o f  i s a good example.  A n o t h e r advantage o f b r a n c h i n g  i s t h a t head o f f i c e can c o m p l e t e l y  c o n t r o l p o l i c y — s u b j e c t o f c o u r s e t o t h e laws o f t h e h o s t c o u n t r y .  Big-  ness i s a s s o c i a t e d w i t h s a f e t y i n b a n k i n g and t h i s r e s u l t s i n an advantage f o r b r a n c h i n g .  The p u b l i c i s l i k e l y t o have more c o n f i d e n c e i n  17 d e a l i n g w i t h a f o r e i g n b r a n c h o f t h e BankAmerica t h a n i f say BankAmerica Corporation  opened a f o r e i g n s u b s i d i a r y under a d i f f e r e n t name.  A well  known name above t h e door i s an u n d e n i a b l e advantage t o b r a n c h i n g . The f a c t remains however t h a t , o f t h e many forms of i n t e r n a t i o n a l b a n k i n g , t h e c r e a t i o n of f o r e i g n branches i s t h e most c o n t r o v e r s i a l : However s c r u p u l o u s l y a f o r e i g n b r a n c h r e f r a i n s from p o a c h i n g on t h e p r e s e r v e o f i t s h o s t s , i t s mere e x i s t e n c e t a k e s b u s i n e s s from them, because whenever a f o r e i g n b r a n c h i s e s t a b l i s h e d , t h e p a r e n t bank t r a n s f e r s t o i t t h e b u s i n e s s and d e p o s i t s t h a t p r e v i o u s l y went t o i t s l o c a l c o r r e s p o n d e n t banks.10 There i s disagreement among b a n k e r s about t h e p r e f e r r e d method of f o r e i g n e x p a n s i o n i n t h e f a c e o f a mounting t i d e o f n a t i o n a l i s m around the w o r l d .  John Coleman, f o r m e r l y Deputy Chairman o f The R o y a l Bank o f  Canada, s t a t e d i n 1971 t h a t : "The w o r l d wide b r a n c h system i s n o t t h e system o f t h e f u t u r e . U n t i l r e c e n t l y i t appeared as i f t h e Canadian I m p e r i a l Bank o f Commerce and C i t i b a n k had ( i n s p i t e o f Coleman's remarks) opted f o r t h e branch route.  One major advantage t o b r a n c h i n g i s t h a t head o f f i c e r u n s  i t s own show and b o t h t h e Canadian I m p e r i a l Bank o f Commerce and  Citi-  bank have, u n t i l r e c e n t l y , e x h i b i t e d a c l e a r c u t d e s i r e t o c o n t r o l whatever b u s i n e s s they engage i n .  D u r i n g N. J . McKinnon's c h a i r m a n s h i p o f  the Canadian I m p e r i a l Bank o f Commerce t h i s was c e r t a i n l y t r u e but t h e p i c t u r e has now changed somewhat.  Fewer f o r e i g n b r a n c h e s a r e b e i n g  opened and emphasis seems t o be on p a r t i c i p a t i o n i n c o n s o r t i a .  For  example t h e Canadian I m p e r i a l Bank o f Commerce r e c e n t l y t o o k an e q u i t y p o s i t i o n (20 p e r c e n t ) i n t h e Energy Bank of England a l o n g w i t h  three  18  o t h e r b a n k i n g p a r t n e r s i n t e r e s t e d i n f i n a n c i n g t h e development o f o i l 12 i n t h e N o r t h Sea. W h i l e t h e e x p a n s i o n o f f o r e i g n branches as an o p e r a t i n g v e h i c l e may slow down somewhat, i t i s s a f e t o say t h a t t h e e x i s t i n g  branches  w i l l c o n t i n u e t o make a s i g n i f i c a n t c o n t r i b u t i o n t o f o r e i g n o p e r a t i o n s of E.  Canadian and U.S. banks. S u b s i d i a r i e s and A f f i l i a t e s Both American and Canadian banks o c c a s i o n a l l y i n c o r p o r a t e a sub-  s i d i a r y company t o own and o p e r a t e branches i n a f o r e i g n c o u n t r y .  The  Commerce f o r example owns 100 p e r c e n t o f t h e s h a r e s o f t h e C a l i f o r n i a Canadian Bank which o p e r a t e s twenty branches i n C a l i f o r n i a .  Both The  R o y a l Bank o f Canada and The Bank o f Nova S c o t i a have found i t n e c e s s a r y to  i n c o r p o r a t e s u b s i d i a r i e s i n t h e C a r i b b e a n t o t a k e over t h e i r  there.  branches  T h i s a c t i o n was i n d i r e c t response t o h o s t government p r e s s u r e s  to a l l o w e q u i t y p a r t i c i p a t i o n i n t h e s e o p e r a t i o n s .  Equity p a r t i c i p a t i o n  by t h e p a r e n t s i s i n t h e 75 per c e n t range so t h e r e i s no q u e s t i o n about control. The t o p f i v e U.S. banks have many s u b s i d i a r i e s o p e r a t i n g t h r o u g h out t h e w o r l d and engaged i n a wide range o f f i n a n c i a l s e r v i c e s . The c h a r t e r e d banks a l s o use s u b s i d i a r i e s as a v e h i c l e f o r t h e o p e r a t i o n o f near banks i n o t h e r c o u n t r i e s .  The b i g f i v e banks have  each i n c o r p o r a t e d t r u s t companies i n New Y o r k , U.K., and t h e C a r i b b e a n . The a f f i l i a t e r o u t e i s a l s o used by t h e banks o f b o t h c o u n t r i e s . T h i s form o f e n t r y i n t o t h e f o r e i g n market i s used when t h e r e a r e r e s t r i c t i o n s a g a i n s t b r a n c h i n g o r when l o c a l market c o n d i t i o n s i n d i c a t e  this  19  method i s p r e f e r a b l e .  An example would be the approach used by some  c h a r t e r e d banks i n Hong Kong. tages to branching.  I n t h i s market t h e r e a r e l i m i t e d advan-  Says one Canadian b a n k e r :  I n t h i s p a r t of the w o r l d , s t r a i g h t r e p r e s e n t a t i v e s of f i n a n c i a l i n s t i t u t i o n s from the West a r e c o n s i d e r e d o u t s i d e r s t o A s i a n b u s i nessmen. You've got t o get i n t o the b a l l game on the same l e v e l as the A s i a n s t o even hope t o s u r v i v e . You've got t o buy i n t o A s i a n b u s i n e s s i n o r d e r t o even h e a r about the d e a l s b e i n g p l a n n e d . I t s v e r y much a c l o s e d s o c i e t y out h e r e and, i f you don't go t o the r i g h t c o c k t a i l p a r t i e s or s i t on the r i g h t b o a r d s , you a r e n ' t p r i v y t o the k i n d of i n f o r m a t i o n t h a t makes money f o r Canadian firms.13  I n response t o t h i s t y p e of market t h e Toronto-Dominion i n purchased a 40 per c e n t i n t e r e s t i n I n t e r n a t i o n a l C o n s o l i d a t e d  Invest-  ments L t d . , a h o l d i n g company t h a t c o n t r o l s two banks i n Hong Kong Overseas T r u s t Bank and  1970  (the  the Hong Kong I n d u s t r i a l and Commercial Bank)."*"^  Together t h e s e banks have t h i r t y - f i v e branches i n the Hong Kong a r e a engaged p r i m a r i l y i n r e t a i l b a n k i n g . The U.S.  banks a r e engaged i n i n v e s t m e n t s t h r o u g h a f f i l i a t e s  a much b r o a d e r s c a l e t h a n the c h a r t e r e d banks.  on  C i t i c o r p , f o r example,  has consumer f i n a n c e a f f i l i a t e s i n B r i t a i n , B r a z i l , B e l g i u m , Colombia, Hong Kong, the P h i l i p p i n e s , and  i n S w i t z e r l a n d ; f a c t o r i n g companies i n  A u s t r a l i a , B r i t a i n , Canada, Colombia, Panama, and a f f i l i a t e s i n C o s t a R i c a , Panama, and  F.  J o i n t V e n t u r e s or  S p a i n ; and c r e d i t c a r d  Venezuela.  Consortia  T h i s v e h i c l e has e v o l v e d  s i n c e t h e 1960's as a method of e n t e r i n g  merchant b a n k i n g on a t r u l y i n t e r n a t i o n a l s c a l e .  B a s i c a l l y , a j o i n t ven-  t u r e i s a p a r t n e r s h i p of ( u s u a l l y ) t h r e e t o s i x l a r g e banks who  pool part  20 of t h e i r r e s o u r c e s  t o e n t e r a s p e c i f i c market.  the p a r t n e r banks a r e always k e p t  Domestic o p e r a t i o n s  of  separate.  Merchant b a n k i n g i s d i f f i c u l t t o d e f i n e but i t can be s a i d t h a t i t i n c l u d e s almost every type of f i n a n c i n g i m a g i n a b l e . underwrite  Merchant b a n k e r s  s e c u r i t y i s s u e s ; extend l o a n s over s h o r t , medium, and  long  terms; t a k e e q u i t y p o s i t i o n s i n companies; a s s i s t c o r p o r a t e mergers; s e l l a d v i c e , d e a l i n f o r e i g n exchange; manage m u t u a l f u n d s ; and w r i t e insurance  . . . and  the l i s t goes on.  under-  These b a n k i n g p r a c t i c e s  have l o n g been common i n C o n t i n e n t a l Europe i n c o n t r a s t t o the A n g l o Saxon t r a d i t i o n i n w h i c h banks a c t c h i e f l y as d e p o s i t o r i e s and of s h o r t term c r e d i t .  extenders  D u r i n g the p a s t decade however the b a s i c d i s t i n c -  t i o n between d e p o s i t and merchant banks has faded somewhat.  Both the  U.S.  that hold  and Canadian banks have i n c o r p o r a t e d f o r e i g n a f f i l i a t e s  e q u i t i e s , a s s i s t i n s e c u r i t y u n d e r w r i t i n g s , and p r o v i d e l o n g term v e n ture financing. An example of a l a r g e i n t e r n a t i o n a l j o i n t v e n t u r e merchant b a n k i n g i s the O r i o n Banking Group.  engaged i n  The p a r t n e r s a r e The  Royal  Bank of Canada, The Chase Manhattan C o r p o r a t i o n , N a t i o n a l W e s t m i n s t e r Bank, and Westdeutsche Landesbank G i r o z e n t r a l e .  Members of the  Orion  group i n c l u d e :  —  O r i o n Bank L t d . w h i c h p r o v i d e s f i n a n c i a l c o u n s e l l i n g , manages i n t e r n a t i o n a l underwritings, organizes consortium  loans,  and  a s s i s t s i n mergers and a c q u i s i t i o n s ; O r i o n Termbank L t d . w h i c h s p e c i a l i z e s i n l a r g e s c a l e E u r o currency loans;  and  21 —  Orion Multinational Services Ltd. which conducts research and acts as the central planning agency for the partners. The evolution of consortia serves to underscore the need for  bigness i n banking.  As the credit demands of major multinational c l i e n t s  and governments increase i t i s l i k e l y that major banks w i l l continue to meet the challenge at least partly v i a the consortia route. SUMMARY Based on the above discussion, the only type of international operation excluded from our d e f i n i t i o n of international banking i s the correspondent r e l a t i o n s h i p .  The foreign representative o f f i c e , while  l i k e l y only representing a nominal investment, does q u a l i f y . branches, and subsidiaries also q u a l i f y .  Agencies,  A f f i l i a t e s f i t the d e f i n i t i o n  provided the investing bank exercises e f f e c t i v e control over the company.  P a r t i c i p a t i o n i n consortia presents a b i t of a problem.  no single bank has e f f e c t i v e control. A u s t r a l i a and New  Often  For example the Bank of Montreal,  Zealand Banking Group Ltd., Irving Trust Co. of  New  York, and Crocker Citizens Bank of C a l i f o r n i a each put up $13.75 m i l l i o n to launch the Melbourne-based Australian International Finance Corporation.  Is this a direct investment by the three foreign partners?  While  the investment admittedly i s i n some 'grey' area between p o r t f o l i o and d i r e c t investment, this writer would argue that because each of the companies have representation i n management and take an active part i n d i r e c t i o n of operations, the investment should be c l a s s i f i e d as d i r e c t . Support for this viewpoint i s provided by the U.S. government:  22 Although d e f i n i t i o n s vary greatly from country to country, d i r e c t investment generally covers only investment i n which business i s controlled from abroad. The U.S. government defines t h i s as an ^ ownership interest i n foreign enterprise of at least ten per cent.  In summary, then, our d e f i n i t i o n of international banking i s very broad i n scope and includes v i r t u a l l y any international f i n a n c i a l a c t i v i t y undertaken by the major banks. a direct investment be involved.  The key variable i s only that  It should be noted that the d e f i n i t i o n  of international banking that has evolved i n this chapter i s consistent with the self-image of the major international banks.  The Chase Manhattan  Bank, for example, thinks of i t s e l f as: "An agressive, high quality international f i n a n c i a l services corporation.""^ The d e f i n i t i o n i s also consistent with the concept of international banks of the future: It i s now apparent that the world bank of the future w i l l range from property investment to handling companies' cash flow problems on a multinational basis, or from managing p o r t f o l i o s which are invested on a number of the world's stock exchanges to running r e t a i l branch networks i n as many countries as possible round the globe.18 Figure 2-1 i s presented to give the reader some idea of the organi z a t i o n a l structure of the international operations of a large U.S. bank.  U.S. BANK HOLDING COMPANY  EQUITY IN FOREIGN BANK  EDGE CORPORATIONS F i g u r e 2-1  ORGANIZATIONAL STRUCTURE OF THE FOREIGN ACTIVITIES OF A LARGE U.S. BANK  24  Notes f o r Chapter Two ^ An A c t R e s p e c t i n g Banks and B a n k i n g (Ottawa: Queen's P r i n t e r , 1967). 2 D. R. Mandich, " I n t e r n a t i o n a l Loans: P r o f i t C e n t r e o r L o s s L e a d e r ? " J o u r n a l o f Commercial Bank L e n d i n g (Sept. 1972), p. 39. 3 Canadian B u s i n e s s , 'From Ottawa' ( J a n u a r y 1974), p. 6. 4 Quoted i n The Canadian Banker and ICB Review, 1-74, p. 21. ^ Bankers T r u s t New Y o r k C o r p o r a t i o n , 1973 A n n u a l R e p o r t . BankAmerica C o r p o r a t i o n , 1973 A n n u a l R e p o r t . ^ Report o f t h e R o y a l Commission on B a n k i n g and F i n a n c e , 1964, p. 373. g Bank o f Canada Review (August 1974). 9 The F i n a n c i a l P o s t (December 28, 1974), p. 9. "Banking A c r o s s F r o n t i e r s , " The Economist (Nov. 21, 1964), p. 846. Quoted i n "The Bankers Take t h e P l u n g e , " The E x e c u t i v e (June 1971), p. 32. 12 John D a v i d s o n , "Canadian Banks T h i n k G l o b a l l y , " Canadian Banker and ICB Review, 1-74. 13 Quoted i n The F i n a n c i a l P o s t (October 13, 1973), p. 1. 14 . , Ibid. 1 5  "The Bankers Take t h e P l u n g e . "  S. H. Robock and K. Simmonds. I n t e r n a t i o n a l B u s i n e s s and M u l t i n a t i o n a l E n t e r p r i s e (Georgetown, Ont.: R. D. I r w i n , I n c . , 1973), p. 40. ^ I  Chase Manhattan C o r p o r a t i o n , A n n u a l R e p o r t , 1973. Q  The Banker, 122 (1972), 777.  Chapter  Three  IMPORTANCE OF INTERNATIONAL BANKING The t r e n d toward  economic i n t e r d e p e n d e n c e  among n a t i o n s of t h e  w o r l d i s e v i d e n c e d by a d r a m a t i c e x p a n s i o n of w o r l d t r a d e over t h e p a s t decade.  T o t a l e x p o r t s of a l l c o u n t r i e s i n 1973  billion.''"  grew 37 per cent to. $566  I n c o n s t a n t d o l l a r s t h i s i n c r e a s e amounted t o 13 per  cent—  r o u g h l y double t h e r e a l growth r a t e i n w o r l d G.N.P. Over the p a s t decade, t r a d e has been growing o f about 10 per cent compared w i t h a g l o b a l GNP  a t an a n n u a l average  growth r a t e of a p p r o x i -  2 mately 5 per c e n t .  The r e d u c t i o n i n t r a d e b a r r i e r s i n c l u d i n g  the  G e n e r a l Agreement on T a r i f f s and Trade (GATT) has been an i m p o r t a n t  con-  t r i b u t i n g f a c t o r t o the growth of t r a d e . One banking.  can l e g i t i m a t e l y ask of c o u r s e what the above has t o do w i t h  The answer i s t h a t f o r almost a l l f o r e i g n t r a d e t r a n s a c t i o n s  t h e r e a r e two monetary u n i t s i n v o l v e d — t h e c u r r e n c y of the e x p o r t i n g c o u n t r y and t h e c u r r e n c y of the i m p o r t i n g c o u n t r y .  F o r e i g n t r a d e r s be-  come i n v o l v e d i n what Binhammer c a l l s a 'double s a l e ' o r  'double  3 purchase.'  That i s , an i m p o r t e r d e s i r i n g t o purchase Japanese automo-  b i l e s must f i r s t buy Japanese yen and then buy the a u t o m o b i l e .  The  have l o n g been the most i m p o r t a n t s u p p l i e r o f f o r e i g n exchange t o  banks facili-  t a t e t r a d e between n a t i o n s . Canadian c h a r t e r e d banks m a i n t a i n a w o r l d - w i d e network of c o r r e s pondent banks t o f a c i l i t a t e the f i n a n c i a l f l o w s t h a t must accompany f o r eign trade.  B a s i c a l l y t h e r e l a t i o n s h i p between a Canadian bank and i t s 25  26 correspondent c o n s i s t s of r e c i p r o c a l deposit accounts. t a i n e d by a c h a r t e r e d  The account main-  bank w i t h a f o r e i g n c o r r e s p o n d e n t i s u s u a l l y denom-  inated i n the currency u n i t of the l a t t e r .  The c o r r e s p o n d e n t on t h e  o t h e r hand o f t e n m a i n t a i n s a Canadian d o l l a r account a t t h e c h a r t e r e d bank.  I t has a l s o become q u i t e common f o r t h e c h a r t e r e d  banks t o main-  t a i n U.S. d o l l a r denominated d e p o s i t s w i t h t h e i r f o r e i g n c o r r e s p o n d e n t s — p a r t l y t o f a c i l i t a t e t h e l a r g e volume o f t r a d e i n U.S. c u r r e n c y and p a r t l y f o r investment purposes.  These d e p o s i t s  a r e r e f e r r e d t o as 'Euro-  d o l l a r s ' w h i c h a r e s i m p l e U.S. d o l l a r s l o c a t e d o u t s i d e t h e c o u n t r y . There i s no q u e s t i o n  t h a t f i n a n c i n g f o r e i g n t r a d e i s an impor-  tant f u n c t i o n of the banking i n d u s t r y .  However i t i s a s e r v i c e t h a t can  be o f f e r e d from a domestic base w i t h o u t d i r e c t f o r e i g n i n v e s t m e n t .  The  maintenance o f t r a n s a c t i o n s b a l a n c e s w i t h f o r e i g n c o r r e s p o n d e n t s i s r e a l l y a l l that i s required.  I n t h e c i r c u m s t a n c e s , and i n k e e p i n g w i t h  our d e f i n i t i o n o f f o r e i g n b a n k i n g developed i n Chapter Two, f i n a n c i n g t r a d e f l o w s does n o t q u a l i f y a s an i m p o r t a n t c o n t r i b u t i o n o f i n t e r n a t i o n a l banking.  T h i s does n o t mean t h a t f i n a n c i n g f o r e i g n t r a d e i s n o t  i m p o r t a n t p e r s e . As i m p o r t a n t t r a d i n g n a t i o n s , i t i s v i t a l t h a t t h e United  S t a t e s and Canada each have a h i g h l y developed b a n k i n g system  w h i c h p r o v i d e s e x p o r t - i m p o r t f i n a n c i n g and o p e r a t e s t h e f o r e i g n exchange markets.  To r e i t e r a t e , i t i s t h i s w r i t e r ' s b e l i e f t h a t t h e above  func-  t i o n s can be f u l f i l l e d from a domestic base and w i t h o u t t h e n e c e s s i t y of d i r e c t f o r e i g n i n v e s t m e n t by t h e banks. The nations  banks o f c o u r s e a l s o f a c i l i t a t e c a p i t a l f l o w s among t h e  of the world.  Here a g a i n t h i s w r i t e r would argue t h a t no g r e a t  27 impediment t o c a p i t a l f l o w s would be encountered i f a s i m p l e c o r r e s p o n d e n t banks were used.  One  a n a t i o n such as Canada t h a t has  system of  need o n l y l o o k a t the e x p e r i e n c e of  imposed s e v e r e r e s t r i c t i o n s on the  entry  of f o r e i g n banks f o r e v i d e n c e t h a t c a p i t a l f l o w s can indeed t a k e p l a c e on a huge s c a l e .  I t i s not n e c e s s a r y f o r C i t i c o r p of New  b r a n c h i n Toronto t o a l l o w one p o r t f o l i o investment i n t h i s  Y o r k t o have a  of i t s customers t o make a d i r e c t or country.  I t s h o u l d not be i n f e r r e d from the above t h a t the w r i t e r i s opposed t o f o r e i g n b r a n c h i n g . intended  On the c o n t r a r y : the d i s c u s s i o n i s m e r e l y  t o c a s t doubt upon the u s u a l l y a c c e p t e d e x p l a n a t i o n  i m p o r t a n c e of f o r e i g n b a n k i n g i s i n f i n a n c i n g t r a d e and From the p o i n t of v i e w of the h o s t c o u n t r y ,  that  capital  the  flows.  the r e a l i m p o r t a n c e  of i n t e r n a t i o n a l b a n k i n g i s t h a t i t makes a v e r y s i g n i f i c a n t c o n t r i b u t i o n t o the c r e a t i o n of f i n a n c i a l a s s e t s and  the development of  efficient  f i n a n c i a l markets.  There i s no doubt t h a t the t r a n s m i s s i o n of f i n a n c i a l t e c h n o l o g y , as w e l l as the more f a r - r e a c h i n g e s t a b l i s h m e n t of new types of f i n a n c i a l i n s t i t u t i o n s by f o r e i g n e r s has p l a y e d a l a r g e p a r t i n the f i n a n c i a l development of most c o u n t r i e s . ^ The  development of f i n a n c i a l markets i s e s s e n t i a l t o economic g r o w t h — a t  l e a s t i n 'western' economies. G o l d s m i t h has p o i n t e d out t h a t e v e r y modern economy has a s u p e r s t r u c t u r e of f i n a n c i a l a s s e t s t h a t e x i s t s i d e by s i d e w i t h the  infra-  s t r u c t u r e of n a t i o n a l w e a l t h composed of p h y s i c a l a s s e t s . ~* F i n a n c i a l a s s e t s of c o u r s e a r e l a r g e l y a p r o d u c t of the b a n k i n g system.  A finan-  c i a l a s s e t can be d e f i n e d as a c l a i m a g a i n s t some o t h e r economic u n i t .  28 Unlike a physical asset, the f i n a n c i a l asset of one party i s the debt of another.  I t follows that i n a closed economy the net value of f i n a n c i a l  assets would be zero. It has been found that i n an advanced economy such as the U.S., f i n a n c i a l i n s t i t u t i o n s (primarily the banks) are connected as holders or issuers with a majority portion of a l l f i n a n c i a l instruments  outstanding.  1  Furthermore this r e l a t i o n s h i p has increased over time. The following example i s meant to i l l u s t r a t e the creation of f i n a n c i a l assets: a)  assume a firm purchases ten acres of i n d u s t r i a l land f o r $10,000 and wants to erect a warehouse costing $90,000;  b)  bank A i s w i l l i n g to finance 100 per cent of the project secured by a mortgage bond of $100,000;  c)  bank A i n turn borrows $10,000 v i a term deposits from each of ten customers;  d)  a l l ten bank A customers lever their investment by borrowing $5,000 each from bank B; and  e)  bank B i n turn borrows $50,000 v i a term deposit from another depositor.  The end r e s u l t i s : Real Assets:  F i n a n c i a l Assets:  Land & Building $100,000  Mortgage Bond Bank A term dep.  $100,000 100,000  Bank B loans  50,000  Bank B deposits  50,000 $300.000  29 G o l d s m i t h has argued t h a t a measure o f t h e l e v e l o f economic development o f a c o u n t r y can be o b t a i n e d by i t s " f i n a n c i a l r a t i o . T h e  interrelations  r a t i o i s o b t a i n e d by d i v i d i n g t h e g r o s s v a l u e o f f i n a n c i a l  a s s e t s by t h e v a l u e o f r e a l a s s e t s o r n a t i o n a l w e a l t h p l u s n e t f o r e i g n balance.  I n t h e h y p o t h e t i c a l example above t h e r a t i o : would be  300,000 _ 100,000 =  w h i c h i n r e a l l i f e would i n d i c a t e a v e r y h i g h l e v e l o f development. As a c o u n t r y d e v e l o p s , i t s f i n a n c i a l s u p e r s t r u c t u r e grows more r a p i d l y than i t s s t o c k o f r e a l a s s e t s .  The r e a s o n i s t h a t i t has been  necessary f o r the c r e a t i o n of f i n a n c i a l i n t e r m e d i a r i e s t o f a c i l i t a t e f l o w s o f s a v i n g s from s u r p l u s t o d e f i c i t u n i t s .  A diagrammatic  illus-  t r a t i o n o f t h e f a m i l i a r p r o c e s s i s as f o l l o w s :  DEFICIT SPENDING UNIT s e l l primary  securities  j  INTERMEDIARY  sell indirect  securities  [ SURPLUS SPENDING UNITS  Adding a f i n a n c i a l i n t e r m e d i a r y has t h e e f f e c t o f i n c r e a s i n g t h e f i n a n c i a l i n t e r r e l a t i o n r a t i o ( i n t h e s i m p l e case by a f a c t o r o f 2 ) . The c o n t r i b u t i o n o f f o r e i g n b a n k i n g t o t h e f i n a n c i a l s t r u c t u r e can be i n s e v e r a l a r e a s .  super-  I t may s i m p l y i n v o l v e t h e c r e a t i o n  30 of a whole r e t a i l b a n k i n g system f o r a c o u n t r y .  An o u t s t a n d i n g example  of t h i s i s t h e Canadian b a n k i n g system i n t h e C a r i b b e a n .  These banks  have u n q u e s t i o n a b l y a i d e d i n t h e development o f a f i n a n c i a l s u p e r s t r u c t u r e and thus i n an a t t e n d e n t i n c r e a s e i n n a t i o n a l w e a l t h . I t has been found t h a t , u n t i l World War I , f o r e i g n banks h e l d a dominating or a t l e a s t a very strong p o s i t i o n i n v i r t u a l l y every country i n which t h e y o p e r a t e d .  Up t o t h i s time then t h e main c o n t r i b u t i o n  would have been t o c r e a t e a r e t a i l b a n k i n g system f o r a c o u n t r y . F o r e i g n banks may a l s o f o c u s on t h e development o f a market segment n e g l e c t e d by i n d i g e n o u s f i n a n c i a l i n t e r m e d i a r i e s . A good example o f t h i s i s t h e e n t r y i n t o medium term commercial  f i n a n c i n g by U.S. and  Canadian banks o p e r a t i n g i n Europe. On a broader s c a l e , f o r e i g n banks can f a c i l i t a t e f i n a n c i n g a c r o s s n a t i o n a l borders.  T h i s a b i l i t y t o supplement domestic funds w i t h an  o u t s i d e source o r m o b i l i z e s u r p l u s domestic funds f o r use abroad has enabled t h e banks t o p l a y a s i g n i f i c a n t r o l e i n t h e economic development of many c o u n t r i e s .  I n a d d i t i o n , Goldsmith r e p o r t s that  P r o b a b l y as i m p o r t a n t f o r t h e f i n a n c i a l development o f most c o u n t r i e s as t h e f l o w of funds a c r o s s i n t e r n a t i o n a l b o u n d a r i e s was t h e example p r o v i d e d by t h e more advanced c o u n t r i e s . T r a n s f e r o f t e c h n o l o g y and e n t e p r e n e u r s h i p have been e a s i e r t o a c c o m p l i s h , and on t h e whole more s u c c e s s f u l , w i t h r e s p e c t t o f i n a n c i a l i n s t r u m e n t s and f i n a n c i a l i n s t i t u t i o n s than i n many o t h e r f i e l d s . 8  The l a t t e r sentence i n c l u d e s t h e assumption  t h a t f i r m s i n more advanced  c o u n t r i e s have some s o r t of market advantage t o e x p l o i t i n t h e h o s t country.  T h i s i s an i m p o r t a n t p o i n t which w i l l be d i s c u s s e d i n Chapters s i x  and seven below.  31  One i m p l i c a t i o n o f t h e i n t r o d u c t i o n o f f o r e i g n banks i s t h a t i t opens up a w i d e r range o f c h o i c e t o h o l d e r s and i s s u e r s o f f i n a n c i a l assets.  T h i s . o f f e r s an advantage i n t h a t a c l o s e r f i t s h o u l d be  possible  9 i n matching asset h o l d i n g s w i t h asset preference. seem t o r e c o g n i z e t h i s c o n t r i b u t i o n .  Canadian b a n k e r s  Says A l l e n Lambert, Chairman o f t h e  Toronto-Dominion: I n t e r n a t i o n a l b u s i n e s s has been d e v e l o p i n g r a p i d l y i n t h e A s i a n P a c i f i c r e g i o n , and Toronto-Dominion Bank was one o f t h e e a r l i e s t t o p a r t i c i p a t e i n t h i s . The development of new b a n k i n g s e r v i c e s has transformed the f i n a n c i a l s u p e r s t r u c t u r e of the A s i a n / P a c i f i c r e g i o n and t h e r e now e x i s t s a much g r e a t e r v a r i e t y o f f i n a n c i a l i n s t r u m e n t s and a r a p i d growth o f f i n a n c i a l institutionsTTO  I n a d d i t i o n i t has been found t h a t t h e i n t r o d u c t i o n o f a f o r e i g n bank often  'shakes up' t h e l o c a l market and r e s u l t s i n l o w e r i n t e r e s t  costs  and g e n e r a l l y more e f f i c i e n t s e r v i c e s t o customers. SUMMARY  The o v e r r i d i n g i m p o r t a n c e o f i n t e r n a t i o n a l b a n k i n g t h e n i s t h a t i t a s s i s t s i n creating a f i n a n c i a l superstructure  i n the host country.  G o l d s m i t h has found a p a r a l l e l i s m between economic and f i n a n c i a l d e v e l o p ment, however he c a u t i o n s  that:  t h e r e i s no p o s s i b i l i t y of e s t a b l i s h i n g w i t h c o n f i d e n c e t h e d i r e c t i o n of t h e c a u s a l mechanism; i . e . , o f d e c i d i n g whether f i n a n c i a l f a c t o r s were r e s p o n s i b l e f o r t h e a c c e l l e r a t i o n o f economic development o r whether f i n a n c i a l development r e f l e c t s economic growth whose mains p r i n g s must be sought e l s e w h e r e . 1 1  Predominant t h i n k i n g however s u p p o r t s t h e v i e w t h a t t h e c a u s a l c h a i n runs from f i n a n c i a l development t o economic development.  The  32  reason for this view i s that i t has been observed that f i n a n c i a l  insti-  tutions tend to f a c i l i t a t e the flow of funds to the best user i n the system: i . e . , to that economic unit that w i l l generate-the highest return on the funds employed. Another important (but controversial) contribution of internat i o n a l banking i s that i t tends to weaken the boundaries set up to separate nation states.  The b i g banks, l i k e other multinationals have  been described as: a modern concept designed to meet the requirements of a modern age; the nation state i s a very old fashioned idea and badly adapted to serve the needs of our present complex world.12 Nationalism i s an outmoded concept and any contribution the banks, by their active expansion across national boundaries, can make to promote the growth of economic interdependence among nations can be considered worthwhile. In summary, international banking makes a key contribution to the development  of world f i n a n c i a l markets.  Furthermore there are i n d i -  cations that the trend toward international banking i s here to stay. Accordingly i t i s probably time to develop some insights into the forces that have caused the banks to expand—but f i r s t a discussion of the r e l a t i v e size and growth of the foreign operations of the U.S. and Canadian banks.  33  Notes f o r Chapter Three 1 2  B u s i n e s s Week ( J u l y 6,  1974)  Ibid.  3 H. H. Binhammer, Money, Banking and the Canadian F i n a n c i a l (Toronto: Methuen, 1968). 4 R. W. G o l d s m i t h , F i n a n c i a l S t r u c t u r e and Development (New Haven, Conn.: Y a l e U n i v e r s i t y P r e s s , 1969). System  5  Ibid.  6  Ibid.  7  Ibid.  g I b i d . , p. 47. •  D. E. Bond and R. A. S h e a r e r , The Economics o f the Canadian F i n a n c i a l System (Toronto: P r e n t i c e - H a l l , 1972). The Toronto Dominion Bank, Annual Report, 1973. Goldsmith, p. 48. 12  George B a l l quoted i n F o r t u n e , 75, No.  6 (June 1, 1967), 80.  Chapter Four GROWTH OF INTERNATIONAL BANKING It  i s the primary purpose of this chapter to trace the growth  over the past ten years of the international banking a c t i v i t i e s of and Canadian banks.  U.S.  The following chapter w i l l then explore the more  popular explanations offered for the rapid growth experienced. To place the growth experience of U.S.  and Canadian banks i n per-  spective i t may be worthwhile to discuss the o v e r a l l growth of internat i o n a l banks i n recent years.  Since 1970,  'The Banker' has published an  annual l i s t of the top 300 commercial banks i n the world for  a partial listing).  (see Table  4-1  Since banks perform somewhat d i f f e r e n t functions  in various countries i t i s d i f f i c u l t to establish c r i t e r i a upon which to base the annual rankings but i t i s clear that p r o f i t s have never been considered. Deposit taking and short term lending constitute t y p i c a l banking a c t i v i t i e s and any companies performing this service are included i n the l i s t .  However banks a l l over the world are d i v e r s i f y i n g wherever  permitted by l e g i s l a t i o n and therefore the l i s t includes several mixed banks who  combine deposit taking and short term lending with other finan-  c i a l services.  This policy i s consistent with the broad d e f i n i t i o n of  international banking developed  i n Chapter two.  U.S.  bank holding com-  panies represent a good example of 'mixed banks' included i n the annual l i s t prepared by The Banker. In 1964  the top ten banks of the world had deposits t o t a l l i n g 34  35 T a b l e 4-1 THE WORLD'S MAJOR BANKS, 1973  Rank  Bank  Head o f f i c e  Date o f accounts  Assets less contra a/c  Total deposits  Capit'l &reserves  1  BankAmerica  San F r a n c i s c o  31.12.73 31.12.72  48,772 40,465  41,453 35,085  1,550 1,454  2  Citicorp  New Y o r k  31.12.73 31.12.72  44,018 34,385  34,942 27,704  1,770 1,515  3  Chase Manhattan Corp  New Y o r k  31.12.73 31.12.72  36,790 30,704  29,913 25,032  1,348 1,262  4  Banque N a t i o n a l e de P a r i s  Paris  31.12.73 31.12.72  30,142 21,034  29,780 20,732  251 205  5  D a i - I c h i Kangyo Bank  Tokyo  30.9.73 30.9.72  28,467 20,969  21,298 16,815  845 594  6  B a r c l a y s Bank  London  31.12.73 31.12.72  28,304 21,591  24,748 18,790  1,586 1,394  7  N a t i o n a l Westmins t e r Bank  London  31.12.73 31.12.72  27,555 20,568  24,802 18,887  2,095 1,265  8  F u j i Bank  Tokyo  30.9.73 30.9.72  24,418 17,636  18,735 14,551  1,083 784  9  Deutsche Bank  Frankfurt  31.12.73 31.12.72  24,389 18,212  22,847 17,050  836 617  10  Sumitomo Bank  Osaka  30.9.73 30.9.72  23,905 17,127  18,233 14,201  879 624  17  J.P. Morgan & Co.  New Y o r k  31.12.73 31.12.72  19,905 16,128  15,367 12,839  957 881  18  Manufacturers Hanover Corp  New Y o r k  31.12.73 31.12.72  19,540 16,163  17,210 14,150  895 846  28  R o y a l Bank o f Canada  Montreal  31.10.73 31.10.72  17,737 14,567  16,816 13,769  491 449  35  Canadian I m p e r i a l Bank o f Commerce  Toronto  31.10.73 31.10.72  15,669 13,133  14,815 12,414  495 466  41  Bank o f M o n t r e a l  Montreal  31.10.73 31.10.72  13,988 11,138  13,304 10,535  390 370  55  Bank o f Nova S c o t i a  Halifax  31.10.73 31.10.72  10,462 8,647  9,769 8,072  340 308  71  Toronto-Dominion Bank  Toronto  31.10.73 31.10.72  9,030 7,354  8,513 6,953  407 306  Source: The Banker, June 1974.  36 $73,407 m i l l i o n ( i n c l u d i n g t h e two l a r g e s t Canadian banks)."*"  By t h e end  of 1973 t h e t e n l a r g e s t banks i n t h e w o r l d had t o t a l d e p o s i t s o f 2 $266,751 m i l l i o n .  T h i s r e p r e s e n t s a compound a n n u a l growth r a t e o f a l -  most 14 p e r c e n t . D u r i n g t h e t e n year p e r i o d from 1964 t o 1973 t h e r e were s u b s t a n t i a l changes i n t h e top t e n r a n k i n g s : 1964 (1973 r a n k )  1973 (1964 r a n k )  1.  (1) Bank o f A m e r i c a  (1) BankAmerica C o r p o r a t i o n  2.  (3) Chase Manhattan  (3) C i t i c o r p  3.  (2) F i r s t N a t i o n a l C i t y  (2) The Chase Manhattan Corp.  (1st National City)  4. (18) M a n u f a c t u r e r s Hanover T r u s t  (31) Banque N a t i o n a l e de P a r i s  5.  (41) D a i - I c h i Kangyo Bank  (6) B a r c l a y s Bank  6. (21) M i d l a n d Bank  (5) B a r c l a y s Bank  7. (23) C h e m i c a l Bank  (17) N a t i o n a l Westminster  8. (28) The R o y a l Bank o f Canada  (20) F u j i Bank  9. (17) Morgan Guaranty T r u s t  (26) Deutsche Bank  10. (35) Can. I m p e r i a l Bank o f Com.  (23) Sumitomo Bank  As was noted i n Chapter One, several of the major banks now i n the top ten have arrived there v i a mergers and acquisitions.  In fact a  common theme has emerged since the l a t e 1960's i n the international banking scene.  It i s that the large banks are s t r i v i n g for increasingly  sophisticated ways to overcome the constraints on growth imposed by their environment. T r a d i t i o n a l l y the share of the market was sustained or increased by direct competition between l i k e i n s t i t u t i o n s . But i n recent years  37 r a t i o n a l i z a t i o n and d i v e r s i f i c a t i o n i n t o near b a n k i n g a r e a s of a c t i v i t y have become de r i g u e u r f o r t h e b i g o r medium s i z e d banks s e e k i n g f o r something more t h a n t h e n a t u r a l growth a r i s i n g o u t o f i n c r e a s e s i n money s u p p l y and demand f o r c r e d i t . 3  Of c o u r s e t h e q u i c k e s t way t o move i n t o t h e b i g l e a g u e s of banking  i s t h r o u g h a c o r p o r a t e merger.  I n 1970 D a i - I c h i and Nippon Kangyo  Banks of Japan merged t h e i r o p e r a t i o n s t o become t h e f i f t h l a r g e s t bank i n the world. the  Banker's  P r i o r t o t h e merger each bank ranked around f o r t i e t h i n list.  T h i s merger touched o f f a wave o f a g g r e s s i v e i n t e r n a t i o n a l expans i o n by Japan's major banks.  I n 1971 t h e Japanese banks began  setting  up i n t e r n a t i o n a l b r a n c h networks and t h e y a g g r e s s i v e l y e n t e r e d t h e E u r o c u r r e n c y markets on a s u b s t a n t i a l s c a l e .  T h i s r a p i d e x p a n s i o n has  r e c e n t l y been h a l t e d and t h e r e i s some e v i d e n c e t h a t t h e Japanese may have been somewhat overeager i n t h e i r e x p a n s i o n i s t i c z e a l . Post describes the banking ' i n v a s i o n ' t h i s  The  Financial  way:  Anyone who has e v e r been s t a n d i n g i n a l i n e i n v a d e d by a squad of Japanese t o u r i s t s w i l l u n d e r s t a n d t h e b r u i s e d f e e l i n g s of t h e i n t e r n a t i o n a l b a n k i n g community. The Japanese banks a r r i v e d w i t h a t y p i c a l l y l a r g e and c o - o r d i n a t e d bang. I t h u r t . And t h e n t h e y d r a m a t i c a l l y r e v e r s e d d i r e c t i o n l a s t w i n t e r (1973). But t h i s t i m e t h e y were t h e ones who were b r u i s e d . 4 I t appears t h a t a t t h e b e g i n n i n g of t h e 1970's t h e Japanese banks began t o make s u b s t a n t i a l low r a t e , medium term Euro c u r r e n c y l o a n s .  "It  was as i f t h e y [ t h e Japanese] had a d i f f e r e n t message from t h e r e s t o f us,""' one banker commented i n o b v i o u s r e f e r e n c e t o t h e g e n e r a l consensus of  o p i n i o n t h a t i n t e r e s t r a t e s would soon r i s e .  The Japanese banks were  accused of u s i n g 'dumping' t a c t i c s i n r e d e p l o y i n g t h e c o u n t r y ' s f o r e i g n  38 exchange r e s e r v e s t o t h e i r p r i m a r y l o a n o u t l e t — r e s o u r c e r i c h d e v e l o p i n g countries. The 1973  M i d d l e E a s t war and t h e r e s u l t a n t h i k e i n o i l p r i c e s  f o r c e d a change i n t h e Japanese p o s t u r e a l m o s t o v e r n i g h t .  Faced w i t h  a b a l a n c e o f payments d e f i c i t caused by h i g h e r o i l p r i c e s , t h e Japanese had t o borrow i n t h e Euro market.  By t h e second q u a r t e r of 1974,  Euro  d o l l a r b o r r o w i n g s by t h e Japanese banks were s i x t i m e s t h e l e v e l of one y e a r e a r l i e r , and a t s i g n i f i c a n t l y h i g h e r r a t e s o f i n t e r e s t .  The banks  soon f e l l i n t o t h e t r a p of h a v i n g t o borrow s h o r t a t h i g h r a t e s of i n t e r e s t t o fund l o n g term l o a n s a t l o w e r r a t e s .  By June of 1974  Japan-  ese a u t h o r i t i e s had o r d e r e d t h e i r banks t o cease making l o a n s i n t h e Euro c u r r e n c y market.  T h i s a c t i o n e f f e c t i v e l y stopped t h e Japanese ex-  p a n s i o n and a r e a s o n a b l e guess would be t h a t t h e Japanese banks have s l i p p e d c o n s i d e r a b l y i n 1974.  ( R a t i n g s w i l l be p r e p a r e d ( i n June  1975)  by The Banker.) The y e a r 1972 300  saw a f u r t h e r r e s h u f f l i n g of p o s i t i o n s i n t h e top  l i s t due p r i m a r i l y t o d i f f e r i n g r a t e s o f economic growth i n home  markets d i s c u s s e d below.  There a r e of c o u r s e some f a c t o r s o u t s i d e t h e  c o n t r o l of t h e banks t h a t c o n t r i b u t e t o t h e i r r e l a t i v e growth r a t e s . Re-alignment of c u r r e n c i e s can have a s u b s t a n t i a l i m p a c t . i n 1972  For example,  t h e r e v a l u a t i o n o f t h e D-mark and t h e f r a n c a l l o w e d major German  and F r e n c h banks t o improve t h e i r w o r l d r a n k i n g .  I t s h o u l d be n o t e d  however t h a t t h e impact o f a r e v a l u a t i o n o r d e v a l u a t i o n of t h e l o c a l c u r r e n c y i s l a r g e l y dependent upon t h e degree t o w h i c h a bank has gone international.  The t r u e i n t e r n a t i o n a l banks have a s s e t s and  liabilities  39 i n s e v e r a l c u r r e n c i e s and the e f f e c t o f a c u r r e n c y r e a l i g n m e n t may  be  diffused. The r a p i d e x p a n s i o n of major i n t e r n a t i o n a l banks c o n t i n u e d i n 1973 w i t h t h e Japanese banks a g a i n showing t h e f a s t e s t growth r a t e s . T a b l e 4-2  shows t h e comparative  Japanese,  and E.E.C. b a n k s .  growth r a t e s s i n c e 1971 o f t h e top  U.S.,  7  R a p i d growth i n 1973 r e s u l t e d i n the F u j i Bank and Sumitomo Bank p u s h i n g i n t o t h e top t e n f o r the f i r s t time and t h e D a i - I c h i Kangyo Bank overtaking Barclays i n f i f t h spot.  A g a i n , exchange r a t e s p l a y e d a r o l e  i n t h e r e l a t i v e growth r a t e s w i t h Japan showing up w e l l due p a r t l y t o r e v a l u a t i o n of the In  Yen.  c l o s i n g t h i s s e c t i o n i t i s p r o b a b l y a d v i s a b l e t o p o i n t out  some of the weaknesses i n t h e use of b a l a n c e sheet d a t a t o compare t h e r e l a t i v e s i z e and growth r a t e s of t h e w o r l d ' s l e a d i n g banks.  The  lem o f exchange r a t e r e a l i g n m e n t has a l r e a d y been mentioned.  However  t h e r e a r e o'ther p o t e n t i a l problem a r e a s . Bank has attempted of  George F o r r e s t of B a r c l a y s  t o r e l a t e the s i z e of major w o r l d banks t o t h e r a t i o g  the money s u p p l y t o GNP  i n t h e i r home c o u n t r y .  s i m i l a r t o t h a t of G o l d s m i t h  financial sophistication.  fused w i t h Goldsmith's  The approach i s  (see Chapter Two),who found t h a t a h i g h  r a t i o of money and near money t o GNP of  prob-  i s somewhat i n d i c a t i v e of a l a c k  T h i s p a r t i c u l a r r a t i o s h o u l d not be  con-  ' f i n a n c i a l i n t e r r e l a t i o n s r a t i o ' which i s t h e  r a t i o of the g r o s s v a l u e of a l l f i n a n c i a l a s s e t s t o n a t i o n a l w e a l t h .  A  h i g h v a l u e f o r the l a t t e r i s i n d i c a t i v e of a f i n a n c i a l l y advanced c o u n t r y . On t h e o t h e r hand a h i g h r a t i o of money t o GNP  o f t e n i n d i c a t e s t h a t more  40  T a b l e 4-2 COMPARATIVE GROWTH RATES OF MAJOR BANKS 1973  /o  1972  Change  /o  1971  Change  TOP 10 U.S. BANKS ($ m i l l i o n s ) 1 2 3 4 5 6 7 8 9 10  BankAmerica Corp F i r s t N a t i o n a l C i t y Corp The Chase Manhattan Corp J.P. Morgan & Co. I n c . M a n u f a c t u r e r s Hanover Corp C h e m i c a l New Y o r k Corp Bankers T r u s t New Y o r k Corp Western B a n c o r p o r a t i o n C o n t i n e n t a l I l l i n o i s Corp F i r s t Chicago Corp  48,772 44,018 36,790 19,905 19,540 18,364 18,272 17,751 16,784 15,292 255,488  20.5 28.0 19.8 23.4 20.9 19.8 33.0 17.6 32.0 36.8 24.1  40,465 34,385 30,704 16,128 16,163 15,324 13,737 15,088 12,713 11,181 205,888  21.1 16.8 25.3 18.7 13.8 21.5 23.2 14.8 23.7 27.1 20.6  33,406 28,713 24,507 13,871 14,347 12,702 10,738 13,138 10,081 9,152 170,655  28,467 24,418 23,905 23,433 22,373 18,550 18,215 16,845 16,460 16,298 208,964  35.8 38.4 39.6 39.0 42.1 40.4 47.3 41.8 45.3 51.3 41.3  20,969 17,637 17,127 16,860 15,747 13,212 12,362 11,877 11,331 10,771 147,893  32.9 37.5 38.2 37.8 35.1 10.8 42.0 45.6 46.3 55.3 36.4  15,774 12,823 12,393 12,236 11,658 11,927 8,706 8,158 7,742 6,936 108,353  30,142 28,304 27,555 24,389 23,450 22,821 22,651 20,667 19,395  43.3 31.1 34.0 34.0 17.3 31.8 20.4 38.4 23.8  21,034 21,591 20,568 18,212 19,994 17,321 18,819 14,926 15,663  34.0 15.6 21.0 20.0 35.0 35.9 27.6 18.8 54.1  15,698 18,680 16,982 15,168 13,529 11,078 14,754 12,560 10,161  19,366 238,740  37.2 31.0  14,118 182,246  11.7 29.0  12,639 141,249  TOP 10 JAPANESE BANKS ($ m i l l i o n s ) 1 2 3 4 5 6 7 8 9 10  D a i - I c h i Kangyo F u j i Bank Sumitomo Bank M i t s u b i s h i Bank Sanwa Bank I n d u s t r i a l Bank o f Japan The T o k a i Bank M i t s u i Bank T a i y o Kobe Bank Bank o f Tokyo  TOP 10 EEC BANKS ($ m i l l i o n s ) 1 2 3 4 5 6 7 8 9 10  Banque N a t i o n a l e de P a r i s B a r c l a y s Bank N a t i o n a l Westminster Bank Deutsche Bank C r e d i t Lyonnais S o c i e t e Generale Banca N a z i o n a l e d e l L a v o r e Dresdner Bank Banco d i Roma Westdeutsche Landesbank Girozentrale  Source: The Banker, June 1974.  41 sophisticated f i n a n c i a l assets and markets have not yet been developed. In these countries, banks are by f a r the most important f i n a n c i a l i n s t i tution and their size i s often out of proportion ( i n r e l a t i v e terms) to the domestic economy.  Thus i t i s not unusual to see a bank from a  developing country included i n the top 300 l i s t . In comparing the r e l a t i v e size of banks from developed countries one should be mindful of the appropriate government's view of the r o l e of monetary policy.  The governments of some countries, notably Germany,  focus on the supply of money. restricted.  Thus the growth of domestic deposits i s  Governments of other countries, I t a l y f o r example, use  monetary policy primarily to s t a b i l i z e interest rates.  In recent months  this has resulted i n a very rapid rate of growth i n the I t a l i a n money supply, primarily consisting of deposits at commercial banks.  Italian  banks are thus somewhat larger than one would expect they should be. Another factor to consider i n comparisons of the r e l a t i v e size of banks i n various countries i s whether the commercial banks are considered the major savings medium.  Forrest argues that, i n the United  Kingdom, they are not.  The building societies dominate i n the short term savings markets and the insurance companies the long term market. Thus the majority of savings do not come into the money supply and do not show on the books of the b a n k s — r e s u l t i n g i n 'smaller' banks than otherwise. In Germany, Switzerland, Japan, or Hong Kong, f o r example, the banks are the major savings mediums; 'near money' figures are dramatically boosted and the banks are greatly increased i n s i z e . ^  In an e f f o r t to correct f o r the above problem, Forrest has prepared tables (Tables 4-3 and 4-4), which adjust the asset holdings of world banks by a c o e f f i c i e n t based on the r a t i o of money supply to GNP.''  42  T a b l e 4-3 MONEY EXPRESSED AS A PERCENTAGE OF GROSS NATIONAL EXPENDITURE (RELATIVE TO THE UK IN BRACKETS) ESTIMATED LEVEL AT JUNE 1973  Money U n i t e d Kingdom Argentina Australia Austria Belgium Brazil Canada Denmark Eire Egypt Finland France Germany Greece Hong Kong India Iran Israel Italy Japan Korea Kuwait Mexico New Zealand Netherlands Norway Pakistan Peru Portugal South A f r i c a Spain Sweden Switzerland Taiwan Thailand Turkey USA Yugoslavia  21.2 50.0 20.3 21.3 37.9 22.9 21.7 28.7 24.3 34.6 9.8 30.7 15.3 21.3 48.8 24.7 21.9 21.8 69.3 39.9 12.3 13.2 13.2 20.3 26.0 23.9 39.3 20.8 56.8 20.2 38.2 10.1 48.0 23.7 17.0 12.9 22.0 33.4  Nearmoney 24.5 27.9 41.1 45.1 18.2 3.7 23.2 24.9 32.5 12.2 40.7 20.6 42.8 42.7 64.2 13.6 20.8 40.7 33.9 59.5 21.9 26.3 4.8 11.1 27.7 41.6 16.9 6.4 54.3 25.8 69.1 26.4 ' 66.2 37.6 26.1 19.6 29.0 55.3  Source: The Banker, June 1974.  Money s u p p l y (Money + near-money) 45.7 77.9 61.3 66.4 56.0 26.7 44.9 53.5 56.8 46.9 50.5 51.3 58.2 64.0 113.0 38.3 42.7 62.4 103.1 99.4 34.2 39.5 18.1 31.4 53.6 65.5 56.3 27.2 111.1 46.0 107.3 36.5 114.2 61.3 43.2 32.4 51.0 88.7  (1.00) (1.71) (1.34) (1.45) (1.23) ( .58) ( .98) (1.17) (1.24) (1.03) (1.11) (1.12) (1.27) (1.40) (2.47) ( .84) ( .93) (1.37) (2.26) (2.17) ( .76) ( .86) ( .40) ( -69) (1.17) (1.43) (1.23) ( .60) (2.43) (1.01) (2.35) ( .80) (2.50) (1.34) ( .94) ( -71) (1.12) (1.94)  43 T a b l e 4-4 ADJUSTED RANKING OF TOP TEN BANKS ($000 m i l l i o n ) Adjusted Assets  Unadjusted Assets  Rank  1.  Bank o f A m e r i c a  43.7  48.8  1  2.  F i r s t N a t i o n a l C i t y Bank  39.7  44.0  2  3.  Chase Manhattan Bank  33.1  36.8  3  4.  B a r c l a y s Bank  28.3  28.3  5  5.  N a t i o n a l W e s t m i n s t e r Bank  27.6  27.6  6  6.  Banque N a t i o n a l de P a r i s  26.8  30.1  4  7.  C r e d i t Lyonnais  20.8  23.6  11  8.  Societe Generale  20.4  22.6  12  9.  Deutsche Bank  19.3  24.4  9  M i d l a n d Bank  19.1  19.1  20  10.  Source: The Banker, June 1974.  Applying  t h e F o r r e s t c o e f f i c i e n t t o Canadian banks r e s u l t s i n a s i g n i f i - r  c a n t upward adjustment i n t h e i r r a n k i n g . would advance from t w e n t y - e i g h t h  The R o y a l Bank f o r example,  place to eleventh.  While F o r r e s t ' s a n a l y s i s i s rather i n t e r e s t i n g , there i s a potent i a l l y important flaw.  The i m p l i c i t a s s u m p t i o n i s t h a t t h e major p o r t i o n  of a p a r t i c u l a r bank's a s s e t s a r e based i n t h e home c o u n t r y  and t h u s  s t r o n g l y i n f l u e n c e d by t h e i n s t i t u t i o n a l and monetary arrangements i n that country.  As p o i n t e d out above, t h e t r u l y i n t e r n a t i o n a l banks have  assets located i n several countries. has  F o r example, C i t i c o r p o f New Y o r k  52 p e r cent o f i t s t o t a l d e p o s i t s i n f o r e i g n c o u n t r i e s .  In this  44 case i t i s d i f f i c u l t to argue that the bank's assets should (for comparat i v e purposes) be reduced by a c o e f f i c i e n t based upon domestic (U.S.) economic data. With the above q u a l i f i c a t i o n s i n mind i t can be said that, i n the era of international banking, size and growth have taken on renewed importance. In the past, size represented to a large degree status.  In recent  years, p r o f i t a b i l i t y has become much more important i n banking, but increasingly v o l a t i l e markets and greater involvement i n economic development through monetary policy have made size more important again.  The 1930's depression proved that b i g banks weather storms  better than smaller banks.INGROWTH OF U.S. INTERNATIONAL BANKING In the previous section we discussed the recent growth of the world's major international banks.  No d i s t i n c t i o n was made between the  domestic/foreign composition of their balance sheets.  The intention  rather was to give the reader some f e e l i n g f o r the 'growth c u l t ' that has characterized the banking industry over the past decade. We now switch our approach somewhat and focus on the ten year growth of the international operations of the U.S. banks.  We have not  limited our discussion to the growth experience of the f i v e major U.S. banks but':have chosen to discuss the international growth of the U.S. banking industry i n general.  Specific reference w i l l be made occasion-  a l l y to the experience of the major banks. In an e f f o r t to i l l u s t r a t e the determination exhibited by the U.S. banks i n penetrating foreign markets, we have singled out Canada as a case study.  45 We c l o s e t h i s s e c t i o n w i t h a b r i e f d i s c u s s i o n o f t h e o u t l o o k f o r f u r t h e r growth o f t h e i n t e r n a t i o n a l o p e r a t i o n s o f U.S. banks. As i l l u s t r a t e d by T a b l e 4-5, i n March 1965, U.S. n a t i o n a l banks 12 had 144 f o r e i g n branches  spread around t h e w o r l d . T a b l e 4-5  FOREIGN BRANCHES OF NATIONAL BANKS, BY REGION AND COUNTRY, March 31, 1965 Number  Region & Country L a t i n America Argentina Bahamas Brazil Chile Colombia Dominican R e p u b l i c Ecuador E l Salvador Guatemala Jamaica Mexico Nicaragua Panama Paraguay Peru Uruguay Venezuela C o n t i n e n t a l Europe Belgium France Germany Greece Italy Netherlands Switzerland  68 17 1 15 2 5 1 2 1 2 1 5 1 5 2 2 2 4 12 1 2 3 1 1 3 1  Number  Region & Country  1  Africa Nigeria  1  Near E a s t Lebanon Saudi A r a b i a Dubai  2 1 1  4  36  Far East Hong Kong India Japan Malaysia Okinawa Pakistan Philippines Taiwan Thailand  5 5 10 5 1 2 5 2 1  U.S. o v e r s e a s a r e a C a n a l Zone Guam Puerto Rico Truk I s l a n d s  1 1 11 1  England  14  9 144  TOTAL  C o n s o l i d a t e d a s s e t s and l i a b i l i t i e s o f f o r e i g n branches o f U.S. banks a t December 3 1 s t , 1964 were broken down as i n d i c a t e d i n T a b l e 4-6.  13  46  Table 4-6 ASSETS AND LIABILITIES OF FOREIGN BRANCHES OF NATIONAL BANKS, DECEMBER 31, 1964: CONSOLIDATED STATEMENT (Dollar amounts i n thousands) Number.of branches  138 ASSETS  Loans and discounts Securities Currency and coin Balances with other banks and cash items i n process of c o l l e c t i o n Due from head o f f i c e and branches Fixed assets Customers' l i a b i l i t y on acceptances Other assets Total assets  $1,924,827 178,958 31,331 480,730 320,858 28,352 304,362 50,461 $3,319,879  LIABILITIES Demand deposits of individuals, partnerships, and corporations Time and savings deposits of individuals, partnerships, and corporations Deposits of U.S. Government State and municipal deposits Deposits of banks Other deposits ( c e r t i f i e d and o f f i c e r s ' checks, etc.) Total deposits Due to head o f f i c e and branches Rediscounts and other l i a b i l i t i e s f o r borrowed money Acceptances executed by or for account of reporting branches and outstanding Other l i a b i l i t i e s Total l i a b i l i t i e s  $  730,761 1,178,987 190,932 12,988 753,791 21,468  $2,888,927 8,591 61,015 305,481 55,865 $3,319,879  In commenting on the 1964 results the U.S. Comptroller of the Currency noted that foreign branch assets had increased by 27 per cent over 1963,  a rate well i n excess of the growth rate of domestic banking opera14  tions.  In addition to the foreign branches; i n 1964 thirteen national  banks had direct investment i n eighteen subsidiaries engaged i n  47 i n t e r n a t i o n a l b a n k i n g and f i n a n c e .  The combined a s s e t s o f t h e s e c o r p o r -  a t i o n s exceeded $750 m i l l i o n and t h e i r c a p i t a l funds exceeded $100 m i l l i o n . W h i l e t h e 1964 a n n u a l growth r a t e o f 27 p e r cent i s c e r t a i n l y i m p r e s s i v e , i t does n o t come c l o s e t o matching t h e phenomenal e x p a n s i o n over the f o l l o w i n g nine y e a r s .  By December 31, 1973, a s s e t s o f f o r e i g n  branches o f U.S. banks had reached $121,866 m i l l i o n (see T a b l e 4 - 7 ) . T h i s r e p r e s e n t s a n i n e - y e a r average compound growth r a t e o f almost 50 per c e n t . T a b l e 4-7 ASSETS OF FOREIGN BRANCHES OF U.S. BANKS (In m i l l i o n s of d o l l a r s )  Year  Total  Claims on U.S.  Claims on Forgners  Other  1971 1972 1973 1974  $ 61,253 80,034 121,866 136,983  $4,791 4,735 4,881 7,986  $ 54,678 73,031 112,240 123,823  $1,784 2,268 4,745 5,174  Mar.  1971 1972 1973 1974  34,552 43,684 61,732 68,076  2,694 2,234 1,789 3,070  30,996 30,430 57,761 63,020  862 1,020 2,183 1,986  Mar.  1971 1972 1973 1974  24,428 30,381 40,323 46,062  2,585 2,146 1,642 2,967  21,493 27,787 37,816 42,212  350 447 865 882  L o c a t i o n and C u r r e n c y Form A l l Countries, A l l Currencies Mar. U n i t e d Kingdom 1) A l l C u r r e n c i e s  2) U.S. D o l l a r s  Source: F e d e r a l Reserve B u l l e t i n , June 1974. The growth i n branches and o t h e r f i n a n c i a l o u t l e t s has n o t k e p t pace w i t h a s s e t growth, w h i c h has r e s u l t e d i n l a r g e r average b r a n c h s i z e . By t h e end o f 1973 (see T a b l e 4-8) 125 F e d e r a l Reserve member banks had i n a c t i v e o p e r a t i o n 699 branches i n s e v e n t y - s i x f o r e i g n c o u n t r i e s .  48  T a b l e 4-8 FOREIGN BRANCHES OF U.S. BANKS Location  No.  Location  No.  Abu Dhabi Argentina Austria Bahamas Bahrain Barbados Brunei Belgium Bolivia Brazil Canal Zone Cayman I s l a n d s Colombia Dominican R e p u b l i c Dubai Ecuador E l Salvador F i j i Islands France Germany Greece Guam Guatemala Guyana Haiti Honduras Hong Kong India Indonesia Ireland Israel Italy Jamaica Japan Korea Lebanon  1 38 1 91 2 4 2 9 3 21 2 32 32 16 3 15 1 4 15 30 16 7 3 1 2 3 23 11 6 4 2 8 9 23 3 3  Liberia Luxembourg Malaysia Mariana Islands Marshall Islands Mexico Monaco Netherlands Netherlands A n t i l l e s Nicaragua Okinawa Pakistan Panama Paraguay Peru Philippines Puerto Rico Qatar Saudi A r a b i a Singapore Switzerland Taiwan Thailand T r i n i d a d and Tobago T r u c i a l State of Sharjah Truk I s l a n d s U n i t e d Kingdom Uruguay Venezuela Vietnam V i r g i n I s l a n d s (U.S.) V i r g i n Islands (British)  2 6 5 1 1 5 1 6 3 3 2 4 33 6 6 4 22 1 2 14 9 5 2 6 1 1 52 5 4 3 21 3  Other (West I n d i e s )  14  Total  Source: 1973 A n n u a l R e p o r t , Board o f Governors o f t h e F e d e r a l Reserve System.  699  49  Average b r a n c h s i z e has r i s e n from $23 m i l l i o n i n 1964 t o $174 m i l l i o n a t t h e end of 1973.  An i m p o r t a n t c o n t r i b u t i n g  f a c t o r t o the  growth i n average b r a n c h s i z e has been the r a p i d growth i n s i z e o f branches i n the U n i t e d Kingdom as a r e s u l t o f t h e i r p a r t i c i p a t i o n i n t h e Euro d o l l a r market.  At December 1973, U.S. banks o p e r a t e d f i f t y - t w o  branches i n t h e U n i t e d Kingdom w i t h t o t a l a s s e t s o f $61,7.22 m i l l i o n f o r an average b r a n c h s i z e of $1,187 m i l l i o n , w e l l i n excess of t h e o v e r a l l average. In f a c t i f U.S. branches and a s s e t s i n the U n i t e d Kingdom a r e removed, t h e r e m a i n i n g 647 f o r e i g n branches show a s s e t s t o t a l l i n g o n l y $53,790 m i l l i o n f o r an average s i z e o f $83 m i l l i o n .  I t s h o u l d be n o t e d  t h a t t h e average s i z e o f f o r e i g n branches by any measure i s s t i l l i n r e l a t i o n t o the average s i z e of U.S.  domestic branches.  31, 1973, the 40,408 b a n k i n g o f f i c e s i n t h e U.S.  large  At December  had a s s e t s t o t a l l i n g  $835,224 m i l l i o n w h i c h on average works out t o $21 m i l l i o n p e r b a n k i n g ... 15 office.  -  Unfortunately i t i s not p o s s i b l e  t o compare t h e growth s i n c e  1964 i n average s i z e o f the London b r a n c h e s .  The F e d e r a l Reserve system  o n l y began c o l l e c t i n g monthly d a t a on t h e a s s e t s and l i a b i l i t i e s o f  U.S.  16 branches o p e r a t i n g i n f o r e i g n  c o u n t r i e s i n September  1969.  I t does  appear v e r y l i k e l y however t h a t , because o f p a r t i c i p a t i o n i n t h e Euro d o l l a r market, the London branches have expanded t h e i r average s i z e a t a c o n s i d e r a b l y f a s t e r r a t e than other f o r e i g n branches. I n f a c t , a s s e t s of U.S. banks o p e r a t i n g i n London now an i m p o r t a n t p r o p o r t i o n of the e n t i r e U n i t e d Kingdom b a n k i n g  constitute industry.  50 Bank o f England s t a t i s t i c s i n d i c a t e t h a t r e p o r t i n g banks i n t h e U.K. ( i n c l u d i n g t h e major London c l e a r i n g banks) h e l d a s s e t s t o t a l l i n g f104,391 m i l l i o n a t A p r i l 17, 1974."*"^ The London c l e a r i n g banks, w h i c h i n c l u d e B a r c l a y s , M i d l a n d , L l o y d s , and N a t i o n a l W e s t m i n s t e r , h e l d f23,477 m i l l i o n or  22.4 p e r . c e n t o f t h e t o t a l .  A t t h e same t i m e , U.S. banks o p e r a t i n g i n  London h e l d a s s e t s t o t a l l i n g f28,131 m i l l i o n o r 27 p e r c e n t o f t h e t o t a l . ^ The e x p a n s i o n o f U.S. banks i n t o f o r e i g n markets has, l i k e t h e Canadian banks, been by a v a r i e t y o f means. for  By 1972 ( t h e l a t e s t date  w h i c h s t a t i s t i c s c o u l d be l o c a t e d ) t h e t o p t e n U.S. banks had, i n  a d d i t i o n t o an e x t e n s i v e f o r e i g n b r a n c h network, e s t a b l i s h e d  sixty-five  s u b s i d i a r i e s , 208 a f f i l i a t e s , and e i g h t y - s e v e n r e p r e s e n t a t i v e o f f i c e s i n v a r i o u s f o r e i g n markets."*"^ Canada i s a case i n p o i n t .  Because o f b a n k i n g l e g i s l a t i o n w h i c h  p r o h i b i t s f o r e i g n banks from b r a n c h i n g i n t o Canada, the U.S. banks have c r e a t e d s u b s i d i a r i e s t h a t o f f e r many normal b a n k i n g s e r v i c e s b u t do n o t use t h e word 'bank' i n t h e i r c o r p o r a t e t i t l e . more than 100 f o r e i g n banks  D u r i n g the p a s t few y e a r s  ( p r i m a r i l y U.S.) have e n t e r e d Canadian  f i n a n c i a l markets through a v a r i e t y o f i n d i r e c t ways. c r e a t e d might be termed  The i n s t i t u t i o n s  'near banks' i n t h a t t h e y o f f e r a range o f f i n a n -  c i a l s e r v i c e s t h a t f a l l s somewhat s h o r t o f f u l l s e r v i c e b a n k i n g .  Here i s  how J . A. B o y l e , P r e s i d e n t o f t h e Canadian Bankers A s s o c i a t i o n d e s c r i b e d these operations: T h e i r Canadian o p e r a t i o n s a r e c a r r i e d out m a i n l y through s u b s i d i a r i e s and a f f i l i a t e s , c o v e r i n g almost a l l phases o f what i s g e n e r a l l y u n d e r s t o o d t o be 'banking.' By l a w i n Canada such i n s t i t u t i o n s may n o t d e s c r i b e themselves as 'banks' n o r may t h e y d e s c r i b e t h e i r  51 function formally as 'banking,' but this i s r e a l l y just a matter of semantics. They are very much here and are becoming increasingly important components of the Canadian f i n a n c i a l scene.20  The purpose of Boyle's comment was to make public the concern of Canadian bankers that the foreign operations are v i r t u a l l y unregulated and thus not subject to reserve requirements or d i v e r s i f i c a t i o n r e s t r i c tions.  The Bank of Canada reported that, as at October 31, 1974,  assets  21 of foreign owned f i n a n c i a l i n s t i t u t i o n s t o t a l l e d $1.1 b i l l i o n . It should be noted that the reporting program i s voluntary and this undoubtedly r e s u l t s i n understatement of the figures.  Another  factor contributing to understatement of the figures would be the fact that assets of a f f i l i a t e s (less than 50 per cent foreign owned) are not included.  For example, BankAmerica owns i n excess of 20 per cent of  Montreal Trust, a large Quebec based trust company with assets i n the 22 $600 m i l l i o n range.  These assets are not included i n the Bank of  Canada s t a t i s t i c s . Another method used by foreign banks to enter Canada has been by way of a resident representative.  More than t h i r t y foreign banks oper-  ate representative o f f i c e s i n Canada with the i m p l i c i t blessing of government o f f i c i a l s .  The representative o f f i c e s do place the name of  the foreign bank above the o f f i c e door so to speak which i s t e c h n i c a l l y i n contravention  of the Bank Act.  There are indications however that  the foreign representatives receive a f r i e n d l y welcome from the chartered banks and "are given a warm reception from government o f f i c i a l s and even an off-the-record apology that their o f f i c e cannot have the status of a 23 f u l l operating branch." The clear message that comes out of the  52 Canadian experience i s that banks, especially the American ones, w i l l not l e t r e s t r i c t i v e l e g i s l a t i o n stand i n the way of their growth requirements. The growth rate of the overseas expansion of U.S. banks v i a a f f i l i a t e s , subsidiaries or consortia i s not possible to measure because no s t a t i s t i c s are available. been rapid.  However the suspicion i s that growth has  A review of recent annual reports of the major U.S. banks  indicates that considerable attention i s paid to expansion by vehicles other than branching.  I t appears to be the case however that some major  banks prefer to go i t alone v i a the branch route. recently followed this method.  Citibank has, u n t i l  I t now appears that Citibank may  changing their policy somewhat.  be  In a recent address to a national con-  vention of the Bank Administration I n s t i t u t e , S. C. Eyre, Comptroller of C i t i c o r p stated: The case of Citibank i s perhaps i l l u s t r a t i v e of the altered economics of foreign expansion. Whereas i n the l a t e 1960's, we were frequently adding new overseas branches at the rate of about one new branch every two weeks, i n 1972 we opened only eleven new branches, and we actually closed more branches, by a count of 16 to 11, than we opened.24  At the same time Citibank i s a c t i v e l y investigating further expansion v i a p a r t i c i p a t i o n with foreign banks.  One reason advanced for this somewhat  altered policy i s the s p i r a l l i n g costs of branch operation. BankAmerica on the other hand has pursued a more balanced pattern of international growth.  From 1964 to 1973 the bank expanded i t s i n t e r -  national branches from twenty-seven to 103, an increase of 3.8 times. Over the same period the Bank's international subsidiaries grew from  53 three to twenty-one (seven times) and equity investments i n other ventures grew from eighteen to eighty-one (4.5 times).  The following exerpt  from the 1973 annual report of BankAmerica seems i n d i c a t i v e of i t s p o l i c y toward international expansion: The bank continued to d i v e r s i f y i t s international investments i n commercial banks, leasing firms, finance companies, and m u l t i - s p e c i a l i t y merchant banks. With the growing emphasis on the overseas potential of merchant banks, the bank participated i n the operating of three such i n s t i t u t i o n s i n Southeast Asia and has plans for three more i n 1974. 25  Chase Manhattan bank has expressed a similar policy toward overseas expansion: In expanding our international business base, i t has been our policy to employ a mix of branches, wholly owned subsidiaries, controlled but not wholly owned subsidiaries, and a f f i l i a t e s . The decision on which type of investment to i n i t i a t e depends on our estimate of opport u n i t i e s i n each country.26 27 The following  table i l l u s t r a t e s Chase's worldwide international network. Table 4-9  WORLDWIDE INTERNATIONAL NETWORK—CHASE MANHATTAN BANK Overseas Branches: Canada, Caribbean, & L a t i n America Europe and A f r i c a Asia and the Middle East Total Subsidiaries: Canada, Caribbean, & L a t i n America Europe and A f r i c a Asia and the Middle East Total Affiliates: Canada, Caribbean, & L a t i n America Europe and A f r i c a Asia and the Middle East Total  1969 32 11 12 55  1973 58 19 22 99  10 5 0 15  21 11 2 34  2 4 4 10  4 11 14 29  54  I n summary, t h e growth o f f o r e i g n o p e r a t i o n s o f U.S. banks has been s p e c t a c u l a r .  Over t h e f i v e y e a r p e r i o d ending i n 1972 t h e growth  o f f o r e i g n a s s e t s o f U.S. banks c l e a r l y o u t s t r i p p e d t h e growth o f U.S. 28 t r a d e and d i r e c t i n v e s t m e n t as seen i n t h e f o l l o w i n g  table:  T a b l e 4-10 EXPANSION OF BRANCH BANKING OVERSEAS COMPARED WITH FOREIGN TRADE AND US DIRECT INVESTMENT ABROAD, 1967-1972 ( i n bn $) 1967  1968  1969  1970  1971  1972  A s s e t s o f Overseas Branches o f Member Banks F e d e r a l Reserve System  15.7  23.0  41.1  52.6  67.1  77.4  US E x p o r t s  31.5  34.6  38.0  43.2  44.1  49.8  US Imports  26.8  33.2  36.0  40.0  45.6  55.6  B o o k v a l u e , US D i r e c t Investments Abroad  59.5  65.0  71.0  78.1  86.0  94.0  Western Europe A s s e t s o f Overseas Branches o f Member Banks F e d e r a l Reserve System  10.9  17.3  31.2  39.2  48.1  53.9  US E x p o r t s  10.3  11.3  12.4  14.5  14.2  15.3  US Imports  8.2  10.3  10.1  11.2  12.6  15.4  17.9  19.4  21.7  24.5  27.6  30.7  Global  B o o k v a l u e , US D i r e c t Investments Abroad  As may be seen from t h e above t a b l e , f o r e i g n b r a n c h a s s e t s i n c r e a s e d by 4.9 t i m e s w h i l e U.S. e x p o r t s i n c r e a s e d by 1.6, and d i r e c t i n v e s t m e n t by 1.6 t i m e s . There appears t o be a good p o s s i b i l i t y t h a t U.S. i n t e r n a t i o n a l  55 expansion i s at a crossroad.  I t has been argued that the physical expan-  sion of U.S. banking o f f i c e s abroad i s waning and that asset growth may also slow down.  There are a variety of reasons behind the above thinking.  F i r s t l y , spreads i n the London market are very thin and i t i s unlikely that banks contemplating an o f f i c e there could hope to earn an acceptable l e v e l of p r o f i t s .  Secondly, i t can be argued that the major U.S. banks  are now represented (where permitted by l e g i s l a t i o n ) i n every worthwhile nation and further physical expansion appears improbable. other problems currently muddying the water.  There are  "The devaluation of the  d o l l a r , a tighter competitive s i t u a t i o n as evidenced by rate pressures i n London, the uncertain effects of the emergencies, the administration's announced intention' to phase out exchange controls by the end of 1974 [now done], a l l tend to make expansion through new o f f i c e s a f a r less 29 i n t r i g u i n g proposition." A l i q u i d i t y problem i n the domestic U.S. banking industry may also have a repressive effect on foreign expansion (see Chapter N i n e ) . Professor Paul Nadler of Rutgers University has stated that the l i q u i d i t y  30 problem i s causing: "the worst c r i s i s i n confidence I've ever seen." For reasons that w i l l become clearer i n l a t e r chapters, one cannot help thinking that, while some retrenching might take place, the pause i n growth w i l l be only temporary. CANADIAN GROWTH In t h i s section we w i l l follow a format somewhat similar to that presented for the U.S. case.  After a b r i e f discussion of the o v e r a l l  56 growth of the major chartered banks (which can be compared to Table 4-2), we enter into a discussion of the growth of international operations. Both size of assets and number of banking i n s t a l l a t i o n s are presented. In common with the U.S. case, i t i s considered preferable to use assets as the measure of international growth. Perhaps the entry into international wholesale banking receives more emphasis i n this section.  This i s primarily because the Canadian  banks seem to be focusing more attention on this area than their American counterparts.  While differences i n preference f o r operating forms do  exist within the U.S. banking industry, on the whole i t appears that the U.S. banks have followed a more balanced expansionary  process.  The following table shows the growth rate, since 1971, of the f i v e largest chartered banks. Table 4-11 GROWTH IN ASSETS OF CHARTERED BANKS $ Millions  1973  Change  1972  Change  1971  Royal Bank  17,737  17.8  14,567  17.1  12,430  C.I.B.C.  15,669  19.3  13,133  19.3  11,008  Bank of Montreal  13,988  25.5  11,138  12.7  9,897  Bank of Nova Scotia  10,462  20.9  8,647  26.7  6,823  9,030  22.7  7,354  17.7  6,246  66,886  21.2  54,839  18.7  46,386  Toronto-Dominion  When compared to Table 4-2 i t i s apparent that the Canadian banking industry has been growing at a substantially slower pace than the banking  i n d u s t r i e s of Japan and t h e E.E.C., b u t a t a comparable pace w i t h t h e U.S.  industry.  However the above s t a t i s t i c s do n o t t e l l the whole s t o r y .  I t i s the case t h a t domestic e x p a n s i o n of t h e c h a r t e r e d banks has been r a t h e r slow but f o r e i g n o p e r a t i o n s a r e growing a t a c o n s i d e r a b l y f a s t e r pace.  T a b l e 4-12  s e t s out the i n t e r n a t i o n a l network of t h e c h a r t e r e d  banks as a t December 31,  1973.  Table  4-12  BANK BRANCHES, AGENCIES, SUBSIDIARIES AND December 31, 1973 Number  Country  AFFILIATES  Country  Number  Argentina  5  Indonesia  3  Australia  2  Italy  2  Bahamas  47  Belgium  2  Japan  5  Belize  9  Lebanon  3  Brazil  3  Malaysia  1  Colombia  9  Mexico  3  19  Netherlands  4  Eire  2  Puerto Rico  10  France  6  Singapore  4  Germany (West)  9  Switzerland  1  Dominican  Republic  Great B r i t a i n  27  Greece  2  Guyana  12  Jamaica  United  90  States  Venezuela  62 13  British Virgin Is.  2 6  Haiti  2  U.S.  Virgin Is.  Hong Kong  7  West I n d i e s  India  1  TOTAL  Source: Factbook '74, The Canadian Bankers' A s s o c i a t i o n .  104 477  58  I t appears  r e a s o n a b l e to assume t h a t few p e o p l e r e a l i z e the  ex-  t e n t to which the c h a r t e r e d banks have gone i n t e r n a t i o n a l i n the past t e n years.  I t i s thought  t o be common knowledge t h a t the banks o p e r a t e  f o r e i g n exchange market and imports.  facilitate  the f i n a n c i n g of e x p o r t s  I t i s a l s o f a i r l y w e l l known t h a t a r e t a i l banking  has been conducted  i n the Caribbean  f o r the p a s t 100 y e a r s .  the  and  operation While  a s p e c t s of the f o r e i g n o p e r a t i o n s of Canadian banks c o n t i n u e t o be  these impor-  t a n t , the r e a l growth a r e a d u r i n g the p a s t few y e a r s has been i n merchant and w h o l e s a l e  banking.  I t may  be w e l l to i d e n t i f y t h r e e d i s t i n c t , but i n t e r r e l a t e d  areas  31 of  f o r e i g n currency business.  The  f i r s t a r e a may  o p e r a t i o n of the f o r e i g n exchange market and The  second  be d e s c r i b e d as  export-import  the  financing.  a r e a i n v o l v e s the o p e r a t i o n of a r e t a i l banking b u s i n e s s i n a  f o r e i g n market. Caribbean and  The branch networks of the c h a r t e r e d banks i n the  i n C a l i f o r n i a a r e good examples.  d e s c r i b e d as i n t e r n a t i o n a l w h o l e s a l e  The  t h i r d a r e a may  be  banking.  There a r e a t l e a s t f o u r ways of e n t e r i n g the w h o l e s a l e market on the i n t e r n a t i o n a l a)  branching;  b)  purchase  c)  e s t a b l i s h m e n t of a f o r e i g n s u b s i d i a r y ; and  d)  participation i n international  While may  level:  of e x i s t i n g v e n t u r e s  ( a f f i l i a t e route);  consortia.  the above d i s t i n c t i o n c o n c e r n i n g types of f o r e i g n c u r r e n c y b u s i n e s s  be u s e f u l i n some r e s p e c t s , i t should be remembered t h a t the  59 boundaries  are often fuzzy.  For example a Canadian bank may have a  branch i n London that provides a foreign exchange service, a r e t a i l operation, and engages i n wholesale banking. Unfortunately the f i n a n c i a l data a v a i l a b l e on foreign operations i s not s u f f i c i e n t l y disaggregated to allow precise comparisons of the growth rates of the three areas of foreign operations.  Gross data only  i s provided by the Bank of Canada covering t o t a l foreign currency assets and l i a b i l i t i e s  (see Table 4-13), and t h i s source w i l l be u t i l i z e d below  when discussing the ten year growth rate of foreign currency business. A comparison of the numbers of operating vehicles employed i n foreign countries over the past ten years was  considered as an indicator  of the growth rates of the three areas of foreign currency business. The potential weakness of using this measure rather than some f i n a n c i a l yardstick such as contribution to p r o f i t s or asset growth i s so great that the measure was rejected.  For example the single Bankers Trust  Office i n London i s very large and showing good growth. o f f i c e , which was  "Our London  established i n 1923 and by any measure would rank  among the largest banks i n the United States, continues to grow both i n 32 size and i n p r o f i t contribution."  Thus i t would be possible f o r — s a y  the R o y a l — t o open several Caribbean  'mini branches' but just one major  wholesale outlet operating i n a f i n a n c i a l centre might contribute far more to growth and p r o f i t s . A perusal of recent annual reports of the major chartered banks indicates that they a l l emphasize the importance of their wholesale ations and their p a r t i c i p a t i o n i n consortia.  In the f i n a l analysis  oper-  Table 4-13 CHARTERED BANKS: TOTAL FOREIGN CURRENCY ASSETS AND LIABILITIES End of Period  ASS  L I A B I L I T I E S  E T S Deposits with banks  Call loans  Other loans  Securities  1963  1,013  1,566  538  1,110  9  4,236  1964  1,017  2,011  587  1,597  -33  1965  732  2,287  642  1,384  1966  892  2,622  621  1967  744  2,658  1968  712  1969  Other assets  Deposits of banks  Net foreign assets  Other deposits  Total  816  3,398  4,214  22  5,179  931  4,281  5,211  -33  -8  5,037  1,260  3,822  5,083  -46  1,516  -9  5,643  1,271  4,297  5,568  75  788  2,326  -46  6,470  1,529  4,780  6,309  162  2,943  814  3,263  75  7,806  2,134  5,243  7,378  429  676  3,853  860  6,381  -138  11,632  3,240  8,390  11,630  2  1970  623  4,671  733  7,526  138  13,691  4,915  8,618  13,533  158  1971  715  5,315  516  7,669  254  14,469  6,419  7,743  14,162  307  1972  973  5,510  613  9,524  -48  16,572  8,411  8,607  17,018  -446  1973  537  7,082  546  14,759  375  23,298  13,323  11,255  24,577  -1,279  1974  526  11,692  726  14,885  796  28,626  15,284  14,117  29,400  -774  Total  M i l l i o n s of Canadian d o l l a r s . Source: Bank of Canada Review. August 1974.  61 however we a r e f o r c e d t o d i s c u s s the growth of the i n t e r n a t i o n a l c u r r e n c y b u s i n e s s of the c h a r t e r e d banks i n g r o s s As a t June 3 0 t h , 1974,  terms.  f o r e i g n c u r r e n c y a s s e t s o f Canadian c h a r -  t e r e d banks t o t a l l e d $25,743,000,000 o r about 30 per cent of t o t a l bank a s s e t s of $87,194,000,000.compared t o 1964  f i g u r e s of $5,179,000 and  33 $23,872,000 r e s p e c t i v e l y . p e r i o d was U.S.  Growth of f o r e i g n a s s e t s over t h e t e n y e a r  a t a compound annual r a t e of about 17 per cent compared t o a  growth r a t e of almost 50 per cent per annum over t h e same time  period.  Canadian d o l l a r a s s e t s grew a t about 11.75  per cent over t h e  period.  The growth i n i n t e r n a t i o n a l b u s i n e s s i s c l e a r l y o u t s t r i p p i n g  domestic e x p a n s i o n and, i f t h e p r e s e n t t r e n d c o n t i n u e s , f o r e i g n o p e r a t i o n s w i l l dominate (51 per c e n t ) Canadian b a n k i n g b e f o r e  1990.  W h i l e the above s t a t i s t i c s p r e s e n t a r e a s o n a b l y a c c u r a t e p i c t u r e , the f u l l e x t e n t of t h e Canadian banks' i n t e r n a t i o n a l o p e r a t i o n s i s somewhat u n d e r s t a t e d .  Under t h e Bank A c t o n l y w h o l l y owned s u b s i d i a r i e s  engaged i n b a n k i n g may be c o n s o l i d a t e d i n t h e a n n u a l f i n a n c i a l 34 of  a c h a r t e r e d bank.  investment  statements  The r e s u l t i s t h a t a bank o n l y r e c o r d s i t s  i n a s u b s i d i a r y o r a f f i l i a t e and not t h e l a t t e r ' s t o t a l a s s e t s  on a c o n s o l i d a t e d b a s i s .  For example, the R o y a l Bank of Canada owns 35  ,75 per cent of the c a p i t a l s t o c k o f The R o y a l Bank Jamaica L t d . l a t t e r company had t o t a l a s s e t s as a t September 3 0 t h , 1973, J$75,215,144 (1 Jamaican = $1.10  Canadian) w h i c h e f f e c t i v e l y  f o r e i g n c u r r e n c y a s s e t s of the Canadian bank. was  However t h i s  The  of constitutes investment  c a r r i e d on the books of t h e R o y a l a t $2,532,005 and i t i s t h i s  figure  t h a t appears i n t h e f o r e i g n c u r r e n c y d a t a r e p o r t e d i n t h e monthly Bank  62  of Canada Review.  A l l of the 'big f i v e ' chartered banks have similar  investments, which appear to be carried on the books following the cost rather than the equity method recommended by accountants.  Other foreign  currency assets not included i n the available s t a t i s t i c s include foreign investments i n bank premises and equipment. It i s not possible to accurately determine the magnitude of the understatement  of foreign currency assets owned by the Canadian banks  but, based on sketchy information available, this writer would estimate that i t i s less than 5 per cent of the t o t a l . As mentioned above i t i s not possible to obtain hard data to prove that international wholesale banking i s growing faster than the other two areas of foreign banking.  There i s substantial soft evidence  to support this contention however.  The authors of the Porter Commission  asserted that international wholesale banking was growing much more 36 rapidly than the other areas.  The majority of comments concerning  international operations by Canadian bankers focus on the wholesale area. The following are some samples from Canadian bankers: John H. Coleman, formerly Deputy Chairman, The Royal Bank of Canada: The world wide branch system i s not the system of the future. We just pulled out of Peru for example. Some countries want us to incorporate our branches and offer some of the equity to the nationals. So now the thrust i s to lessen our exposure to these forces (nationalism) by going into wholesale banking.37  Bob Peel, General Manager, Corporate Accounts Development, Bank of Nova Scotia: We've always been a hard core international operation. However we only r e a l l y started to move into Europe i n the l a t e 1950's and, i n  63  terms of wholesale banking, have been doing business internationa l l y since that time.38  F. H. McNeil, formerly President, Bank of Montreal: The bank's international expansion i n the past year (1973) has been primarily i n the inter-bank (wholesale) market. Furthermore, the bank has taken steps to improve i t s a b i l i t y to develop more corporate business abroad. London has been established as a regional o f f i c e with r e s p o n s i b i l i t y f o r operations i n Europe, A f r i c a and the Middle East.39 R. F. Harrison, President, Canadian Imperial Bank of Commerce: A r e l a t i v e l y large proportion of the bank's international business i s i n the wholesale money market field.^® A s i g n i f i c a n t part of the chartered banks recent growth has been the r e s u l t of p a r t i c i p a t i o n i n the f i n a n c i a l markets of B r i t a i n .  As at  A p r i l 17th, 1974, deposits of banks located i n the U.K. t o t a l l e d f104,391 m i l l i o n  4 1  (see Table 4-14). Table 4-14  ASSETS OF BANKS IN THE UNITED KINGDOM BANKS IN THE UNITED KINGDOM: SUMMARY (f m i l l i o n s ) m i o Total Sterling Apr. May June July Aug. Sept. Oct. Nov. Dec. Jan. Feb. Mar. Apr.  18 16 20 18 15 19 17 21 12 16 20 20 17  73,369 73,158 74,603 78,730 82,386 84,932 88,002 92,724 95,490 99,260 100,777 101,049 104,391  34,096 33,930 35,095 36,363 36,755 38,383 38,942 40,536 41,125 41,735 42,454 41,576 42,472  A l l holders Other currencies 39,273 39,227 39,507 42,367 45,631 46,549 49,060 52,188 54,364 57,525 58,323 59,474 61,919  (Source - a l l sections: Bank of England Quarterly B u l l e t i n , June 1974.  64  All  DEPOSIT BANKS: LONDON CLEARING BANKS (£ m i l l i o n s ) Total 1973  1974  Apr. May June July Aug. Sept. Oct. Nov. Dec. Jan. Feb. Mar. Apr.  18 16 20 18 15 19 17 21 12 16 20 20 17  17,932 17,936 18,605 19,669 19,661 20,267 20,749 21,482 21,632 22,299 22,520 22,733 23,477  Sterling  1973  1974  Apr. May June July Aug. Sept. Oct. Nov. Dec. Jan. Feb. Mar. Apr.  18 16 20 18 15 19 17 21 12 16 20 20 17  10,147 9,908 10,191 10,870 11,393 11,599 11,781 12,301 12,766 13,195 13,321 13,114 13,315  Sterling  1973  1974  Apr. May June July Aug. Sept. Oct. Nov. Dec. Jan. Feb. Mar. Apr.  18 16 20 18 15 19 17 21 12 16 20 20 17  20,060 19,796 19,364 20,274 21,687 21,728 22,769 24,855 25,621 26,670 27,418 27,389 28,121  All  holders Other currencies 7,108 7,123 7,307 7,944 8,415 8,522 8,680 9,147 9,551 9,981 9,946 9,919 10,107  3,039 2,785 2,884 2,926 2,978 3,077 3,101 3,154 3,215 3,213 3,376 3,195 3,207 All  OVERSEAS BANKS: AMERICAN (f m i l l i o n s ) Total  1,458 1,467 1,569 1,719 1,802 1,854 1,925 1,984 2,019 2,202 2,223 2,319 2,411  16,474 16,469 17,036 17,950 17,859 18,413 18,823 19,498 19,613 20,097 20,297 20,414 21,066  OVERSEAS BANKS: BRITISH IOVERSEAS & COMMONWEALTH (f m i l l i o n s ) Total  holders Other currencies  Sterling 2,900 2,872 2,841 3,008 3,150 3,500 3,431 3,785 3,945 4,115 4,342 4,045 4,087  holders Other currencies 17,160 16,923 16,523 17,266 18,538 18,228 19,338 21,070 21,676 22,555 23,076 23,343 24,034  65 A p a r t i a l breakdown of the share i n these deposits i s as follows: (Millions) Amount London Clearing banks  %_  f23,477  22.6  Commonwealth banks  13,315  12.8  U.S. banks  28,121  27  The major set of banks ( i n terms of assets) making up the Commonwealth group are Canadian. i n the U.K.  The above figures include a l l currencies on deposit  I f s t e r l i n g deposits are eliminated, then the share i n hold-  4 ing foreign currency deposits (primarily $ U.S.) breaks down as follows: (Millions) Amount London Clearing banks  f 2,411  % 3.9  Commonwealth banks  10,107  16.4  U.S. banks  24,034  38.9  A l l other  25,367  40.8  f61,919  100.0  Total for U.K.  In summary then a case can be made that a substantial portion of the very rapid growth i n the i n t e r n a t i o n a l a c t i v i t i e s of the chartered banks has been i n the wholesale banking area. important  This feature w i l l have  implications when we explore the existing explanations f o r  international banking growth.  66  SUMMARY  To give the reader some idea of the size of foreign operations of Canadian banks compared to large U.S. banks; foreign deposits of the f i v e largest U.S. banks t o t a l l e d approximately 30th, 1974,  $70,000 m i l l i o n at June  compared to $28,732 m i l l i o n for the whole Canadian banking  44 industry.  In fact the combined foreign deposits of BankAmerica and  C i t i c o r p at some $40,000 m i l l i o n exceeded the Canadian f i g u r e . Both U.S.  and Canadian banks have high propensities toward foreign  assets although some interbank differences are evident.  S t r i c t l y com-  parable data i s d i f f i c u l t to locate because the chartered banks do not invariably disclose the domestic/foreign composition of their balance sheets.  The Bank of Canada, of course, publishes only aggregate  data.  Occasionally the president or chairman of a bank w i l l make some comment i n the annual report to shareholders which indicates the size of the p a r t i c u l a r bank's foreign operations.  For example the following are  comments by R. W. Frazee, Executive Vice-President, Royal Bank, i n his 1973 report to shareholders: This i s r e f l e c t e d i n the s i g n i f i c a n t increase i n the bank's foreign currency deposits which grew by 44 per cent during 1973 to $6,400 m i l l i o n at year end. At that date these deposits represented 38 per cent of our t o t a l deposit l i a b i l i t i e s , which gives some i n d i c a tion of the importance to the bank of our foreign operation.^5  More recently the three smaller chartered banks have reported the foreign/domestic asset s p l i t i n their annual reports. for the big f i v e Canadian and U.S. banks are:  Available figures  67 P e r cent F o r e i g n D e p o s i t s t o T o t a l D e p o s i t s  38%  BankAmerica  42%  Royal  Citicorp  52%  CIBC  Chase Manhattan  42%  B/M  32%  Manufactures  28%  BNS  44%  43%  T.D.  36%  Hanover  J.P. Morgan  about  24%  Based on the above d a t a and t h e p r e v i o u s l y mentioned f a c t t h a t f o r e i g n b u s i n e s s i s growing i n g v e r y apparent t h e b i g banks.  a t a f a s t e r pace than d o m e s t i c ,  i t i s becom-  t h a t t h e home o f f i c e l o c a t i o n i s o n l y i n c i d e n t a l t o  They have become m u l t i n a t i o n a l c o r p o r a t i o n s i n every  sense o f t h e word. I n c l o s i n g t h i s s e c t i o n i t s h o u l d be r e i t e r a t e d t h a t growth of f o r e i g n o p e r a t i o n s has been a t a v e r y r a p i d pace over t h e p a s t t e n y e a r s . A l l t h r e e a r e a s o f t h e U.S.  and Canadian banks' f o r e i g n c u r r e n c y b u s i -  ness has grown but t h e most r a p i d growth has o c c u r r e d i n t h e  wholesale  banking s e c t o r .  important  I t i s the general f a i l u r e to recognize t h i s  p o i n t t h a t has l e d the w r i t e r t o q u e s t i o n the v a l i d i t y o f t h e most popul a r e x i s t i n g e x p l a n a t i o n s f o r g r o w t h — t h e s u b j e c t o f t h e next  chapter.  68  Notes f o r Chapter Four  Banks o f the World  1  (1964).  2  3  The Banker  (June 1974).  Ibid.,  (1971), 659.  121  4 Quoted i n the F i n a n c i a l P o s t (Sept. 21, 1974), p. J12. 5  Ibid.  6  Ibid. Adapted from The Banker  7  (June 1973) and  (June 1974).  g G. F o r r e s t , "How  1974)  Comparisons Can M i s l e a d , " The Banker  (June  9 I b i d . , p.  613.  Ibid. 1  1  The Banker  (June 1974).  12 C o m p t r o l l e r o f the Currency, 1964 Annual Report. 1  3  Ibid. Ibid.  Report• ^  Board of Governors o f the F e d e r a l Reserve System, 1973  Annual  16 F e d e r a l Reserve B u l l e t i n (February 1972). 1  7  Bank o f England: Q u a r t e r l y B u l l e t i n (June 1974). Ibid.  19 Banking  H. V. Prochnow and H. V. Prochnow, J r . The Changing World of (New York: Harper and Row, 1974). C.B.A. B u l l e t i n , 17, No. 2 (June 1974). 21 Burrough's C l e a r i n g House (January 1974). Bank o f Canada Review (October 1974). 22  23  J . A. McMyn, "What R u l e s f o r F o r e i g n B a n k i n g ? " Canadian Banker and ICB Review, 1-74. 24 S. C. E y r e , " E x p l o r i n g Some Trends i n I n t e r n a t i o n a l B a n k i n g , " Burrough's C l e a r i n g House ( F e b r u a r y 1974). 25 BankAmerica C o r p o r a t i o n , 1973 A n n u a l R e p o r t , p. 7. 26 The Chase Manhattan C o r p o r a t i o n , 1973 A n n u a l R e p o r t , p. 4. Ibid. 28 E. P. Imhof, " R a p i d E x p a n s i o n o f Overseas B a n k i n g , " I n t e r economics , No. 8/74. 29 E y r e , p. 54. 30 Quoted i n B u s i n e s s Week (September 21, 1974), p. 52. 31 P o r t e r Commission, p. 137. 32 Bankers T r u s t New Y o r k C o r p o r a t i o n , 1972 A n n u a l R e p o r t . 33 Bank o f Canada Review (August 1974). 34 The Bank o f Nova S c o t i a , 1973 A n n u a l R e p o r t . 35 The R o y a l Bank o f Canada, 1973 Annual R e p o r t . 36 P o r t e r Commission, p. 137. 37 Quoted i n The E x e c u t i v e (June 1971), p. 32. 38 Quoted i n The Canadian Banker and ICB Review ( J a n u a r y 1974), p. 9. 39 Bank o f M o n t r e a l , 1973 A n n u a l R e p o r t , p. 13. 40 Canadian I m p e r i a l Bank o f Commerce, 1971 A n n u a l R e p o r t . ^ 4 2  Bank o f E n g l a n d : Q u a r t e r l y B u l l e t i n (June 1974). Ibid.  Ibid. 44 (August 1974) B u s i n e s s Week (September 21, 1974) and Bank o f Canada Review 45 The R o y a l Bank o f Canada, 1973 A n n u a l Report.  Chapter  Five  EXISTING EXPLANATIONS FOR THE GROWTH OF INTERNATIONAL BANKING  The  r o l e of a s e r v i c e industry  i n i n t e r n a t i o n a l b u s i n e s s expan-  s i o n has g e n e r a l l y been thought o f as a p a s s i v e external  one.  or environmental v a r i a b l e i s u s u a l l y held  That i s , some  out as t h e f o r c e  ' p u l l i n g ' a s e r v i c e f i r m t o a f o r e i g n market.  Most s e r v i c e b u s i n e s s e s l i m i t e d the scope o f t h e i r o p e r a t i o n s t o a few f o r e i g n c o u n t r i e s p r i o r t o t h e mid 1950's, but the tremendous volume o f f o r e i g n a c t i v i t y by t h e i r t r a d i t i o n a l l y domestic c l i e n t s , b e g i n n i n g i n the 1960's, i n d u c e d — o r perhaps ' f o r c e d ' — t h e banks, a c c o u n t a n t s , a d v e r t i s i n g a g e n c i e s , and so on, t o go i n t e r n a t i o n a l themselves.1  When commercial banks engage i n i n t e r n a t i o n a l b u s i n e s s they a r e t y p i c a l l y thought of as o p e r a t i n g  the foreign.exchange market and as a  channel and/or source o f f i n a n c i n g f o r t r a d e and c a p i t a l f l o w s . are  Here  two quotes, t h e f i r s t r e l a t i n g t o the Canadian banks, the second t o  U.S. banks, t h a t  i l l u s t r a t e s the popular explanation  for international  growth:  A major r e a s o n f o r Canadian bank expansion l i e s i n the f a c t t h a t Canada r e l i e s t o a v e r y l a r g e e x t e n t on export o f raw m a t e r i a l s , a g r i c u l t u r a l p r o d u c t s , manufactured goods and e n g i n e e r i n g know-how. The banks p r o v i d e a comprehensive network o f f a c i l i t i e s and s e r v i c e s r e l a t i n g to f o r e i g n t r a d e and f i n a n c i a l t r a n s a c t i o n s . 2  There has been a c l o s e c o r r e l a t i o n between the h i g h l e v e l s o f i n t e r n a t i o n a l t r a d e and investment on the onehand, and i n t e r n a t i o n a l a c t i v i t i e s o f U.S. banks on the o t h e r . 3  70  71 The clear implication that follows from these quotes i s that the banks are followers i n the international business arena. The above comments are consistent with the e a r l i e r expressed motivation of the French, English, and German banks, who  claimed their  objective was to track the expansion of their respective countries' external trade and overseas investments. The p a r t i c u l a r intent was to serve domestic customers i n their coloni a l and foreign ventures, to provide them with the services they r e quired, to finance their imports and exports, and to help finance their investments. 4  It i s not clear why banks would f i n d i t necessary to establish a foreign operation to serve domestic customers i n their foreign trade and investment a c t i v i t i e s .  Let us assume that a major Canadian corpora-  tion requires a chartered bank to look after i t s export and import transactions.  In the f i r s t place a l l documents and c o l l e c t i o n s ( l e t t e r s of  c r e d i t , documentary b i l l s , etc.) can be handled by a domestic bank branch whose only contact with the foreign market i s through correspondent banks. Up to this point there i s no need for a Canadian bank to establish overseas.  An o f f i c e set up i n a foreign market just to handle the other end  of trade transactions could hardly hope to survive. The above discussion covers the handling of foreign exchange transactions.  But what about financing foreign trade?  In t h i s area, why  bank expansion abroad i s a function of the growth of foreign trade i s also unclear.  The credit needs of the Canadian company are almost always  provided i n Canadian d o l l a r s .  That i s , no d i s t i n c t i o n i s generally made  i n financing an account receivable, whether i t be due from a company i n  72 Tokyo or Toronto. of Canada, has  J . A. Galbraith, formerly Chief Economist, Royal Bank  noted:  Canadian banks, of course, have always played an important r o l e i n financing Canadian exports and imports. Much of their lending a c t i v i t y i n Canadian dollars helps to accommodate the international trading transactions of their customers. Only a small proportion of bank financing of Canada's international trade i s provided i n U.S. dollars although much of Canada's trade i s invoiced i n U.S. dollars.^  In h i s 1969 M.B.A. thesis, Barry Bruce attempted to explain why the banks go abroad.  Bruce conducted a f i e l d study i n which bankers  from the international divisions of the f i v e major Canadian and major U.S.  banks were interviewed.  five  A l l of the bankers interviewed  stressed that the nature of the flow of trade was  an important force  d i r e c t i n g the banks abroad. It i s interesting to note that the bankers interviewed by the writer continue to stress trade as an important motivating factor i n international expansion of the chartered banks. In summary, the 'foreign trade' argument to explain bank expansion abroad i s open to c r i t i c i s m .  Perhaps the argument has continued to  p r e v a i l somewhat because i t i s not i n the best interests of the banking community to d i s p e l l i t .  F a c i l i t a t i n g foreign trade i s a type of  a c t i v i t y that receives f a i r l y wide public acceptance—unlike  some of the  other banking services such as moving 'hot' money among various world markets. In a speech presented to the Canadian Conference on Banking i n September 1974,  Page Wadsworth, Chairman of the Canadian Imperial Bank  73  of Commerce gave the impression that i n the growth of international banking there are factors other than trade expansion.  The following com-  ment: "Trade expansion has therefore been a s i g n i f i c a n t factor i n the burgeoning of our international banking a c t i v i t i e s i n the 1960's and 1970's '^ was followed, somewhat l a t e r i n the speech, by: 1  the great increase i n a c t i v i t y i n international f i n a n c i a l markets i n recent years, and i n the a c t i v i t i e s of international banks i n these markets, can be characterized as wholesale banking—the fast e f f i c ient movement of high volumes of short, medium, and long term funds g from lenders to borrowers by way of the international banking system. This writer would argue that the rapid growth of wholesale banking i s good evidence that the banks are no longer simply tracking Canadian trade and investment around the world. Bruce did uncover evidence that government regulation was a motivating force behind overseas expansion.  We are i n complete agreement with  this finding and w i l l develop the government variable further when we present our model of foreign bank expansion i n Chapter Eight. Bruce also uncovered some evidence that the 'bandwagon e f f e c t ' influenced the decisions of at least some of the banks. behavior which has been termed  This type of  ' o l i g o p o l i s t i c reaction' w i l l be explored  i n Appendix I I . Several other reasons f o r the growth of the international a c t i v i t i e s of U.S. and Canadian banks have been suggested.  S. C. Eyre, Comp-  t r o l l e r of C i t i c o r p , summarizes the reasons as follows: The reasons f o r this rapid rate of growth are well known. Many banks were catching up with their corporate c l i e n t s , who had expanded  74 abroad. Various exchange controls, imposed throughout the mid 1960's, encourage banks to develop deposit bases overseas. And, of course, a f t e r the credit crunches of 1966 and 1969-70 banks set up foreign branches to be able to tap the Eurodollar market for domestic use.9 Two d i s t i n c t reasons seem to emerge from the above comment: the ' p u l l ' of multinational c l i e n t s and the 'push' of government interference i n the market system. It i s somewhat d i f f i c u l t to argue that the p u l l of the multinational firm influences the Canadian banks.  Canada's multinationals  are few i n number and the writer has been unable to uncover any evidence that the spread of these firms has been a s i g n i f i c a n t influence i n overseas operations of the banks.  About 60 per cent of this country's  foreign d i r e c t investment i s i n the U . S . — l a r g e l y concentrated i n breweries and d i s t i l l e r i e s due to the U.S. prohibition era which severely set back the domestic industry.  Canadian banks only have branches i n a  few states—New York, C a l i f o r n i a , Washington, and Oregon—and  there i s  l i t t l e correlation between the location of Canadian industry i n the U.S. and the location of the Canadian banks. One factor that may have some influence however i s the experience the Canadian banks have gained i n financing U.S. multinationals i n Canada.  Successful banking i s very dependent on personal contact and  favourable experience b u i l t up i n Canada i s thought by some to open up opportunities for the Canadian banks to serve major U.S. firms p a r t i c i pating i n overseas markets.  While there may be some element of truth i n  t h i s l i n e of reasoning, i t appears to this writer to be almost s e l f evident that the U.S. multinational would prefer to deal with i t s major U.S. bankers i n the foreign market.  This i s based on the reasonable  75 assumption t h a t t h e U.S.  bank has l o c a t e d i n the r e l e v a n t f o r e i g n market.  There i s more r e a s o n t o b e l i e v e t h a t the e x p a n s i o n a r y f o r e i g n development of U.S. of U.S.  banks has been caused t o some degree by the  spread  based m u l t i n a t i o n a l s ,  The overseas expansion of U.S. b a n k i n g i s , o f c o u r s e , a l o g i c a l consequence of t h e p r i o r e x p a n s i o n o f American c o r p o r a t i o n s , and of t h e predominant r o l e of the d o l l a r i n f i n a n c i n g t h e w o r l d ' s t r a d e . 1 0 An example of the advantages of b e i n g r e p r e s e n t e d i n s e v e r a l f o r e i g n mark e t s , i s e v i d e n c e d by the e x p e r i e n c e of C i t i b a n k w i t h a l a r g e U.S.  based  multinational. P e r k i n - E l m e r ; a C o n n e c t i c u t based m a n u f a c t u r e r of o p t i c a l and s c i e n t i f i c i n s t r u m e n t s , was l o o k i n g f o r a b l a n k e t c r e d i t c o v e r i n g t h e s h o r t - t e r m and medium term needs, i n l o c a l c u r r e n c i e s , of i t s European s u b s i d i a r i e s i n seven c o u n t r i e s . The company found t h a t o n l y C i t i b a n k , w i t h branches i n a l l seven c o u n t r i e s , c o u l d h a n d l e the loan.11 The s t r e n g t h of t h e ' p u l l ' f o r c e s o v e r — s a y i s open t o some doubt however.  banks i n London.  I n 1953  i n d u s t r i a l subsid-  As a t March 31, 1974,  assets  branches l o c a t e d i n t h e U n i t e d Kingdom t o t a l l e d $68,076 m i l l i o n .  This f i g u r e represented of U.S.  thought  S i n c e the m i d - l a t e 1960's however t h e prime a t t r a c t i o n t o  London has been the E u r o - d o l l a r market. of U.S.  t h e r e were t e n  A t t h i s time the p r i m a r y m o t i v a t i o n was  t o be t o a c q u i r e a s t e r l i n g base and t o s e r v e U.S. iaries.  years—  A s u b s t a n t i a l p a r t o f f o r e i g n growth  d u r i n g t h e p a s t f i v e y e a r s has been i n London. U.S.  the l a s t f i v e  49.6  per cent o f t o t a l a s s e t s  ( $ 1 3 6 , 9 8 3  million)  banks l o c a t e d i n a l l f o r e i g n c o u n t r i e s . The magnitude of a s s e t s c o n c e n t r a t e d i n one c e n t r e p r o v i d e s  76 reasonable evidence that the p u l l force of multinational c l i e n t s might have been somewhat overplayed the U.S.  banks.  as a determinant of foreign expansion of  Furthermore, we w i l l argue l a t e r that the Euro-dollar  market, rather than 'pulling' U.S.  banks abroad, l a r g e l y was  domestic market interference from the U.S.  government.  ference w i l l be a key variable i n developing expansion.  spawned by  Government i n t e r -  a theory of foreign bank  The Euro-dollar market therefore w i l l be seen to be  the  result (or v i c t i m i f you w i l l ) of an aggressive outward 'push' by U.S.  the  banks—a push caused i n part by government interference. In summary, this writer has become somewhat d i s s a t i s f i e d with  the rather stock explanations  that have the banks playing a passive r o l e  i n responding to the needs of their domestic customers—be i t to f a c i l i tate a trade transaction or to finance the customer i n a foreign market. There are good reasons to believe that the banks are considerably more aggressive  than generally believed.  The banks of course do very  little  to promote the idea that they have aggressively expanded—and for good reason.  Maintaining a low p r o f i l e and fostering the b e l i e f that a pas-  sive role i s played i s much more l i k e l y to r e s u l t i n less unfavourable comment from the wide v a r i e t y of observers of the banking industry. Bankers are well aware that they are i n an industry that i s often the target of n a t i o n a l i s t i c opposition.  Says C. Langston, Assistant General  Manager, Canadian Imperial Bank of Commerce: " I t ' s an extremely s e n s i t i v e p o l i t i c a l s i t u a t i o n when you move into a country.  It i s d e f i n i t e l y not  13 i n your interest to step right i n and make waves." Occasionally however some comment i s made that indicates that  77 the chartered banks are more aggressively viewing the world as their market.  For example, here i s a quote from the 1974 annual report of the  Bank of Nova Scotia: Some of t h i s growth i n foreign currency loans r e f l e c t e d our e f f o r t s to meet the financing requirements of our domestic customers. But a larger proportion represented the expansion of our international lending a c t i v i t i e s . 1 4  This writer does not claim to be the f i r s t to recognize the trend away from the passive r o l e of the banks i n foreign expansion.  L. C.  Nehrt, writing i n 1967 reported: A very recent, and most interesting development i n the overseas expansion of U.S. commercial banks, however, i s a tendency toward aggressive investments. Some banks are no longer passively (and often reluctantly) responding to the needs of their domestic customers; rather they are looking upon investments i n an overseas branch i n the same manner as the opening of another branch i n their home state or city.15  Nehrt, however did not explore the underlying reason for the trend toward aggressive expansion.  This would involve developing a theory of growth  and to the writer's knowledge none has been developed for the banking industry to this date. The growth and expansion of the foreign a c t i v i t i e s of Canadian and U.S. banks c e r t a i n l y q u a l i f i e s them as multinationals.  I t therefore  appears appropriate to examine the t h e o r e t i c a l analysis that has been applied to other multinational firms i n an e f f o r t to develop a theory that might be applied to the banking industry.  78 Notes f o r Chapter F i v e  D. B. Z e n o f f and J . Zwick, I n t e r n a t i o n a l F i n a n c i a l Management (Englewood C l i f f s , N.J.: P r e n t i c e - H a l l , 1969), p. 10. I  2 James Montagnes, " I n t e r n a t i o n a l B a n k i n g Canadian S t y l e , " Burrough's C l e a r i n g House (September 1974), p. 73. 3  J . P. K o s z u l , "American Banks i n Europe," i n The C o r p o r a t i o n , C. P. K i n d l e b e r g e r ( e d . ) , p. 276. 4  International  Ibid.  ^ J . A. G a l b r a i t h , Canadian B a n k i n g ( T o r o n t o : Ryerson 1970), p. 307.  Press,  B. D. B r u c e , " I n t e r n a t i o n a l B a n k i n g A c t i v i t i e s of Canadian and American Banks," M.B.A. t h e s i s , U n i v e r s i t y of B r i t i s h C o l u m b i a , 1969. J . P. R. Wadsworth, "Why Do Canadian Banks Want t o E s t a b l i s h Abroad?" from speech p r e s e n t e d t o t h e Canadian C o n f e r e n c e on B a n k i n g , T o r o n t o , September 16, 1974. 7  8  Ibid.  9  S. C. E y r e , " E x p l o r i n g Some Trends i n I n t e r n a t i o n a l B a n k i n g , " Burrough's C l e a r i n g House ( F e b r u a r y 1974), p. 54. J . M a i n , "The F i r s t R e a l I n t e r n a t i o n a l B a n k e r s , " F o r t u n e (December 1967), p. 143. I I  I b i d . , p. 198.  12 Bank of E n g l a n d : Q u a r t e r l y  B u l l e t i n (June 1974).  Quoted i n The Canadian Banker and ICB Review ( J a n u a r y 1974), p. 12. 1 4  The Bank of Nova S c o t i a , 1974 A n n u a l R e p o r t , p. 19.  L. C. N e h r t , I n t e r n a t i o n a l F i n a n c e f o r M u l t i n a t i o n a l B u s i n e s s ( S c r a n t o n , Penn.: I n t e r n a t i o n a l Textbook Company, 1967), p. 351. 1 5  Chapter Six  THEORIES OF THE CAUSES OF DIRECT FOREIGN INVESTMENT This chapter of the paper forms the foundation of what i s hoped w i l l be a sound micro-theory of international banking expansion.  There  i s a considerable volume of l i t e r a t u r e , a l b e i t of an inconclusive nature, dealing with the theory of d i r e c t foreign investment.  The studies that  this writer has been able to locate deal exclusively with U.S.  indus-  t r i a l firms; however, as mentioned i n the introduction, there i s no obvious reason that a service industry such as banking should not be subj e c t to some common objectives, opportunities, uncertainties, and r i s k s when making a d i r e c t foreign investment. What follows w i l l be a rather rapid run through the f i e l d of investment theory.  The chapter i s organized as follows:  a)  d e f i n i t i o n of d i r e c t foreign investment (p. 80);  b)  d i s t i n c t i o n between d i r e c t and p o r t f o l i o investment (p. 80);  c)  b r i e f discussion of interest rate arbitrage (p. 81);  d)  introduction to d i r e c t investment theory (p. 83);  e)  Aliber's theory (p. 84);  f)  imperfections  g)  monopolistic  h)  oligopoly and need for growth (p. 94);  i)  summary (p. 97).  i n c a p i t a l markets (p. 88); advantage (p. 90);  79  and  80 The n e x t two c h a p t e r s w i l l be devoted t o a p p l y i n g t h e c o n c e p t s d i s c u s s e d i n t h i s c h a p t e r t o a t h e o r e t i c a l model t h a t might be a p p l i e d to the banking i n d u s t r y . (a)  A d i r e c t f o r e i g n i n v e s t m e n t i s d e f i n e d a s : " t h e amount i n v e s t e d  by r e s i d e n t s o f a c o u n t r y i n a f o r e i g n e n t e r p r i s e over w h i c h they have e f f e c t i v e control.""'" (b)  The d i s t i n c t i o n between d i r e c t and p o r t f o l i o i n v e s t m e n t i s t h a t  the former i n v o l v e s a n e t t r a n s f e r o f r e a l c a p i t a l t o t h e h o s t c o u n t r y t o g e t h e r w i t h e n t r y i n t o a h o s t c o u n t r y i n d u s t r y by a f i r m e s t a b l i s h e d i n some o t h e r c o u n t r y , whereas p o r t f o l i o i n v e s t m e n t o n l y i n v o l v e s t h e transfer of f i n a n c i a l c a p i t a l .  Another d i s t i n g u i s h i n g f e a t u r e o f t h e two  t y p e s o f f o r e i g n investment i s t h a t d i r e c t investment i s v i r t u a l l y t h e e x c l u s i v e domain o f t h e c o r p o r a t i o n w h i l e p o r t f o l i o i n v e s t m e n t i n c l u d e s s u b s t a n t i a l p a r t i c i p a t i o n by i n d i v i d u a l s . The p i o n e e r i n g work i n p o r t f o l i o i n v e s t m e n t t h e o r y was  carried  2 out by M a r k o w i t z .  Using a c r i t e r i o n c a l l e d  'portfolio  efficiency,'  M a r k o w i t z c o n f i n e d h i s a t t e n t i o n t o s e l e c t i n g from a l i s t o f s e c u r i t i e s a s u b - s e t t h a t s a t i s f i e d t h e d u a l investment c r i t e r i a o f (1) h i g h e s t exp e c t e d r e t u r n f o r a g i v e n l e v e l o f r i s k , and (2) l o w e s t l e v e l o f r i s k f o r a given l e v e l of expected r e t u r n .  The d u a l c r i t e r i a can be  illus-  t r a t e d as f o l l o w s : risk  I  I efficient frontier (of p o r t f o l i o s )  expected return  81 U n f o r t u n a t e l y d i r e c t investment cannot be d e a l t w i t h i n a parameter model.  two  Many o t h e r f a c t o r s b e s i d e expected r e t u r n and p e r c e i v e d  r i s k p l a y a r o l e i n the i n v e s t m e n t d e c i s i o n p r o c e s s .  These 'other  f a c t o r s ' s h o u l d become c l e a r as we proceed through t h e n e x t t h r e e chapters. (c)  E a r l y t h e o r y s i m p l y grouped p o r t f o l i o and d i r e c t i n v e s t m e n t t o -  g e t h e r and assumed t h a t b o t h responded  t o d i f f e r e n t i a l r a t e s of r e t u r n .  For example, i f domestic i n t e r e s t r a t e s a r e l e s s than f o r e i g n i n t e r e s t r a t e s f o r s e c u r i t i e s i n a s i m i l a r r i s k c l a s s , and the c o s t of hedging i n t h e f o r w a r d exchange market i s l e s s than t h e i n t e r e s t r a t e then a f l o w of f o r e i g n investment s h o u l d o c c u r . l e t us assume t h e f o l l o w i n g Canadian 180 day T.B. B r i t i s h 180 day T.B.  differential,  By way of i l l u s t r a t i o n  situation: rate rate  Canadian p r i c e of one pound  4% 8% $2.50 spot $2.48 f o r w a r d  A Canadian r e s i d e n t p u r c h a s i n g a f1,000 bond w i l l go t h r o u g h t h e following process: 1)  exchange $2,500 Canadian f o r f1,000;  2)  purchase B r i t i s h T.B.  3)  engage i n a f o r w a r d c o n t r a c t t o s e l l f1,040 a t a r a t e o f $2.48;  4)  r e c e i v e cheque f o r f1,040 i n 180 days; and  5)  exchange f l , 0 4 0 a t $2.48 f o r $2,579.20 Canadian.  for fl,000;  82 A l t e r n a t i v e l y the same Canadian may purchase a $2,500 Canadian T.B. and at the end of 180 days w i l l receive $2,550 ($2,500 p r i n c i p a l and $50 i n t e r e s t ) .  The assumption i s that r a t i o n a l investors w i l l take  advantage of the interest rate d i f f e r e n t i a l and invest their funds i n the United Kingdom.  This example assumes that the f u l l force of i n t e r e s t  arbitrage has not yet taken e f f e c t .  If the above process were to con-  tinue for many transactions the forward discount of f should wipe out the interest rate d i f f e r e n t i a l as follows:  r f = rs  (1 + id) (1 + i f )  r f = 2.50  (1.02) (1.04)  r f = 250 (.980) r f = 2.45 At a forward rate of 2.45, the return i n Canadian d o l l a r s from either i n vestment would be the same. Since at least the 1960's however there has been a growing awareness that not a l l c a p i t a l flows are sensitive to interest rate d i f f e r entials.  That i s , large c a p i t a l flows have been observed even when the  forward market has adjusted to remove any interest rate d i f f e r e n t i a l .  A  diagrammatic representation of Canada's case might be as follows; The diagram implies that Canada, with a domestic interest rate just equal to the world rate, w i l l s t i l l have an inflow of c a p i t a l (direct investment).  The determinants of d i r e c t investment must therefore  be found i n something other than market y i e l d s .  83 >1 Can i World 1 slope = interest s e n s i t i v i t y of p o r t f o l i o flows  1  <1  Net c a p i t a l outflow As mentioned  (d)  0  Net c a p i t a l inflow  above, no conclusive theory of direct investment  has been developed and accepted by economists.  Ragazzi claims that the  main t h e o r e t i c a l focus i s on the advantages of 'superior knowledge' which allows a foreign firm to earn a higher rate of return than indigenous 3 firms.  A l i b e r seems to agree:  the t r a d i t i o n a l theory of foreign investment—the Hymer-Kindleberger view—suggested that firms with a monopolistic advantage expanded into foreign markets to exploit their advantage abroad. 4  Other authors, including Knickerbocker focus on the o l i g o p o l i s t i c behavior of multinationals as providing the main motivation f o r direct investment.^  Kindleberger (who seems mainly i n the 'superior knowledge'  camp) argues that: direct investment belongs more to the theory of i n d u s t r i a l organization than to the theory of international c a p i t a l movements.  This statement c e r t a i n l y seems to indicate recognition that i n d u s t r i a l  84  s t r u c t u r e p l a y s a r o l e i n d i r e c t investment. mon ground  than disagreement  Perhaps  i n t h e v a r i o u s camps.  t h e r e i s more com-  That i s , s u p e r i o r know-  l e d g e and o l i g o p o l i s t i c s t r u c t u r e may be c l o s e l y r e l a t e d and b o t h s e r v e to e x p l a i n d i r e c t investment.  I n f a c t Stephen Hymer would p r o b a b l y  o b j e c t t o t h e s e p a r a t i o n o f t h e two t h e o r e t i c a l approaches.  W h i l e he i s  c r e d i t e d w i t h b e i n g t h e f i r s t t o develop t h e 'knowledge' t h e o r y , ^ he l a t e r c o n c e n t r a t e d on o l i g o p o l i s t i c b e h a v i o r as a m o t i v a t o r o f d i r e c t i n g vestment.  The main purpose o f t h i s c h a p t e r i s t o r e v i e w t h e e x i s t i n g  t h e o r i e s o f d i r e c t investment w i t h a v i e w t o u s i n g c e r t a i n  concepts  a l r e a d y developed t o f o r m u l a t e a m i c r o - t h e o r y o f i n t e r n a t i o n a l b a n k i n g . I n t h e c i r c u m s t a n c e s we do n o t f e e l o b l i g e d t o f a l l i n t o any p a r t i c u l a r 'camp.'  There may be some u s e f u l i n s i g h t s p r o v i d e d by a l l o f t h e  approaches. (e)  ALIBER'S THEORY One t h e o r y t h a t does n o t appear t o have a c h i e v e d wide a c c e p t a n c e  but w h i c h i s i n c l u d e d here because o f i t s p o s s i b l e r e l e v a n c e t o b a n k i n g i s t h e one advanced by A l i b e r .  He argues  that:  The key f a c t o r s i n e x p l a i n i n g d i r e c t f o r e i g n investment i n v o l v e c a p i t a l market r e l a t i o n s h i p s , exchange r i s k , and t h e market's p r e f e r ence f o r h o l d i n g a s s e t s denominated i n s e l e c t e d c u r r e n c i e s . ^  The l a t t e r p a r t o f t h i s q u o t a t i o n i s l a t e r developed by A l i b e r i n h i s book, The I n t e r n a t i o n a l Money Game."^  P o r t r a y i n g t h e U.S. d o l l a r as  'the p r e f e r r e d c u r r e n c y brand name' o r ' c u r r e n c y a t t h e t o p o f t h e h i t parade,' A l i b e r p o i n t s o u t s e v e r a l advantages  t h a t a c c r u e t o companies  85 d o i n g t h e i r main volume o f b u s i n e s s i n U.S. d o l l a r s . r e s e a r c h was conducted  A l i b e r ' s main  d u r i n g a time when t h e U.S. d o l l a r was c l e a r l y  o v e r v a l u e d i n terms of t h e c u r r e n c i e s o f most o t h e r developed c o u n t r i e s . The  i m p l i c a t i o n t h a t f o l l o w s i s t h a t p r o d u c t i o n c o s t s should be h i g h e r  i n t h e U.S. than i n c o u n t r i e s w i t h undervalued  c u r r e n c i e s and conse-  q u e n t l y t h e r e i s an i n c e n t i v e f o r i n d u s t r i a l f i r m s t o l o c a t e p r o d u c t i o n f a c i l i t i e s outside the United States. A l i b e r a l s o argues  t h a t t h e r i s k o f exchange r a t e f l u c t u a t i o n s  work t o the advantage o f f i r m s i n t h e s t r o n g c u r r e n c y a r e a s . i s t h a t the: " p a t t e r n o f d i r e c t f o r e i g n investment  r e f l e c t s that source  c o u n t r y f i r m s c a p i t a l i z e t h e same stream o f expected r a t e than h o s t c o u n t r y firms.""''''" That  His thesis  earnings at a higher  i s , A l i b e r would argue t h a t a U.S.  f i r m and a h o s t c o u n t r y f i r m may w e l l p e r c e i v e an o p p o r t u n i t y t o e x p l o i t a market i n the h o s t c o u n t r y and b o t h may come up w i t h t h e same p r o j e c t e d cash f l o w .  A l i b e r argues however t h a t , because o f a d e f i n i t e b i a s i n  the s e c u r i t i e s markets, the U.S. f i r m w i l l be a b l e t o o b t a i n  cheaper  f i n a n c i n g and thus be w i l l i n g . t o pay more f o r the income stream  (attach  a h i g h e r c a p i t a l i z a t i o n r a t e ) than the host c o u n t r y f i r m : " I n W a l l S t r e e t a r g o t , e v e r y t h i n g e l s e b e i n g e q u a l , t h e P/E r a t i o i s h i g h e r f o r U.S.  12 f i r m s than f o r non U.S. f i r m s . " caused by the tendency  The b i a s i n t h e s e c u r i t i e s market i s  o f i n v e s t o r s i n the source c o u n t r y t o n e g l e c t t o  p e n a l i z e p r o j e c t e d e a r n i n g s by some r e a l i s t i c  coefficient representing  exchange r a t e r i s k . A l i b e r ' s t h e o r y has been c h a l l e n g e d on e m p i r i c a l grounds by R a g a z z i , who p o i n t s out t h a t U.S. d i r e c t  investment  continued to flow  86 into Europe i n recent years when several European currencies were con13 sidered stronger than the U.S.  dollar.  Ragazzi also puts forth the  normative argument that there i s no reason for the market not to place a penalty on foreign income streams to allow for exchange r i s k .  Based on  this he then proceeds to show that A l i b e r ' s theory should be reversed: In fact, i t i s possible to argue, contrary to A l i b e r , that firms i n weak currency areas have an advantage investing i n strong currency areas i f the interest rate d i f f e r e n t i a l underestimates the exchange risk.I 4  On the other hand some support for A l i b e r ' s theory i s provided by Dunning: As far as i t goes, I am f u l l y persuaded that the factors he [Aliber] mentions—noticeably that the world market of investors may attach a d i f f e r e n t exchange r i s k premium to equities denominated i n d i f ferent currencies and hence evaluate investment opportunities d i f f e r e n t l y — s h o u l d be incorporated i n any generalized theory of investment behavior.15  However Dunning goes on to make i t clear that he does not view A l i b e r ' s theory as a substitute for the Hymer/Kindleberger 'superior knowledge' approach.  Rather, he sees A l i b e r ' s work as providing an important addi16  t i o n a l contribution to the more popular approach. A l i b e r continues to hold h i s position however, although he admits that the various competing theories of foreign d i r e c t investments inconclusive."'"  7  been carried out.  are  Rigorous testing i s required and apparently has not yet It should be pointed out that Aliber's theory implies  that, should the U.S. become a weak currency area (a p o s s i b i l i t y not too far fetched today) then there should be an increasing amount of 'cross  87  hauling'; that i s d i r e c t investment i n the U.S. by firms located i n strong currency  areas. Other theories of d i r e c t investment f a l l roughly  gories: (1) focus on imperfections monopolistic  into three cate-  i n the c a p i t a l market, (2) focus on  advantage, and (3) focus on oligopoly and need for growth.  Ragazzi has conviently placed the three approaches i n perspective by pointing out that a l l of them focus on some deviation from p e r f e c t l y com18 p e t i t i v e conditions i n the international market. the main requirements for p e r f e c t l y competitive 1)  Ragazzi summarizes 19 conditions as follows:  the rate of return and r i s k of foreign equities e f f e c t i v e l y r e f l e c t the rate of p r o f i t and r i s k of foreign enterprises;  2)  enterprises of one country have no s p e c i a l advantage that allow them to operate subsidiaries i n another country more p r o f i t a b l y than l o c a l enterprises;  3)  the objective of both i n d i v i d u a l s and enterprises i s the maximization of p r o f i t i n competitive markets; and  4)  individuals and enterprises attach the same premium to exchange r i s k s and are equally able to cover themselves against such risks. It can be argued that, under p e r f e c t l y competitive  there w i l l be p o r t f o l i o investment only.  conditions,  No d i r e c t investment w i l l take  place because i t can reasonably be assumed that a foreign subsidiary w i l l incur higher costs than indigenous firms i n the same industry. The reasons include transportation and communication costs with the  88 parent,  and  l a c k of knowledge about l o c a l c u l t u r e and  Under c o n d i t i o n s of p e r f e c t c o m p e t i t i o n  institutions.  t h e n , funds would f l o w between  c o u n t r i e s i n response t o temporary y i e l d d i f f e r e n t i a l s i n g i v e n c l a s s e s and  the need f o r i n v e s t o r s t o d i v e r s i f y p o r t f o l i o s .  w o r l d markets a r e not p e r f e c t l y c o m p e t i t i v e  risk  However the  as the f o l l o w i n g d i s c u s s i o n  illustrates. (f)  IMPERFECT CAPITAL MARKETS R a g a z z i argues t h a t i m p e r f e c t i o n s  i n the market f o r s e c u r i t i e s  20 may  be an i m p o r t a n t d e t e r m i n a n t of f o r e i g n d i r e c t i n v e s t m e n t .  By  re-  l a x i n g the assumption t h a t the r a t e of p r o f i t s from a f o r e i g n e n t e r p r i s e i n a g i v e n r i s k c l a s s i s a c c u r a t e l y r e f l e c t e d by the r a t e of r e t u r n i t s outstanding investment.  s h a r e s one may  a r r i v e at a motivating  on  factor for direct  I f s e c u r i t i e s markets are p o o r l y developed ( l a c k i n g depth  and b r e a d t h ) the r e t u r n on a p o r t f o l i o i n v e s t m e n t i n a p a r t i c u l a r company may  be s u b s t a n t i a l l y lower than the r e t u r n a v a i l a b l e i f c o n t r o l i s  obtained.  T h i s i s p a r t i c u l a r l y t r u e i n Europe where l a c k of  or downright m i s l e a d i n g  information  i n f o r m a t i o n seems t o have developed i n t o a market  norm.  I n the c i r c u m s t a n c e s ,  ples.  The  e q u i t i e s t r a d e a t r e l a t i v e l y low P/E  s i t u a t i o n i s so bad  multi-  i n Europe t h a t some major banks have  e s t a b l i s h e d ' i n t e l l i g e n c e ' u n i t s t o s i f t through the b i t s and i n f o r m a t i o n a v a i l a b l e about companies.  One  pieces  of  example i s ' E u r o f i n a n c e , ' a  company o p e r a t e d by s i x t e e n major banks i n c l u d i n g the Bank of Nova S c o t i a . O p e r a t i n g out of P a r i s , " I t was  b o r n i n 1961  w i t h the merchant b a n k i n g f i r m of L a z a r d  when an i n v e s t m e n t a n a l y s t  F r e r e s got f e d up w i t h  corporate  89  secrecy  and down-right f i n a n c i a l l y i n g p r a c t i s e d by many o f Europe's  21 l a r g e s t companies."  The company p r o v i d e s  ders p r i m a r i l y , but a l s o s e l l s r e s e a r c h  information  to i t s sharehol-  to i n v e s t o r s .  R a g a z z i has shown t h a t w h i l e t h e r a t e o f r e t u r n on U.S. t i e s corresponds r o u g h l y the standard  w i t h t h a t o f other  industrialized  securi-  countries,  d e v i a t i o n o f past annual r a t e s o f r e t u r n has i n g e n e r a l ,  22 been lower i n the U.S. than i n most e c o n o m i c a l l y According  t o Markowitz's p o r t f o l i o theory,  advanced  countries.  the i n v e s t o r , given a  choice  between s e c u r i t i e s o f e q u a l r e t u r n but d i f f e r e n t r i s k c l a s s e s w i l l  always  s e l e c t the lower r i s k a s s e t s . Risk  Expected  T h i s should  provide  return  i n v e s t o r s a l l over t h e world w i t h a s t r o n g  i n c e n t i v e t o seek out t h e developed s e c u r i t i e s markets o f New York and London. However w h i l e market i m p e r f e c t i o n s  may cause p o r t f o l i o  flows,  t h i s w r i t e r i s o f the o p i n i o n t h a t R a g a z z i takes a r a t h e r l a r g e step i n assuming t h a t these i m p e r f e c t i o n s ment.  There seems t o be l i t t l e  cause a r e v e r s e  flow o f d i r e c t  invest-  reason t o assume t h a t because t h e r a t e o f  r e t u r n on e q u i t i e s i s lower than c o r p o r a t e  p r o f i t returns  that  investors  90 w i l l seek another market.  I f t h i s phenomenon were to o c c u r i n the  U.S.  then one would expect a l a r g e number of i n v e s t o r s to seek c o n t r o l of the U.S.  company r a t h e r than l o o k i n g to some f o r e i g n markets f o r a b e t t e r  portfolio return. ment i n the U.S. The  R a g a z z i ' s example o f c o u r s e — E u r o p e a n and U.S.  d i r e c t investment  f a c t s a r e c l e a r but t h e r e may  ferences  i n Europe—cannot  p r o v i d e more important m o t i v a t i o n f o r d i r e c t  be d i s p u t e d .  entrepreneurship) that  investment.  MONOPOLISTIC ADVANTAGE  W i t h i n t h i s broad c a t e g o r y of m o n o p o l i s t i c advantage we 1)  2)  d i f f e r e n t i a t i o n and s p e c i a l marketing  23  skills;  d e p a r t u r e from p e r f e c t c o m p e t i t i o n i n f a c t o r markets  including  technology, a c c e s s to c a p i t a l and p r o p r i e t a r y m a n a g e r i a l 3)  include:  d e p a r t u r e s from p e r f e c t c o m p e t i t i o n i n goods markets i n c l u d i n g product  The  invest-  be some u n d e r l y i n g p s y c h o l o g i c a l d i f -  ( l i q u i d i t y p r e f e r e n c e , r i s k avoidance,  (g)  portfolio  skills;  i n t e r n a l and e x t e r n a l economies o f s c a l e .  theory i s based  on the assumption  t h a t i n d i g e n o u s f i r m s have d e f i n i t e  advantages i n o p e r a t i n g i n the home markets (knowledge of l o c a l market, c u l t u r e , and shortened communication l i n e s ) and t h e r e f o r e f o r e i g n f i r m s must have some o t h e r advantage t h a t a l l o w s them t o earn h i g h e r p r o f i t s than l o c a l f i r m s .  At l e a s t one author  has q u e s t i o n e d t h i s assump-  t i o n : " I would not a c c e p t t h a t h o s t c o u n t r y f i r m s have an advantage over f o r e i g n f i r m s .  T h i s i m p l i e s t h a t c e t e r i s p a r i b u s the  groups of f i r m s a r e e q u a l l y e f f i c i e n t J.  H.  Dunning.  inevitable  and  t h i s need not be the c a s e . "  two 24  91 Kindleberger  p u t s t h e argument i n s i m p l e terms as f o l l o w s :  25  C = value of asset I = income stream i  = discount  rate  He argues t h a t f o r e i g n f i r m s o p e r a t i n g abroad have some s p e c i a l advantage t h a t a l l o w s them t o g e n e r a t e a l a r g e r ' I ' than i n d i g e n o u s  entrepreneurs  and t h e r e f o r e t h e f o r e i g n f i r m w i l l be w i l l i n g t o pay more f o r t h e income stream than t h e i n d i g e n o u s  entrepreneur.  A key f e a t u r e o f t h i s  formula-  t i o n i s t h e assumption t h a t t h e f o r e i g n f i r m and t h e l o c a l f i r m use t h e same r a t e o f i n t e r e s t ( i ) .  I f d i f f e r e n t r a t e s were used o f c o u r s e i t  would be p o s s i b l e t o produce t h e same a s s e t v a l u e w i t h d i f f e r e n t income streams.  I t i s j u s t at t h i s point that A l i b e r departs  of work by a r g u i n g  from t h e main body  (as d i s c u s s e d above) t h a t s o u r c e c o u n t r y  a lower ' i ' and thus have a h i g h e r c a p i t a l i z a t i o n r a t e than firms.  Kindleberger  considers t h i s  f i r m s do use indigenous  possibility:  I t w i l l happen, t o be s u r e , t h a t i n t e r n a t i o n a l c a p i t a l markets a r e l e s s than p e r f e c t , and t h a t d i f f e r e n c e s i n i c o n t r i b u t e t o t h e f l o w of c a p i t a l . But t h e b e h a v i o r o f d i r e c t i n v e s t m e n t , — t h e r e a d i n e s s of i n v e s t o r s t o borrow i n t h e h o s t c o u n t r y a t t h e same i as r e s i d e n t s f a c e . . . — i n d i c a t e t h a t i t i s c a p i t a l I n o t s m a l l i w h i c h domin a t e s . 26 A unique f e a t u r e o f s u p e r i o r knowledge i s t h a t i t t a k e s on t h e c h a r a c t e r o f a p u b l i c good.  The company t h a t has developed t h e knowledge  may have i n c u r r e d c o n s i d e r a b l e c o s t s w h i c h a r e now 'sunk' and t h e r e f o r e the m a r g i n a l  c o s t s o f e x p l o i t i n g t h e knowledge i n an o v e r s e a s market i s  n e g l i g i b l e i n comparison t o t h e development c o s t t h a t p r o b a b l y  f a c e s an  92 indigenous firm.  Up to this point the theory i s incomplete.  As pointed  out by A l i b e r : The i n d u s t r i a l organization approach to d i r e c t investment did not exp l a i n why the firm chose to exploit the foreign market through investment rather than through exporting or licensing.27 On the surface i t might seem reasonable to expect that  exporting  or l i c e n s i n g should occur i f we s t i c k with the assumption that host country producers have advantages i n their home market. A further p o t e n t i a l problem however i s the implied assumption that the objective of the firm i s to maximize p r o f i t s rather than growth. As w i l l be seen when we discuss the theory focusing on oligopoly this assumption may not be v a l i d .  In other words the firm may prefer d i r e c t  investment even when the return on—-say l i c e n s i n g — i s higher than on d i r e c t investments.  The reason i s that d i r e c t investment shows up i n  consolidated sales and asset figures. Believers i n t h i s approach have offered an a l t e r n a t i v e response 28 however: the market f o r 'advantage' i s imperfect.  I f we set aside f o r  now the above goal of p r o f i t maximization, the decision to license or invest d i r e c t l y should simply involve comparing the net present value of the two separate projected cash flows discounted of c a p i t a l .  at the company's cost  The a l t e r n a t i v e with the greater NPV would then be selected.  The implication of the notion that the market f o r 'advantages' i s imperfect i s that an adequate p r i c e cannot be obtained v i a l i c e n s i n g therefore direct investment i s often the preferred a l t e r n a t i v e even though a large c a p i t a l outlay and the acceptance of increased r i s k i s often required.  93 The authors reviewed seem to miss another important point however and that i s that the recipient of the license may haunt the licensor i n i t s home market.  come back to  The dangers of trading a f o o t b a l l  quarterback to another team i n the same league are well known. same can be said i n s e l l i n g 'advantages,' that U.S.  The  i n fact i t has often been said  firms made a major mistake i n exporting technology to Japan  which soon enabled that country to compete i n the domestic U.S. market. Ragazzi has pointed out—and  t h i s may be p a r t i c u l a r l y relevant  for banking—that many types of advantage cannot be sold because they  29 cannot be embodied i n a license.  Managerial expertise, knowledge of  markets, and i n d u s t r i a l organization are cited as examples.  Another  possible example i s a form of 'corporate s p i r i t ' or a business philosophy that could probably not be sold to another company.  An example that  comes to mind i s the American 'gung ho' marketing outlook versus the European 'status quo' or 'clubby' approach. Economies of scale were c i t e d above as one of the factors leading to monopolistic advantage. external.  Scale economies may be either i n t e r n a l or  The l a t t e r t y p i c a l l y involves v e r t i c a l integration and, be-  cause of i t s obvious i n a p p l i c a b i l i t y to banking, we w i l l not discuss i t here.  Internal scale economics on the other hand usually involve h o r i -  zontal investments and this i s relevant to banking. r e l a t i v e l y standard products may  Increased output of  spread certain fixed costs (financing,  marketing, head o f f i c e administration) over a wider area and thus reduce unit costs.  Kindleberger warns however that, beyond some point there  are counterbalancing diseconomies of scale i n administration which set  30 l i m i t s on the optimum scale of operations.  94 In c l o s i n g t h i s s e c t i o n on m o n o p o l i s t i c pointed  advantage i t should  be  out t h a t an important t h e o r e t i c a l c o n t r i b u t i o n developed by  Raymond Vernon and known as t h e 'Product C y c l e Theory' has been o m i t t e d  31 from the above d i s c u s s i o n . f a c t u r i n g companies.  The theory  deals  e x c l u s i v e l y w i t h manu-  On t h e grounds t h a t i t i s n o t r e a l i s t i c  of money (a bank's p r o d u c t ) p r o g r e s s i n g  through some form o f l i f e  the main t h r u s t o f Vernon's work has n o t been i n c l u d e d . does c o n t r i b u t e some i d e a s t h a t w i l l have a b e a r i n g  cycle,  However Vernon  on our upcoming  development o f a m i c r o - t h e o r y o f i n t e r n a t i o n a l banking. bution  to think  The key c o n t r i -  i s : "The d e c i s i o n - m a k i n g sequence t h a t i s used i n c o n n e c t i o n  i n t e r n a t i o n a l investments, a c c o r d i n g  to various  with  empirical studies, i s  32 not  a model of t h e r a t i o n a l p r o c e s s . "  In t h i s connection  Vernon sees  investments o c c u r r i n g more i n response t o a t h r e a t t o an e s t a b l i s h e d p o s i t i o n r a t h e r than i n response t o an o p p o r t u n i t y  forprofits.  This  view puts him a t l e a s t p a r t l y i n t h e camp o f those who take the o l i g o p o l y approach which i s the s u b j e c t o f t h e next s e c t i o n . (h) OLIGOPOLY AND NEED FOR GROWTH  Terms such as 'bandwagon e f f e c t ' and ' f o l l o w the l e a d e r have been used t o d e s c r i b e  syndrome'  the o f t e n observed f a c t t h a t when one i n d u s t r y  member l o c a t e d a s u b s i d i a r y i n a f o r e i g n c o u n t r y , i n d u s t r y r i v a l s  felt  compelled t o f o l l o w .  growth  and  The i m p l i c a t i o n o f t h i s o b s e r v a t i o n  i s that  r e t e n t i o n o f market share a r e the determinants o f d i r e c t investment  r a t h e r than t h e p r o f i t m o t i v e .  This observation  has r e c e n t l y been sub-  j e c t e d t o q u a n t i t a t i v e a n a l y s i s by F. T. K n i c k e r b o c k e r i n h i s award  95  winning doctoral d i s s e r t a t i o n e n t i t l e d " O l i g o p o l i s t i c Reaction and M u l t i 33 national Enterprise."  O l i g o p o l i s t i c reaction i s defined as an i n t e r -  active kind of corporate behavior by which r i v a l firms i n an industry composed of a few large firms counter one another's moves by making similar moves themselves.  U t i l i z i n g facts and figures from the data bank  of the Harvard Multinational Enterprise Study, Knickerbocker has produced s t a t i s t i c a l evidence that U.S. manufacturing industries have cons i s t e n t l y i l l u s t r a t e d that foreign d i r e c t investment decisions are made with an eye on what industry r i v a l s are doing.  Oligopoly  theory's  notion of interdependency would of course predict this behavior. Knickerbocker's methodology centered around development of an 'entry concentration  index' which i s a measure of the extent to which,  i n the 1948 to 1967 period, 187 major U.S. corporations bunched the establishment  of their manufacturing subsidiaries together  i n twenty-  34 three countries.  His key preliminary finding i s that of approximately  2,000 foreign subsidiaries, almost 50 per cent were established within three year peak c l u s t e r s .  "Industry by industry, country by country, 35 U.S. enterprise invested abroad i n lock-step-like fashion." Two possible conclusions that might be drawn from the above should be d i s p e l l e d : 1)  that the observed sheeplike s t r a i n i s economically  irrational;  and 2)  that oligopoly can only lead to 'bad' r e s u l t s f o r the consumer.  F i r s t there i s no ,a p r i o r i reason to conclude that the observed 'follow  96 the leader syndrome' i s i r r a t i o n a l i n an economic sense.  H. A. Simon  i n h i s well known book, Administrative Behavior, argues that: the l i m i t s of r a t i o n a l i t y have been seen to derive from the i n a b i l i t y of the human mind to bring to bear upon a single decision a l l the aspects of value, knowledge, and behavior that would be relevant.36 Decisions often become based more nearly on a stimulus-response pattern than a choice among a l t e r n a t i v e s .  The stimulus i n the issue at hand of  course i s the penetration of a foreign market by a competitor i n the industry: the response i s to follow. Most firms i n the Western world are very reluctant to lose markets to competitors and consequently i t makes some sense for others i n the industry to checkmate moves abroad. The second conclusion  (that oligopoly i s 'bad') can be disputed.  Knickerbocker suggests that non-collusive behavior has i n fact been documented among most international firms.  In fact, i n many cases, the  a r r i v a l of foreign firms sparks a renewal of competitive vigor among firms i n a p a r t i c u l a r industry located within the host country.  Caves  provides some support f o r this view:  Whatever the market structure that r e s u l t s from the influence of direct investment, i t can be argued that entry by a foreign subsidiary i s l i k e l y to produce more active r i v a l r o u s behavior and improvement i n market performance than would a domestic entry at the same i n i t i a l scale.37 Balassa and Caves have taken a d i f f e r e n t approach than Knickerbocker i n that they focus on the need for growth rather than p r o f i t as a motivation  of direct investment.  Galbraith has put f o r t h a persuasive  97  argument t h a t growth i s indeed a major o b j e c t i v e of the l a r g e  corpora-  tion:  Once the s a f e t y of the t e c h n o s t r u c t u r e i s ensured by a minimum l e v e l of e a r n i n g s , t h e r e i s then a measure of c h o i c e as to g o a l s . Nothing i s so c o m p e l l i n g as the need to s u r v i v e . However, t h e r e i s l i t t l e doubt as to how, overwhelmingly, t h i s c h o i c e i s e x e r c i s e d ; i t i s to a c h i e v e the g r e a t e s t p o s s i b l e r a t e of c o r p o r a t e growth as measured i n sales.38  Balassa's i n d u s t r y may its  hypothesis i s that a f i r m belonging  to an  f i n d i t e a s i e r to i n v e s t abroad s i n c e any  share of the domestic market can be  oligopolistic  a c t i o n to  expected to meet w i t h  increase  retaliation  39 from other p a r t i c i p a n t s i n the i n d u s t r y . entry  i n t o the f o r e i g n market may  s t i r r i n g up a t r a d e war  be h i g h ,  Thus, a l t h o u g h the c o s t i t c o u l d w e l l be  of  cheaper than  at home.  Caves on the other hand h y p o t h e s i z e s t h a t f i r m s i n o l i g o p o l i s t i c i n d u s t r i e s i n each c o u n t r y encounter l i m i t s to i n c r e a s i n g the s a l e s of  40 t h e i r t r a d i t i o n a l product i n the domestic market.  In order  to con-  t i n u e t h e i r growth r a t e , they must choose between expanding a c r o s s product boundary i n the domestic markets or expanding a c r o s s  a  a national  border w i t h t h e i r t r a d i t i o n a l p r o d u c t . (i) SUMMARY I t has  been the purpose of t h i s c h a p t e r to review  various  t h e o r i e s o f f e r e d to e x p l a i n f o r e i g n d i r e c t investment as i t a p p l i e s i n d u s t r i a l firms.  No  s i n g l e theory  seems to be  entirely valid  each o f f e r s p o i n t s t h a t have a r i n g of t r u t h about them. w r i t e r sees no  great  c o n f l i c t between any  of the  theories.  to  although  Indeed  this  98  I t may  be  that A l i b e r ' s theory h i g h l i g h t s p r i m a r i l y a s p e c i a l  type of m o n o p o l i s t i c a d v a n t a g e — f a v o u r a b l e a c c e s s to c a p i t a l markets. The  o l i g o p o l y t h e o r i e s may  a p p r o a c h — i f one  takes the view t h a t  j u s t the p u r s u i t of l o n g i n the  f i e l d believe  maximizing  the p u r s u i t of growth i s r e a l l y  term p r o f i t s i n d i s g u i s e .  t h a t growth may  Hymer/Kindleberger  be  Some p r a c t i t i o n e r s  the b e s t l o n g  term s t r a t e g y  for  profits.  In any information  a l s o r e l a t e c l o s e l y to the  event, the t h e o r i e s  reviewed do p r o v i d e a r i c h source of  from which to b u i l d a theory a p p l i c a b l e  f o r e i g n banking.  to the expansion of  99 Notes f o r Chapter S i x G. R a g a z z i , " T h e o r i e s o f t h e D e t e r m i n a n t s o f D i r e c t F o r e i g n Investment," IMF S t a f f Papers ( J u l y 1973), p. 471. I  2 H. M. M a r k o w i t z , P o r t f o l i o S e l e c t i o n : E f f i c i e n t D i v e r s i f i c a t i o n o f Investments (New York: John W i l e y and Sons I n c . , 1959). 3 R a g a z z i , p. 472. 4 R. Z. A l i b e r , "The M u l t i n a t i o n a l E n t e r p r i s e i n a M u l t i p l e Curr e n c y W o r l d , " i n The M u l t i n a t i o n a l E n t e r p r i s e , J . H. Dunning ( e d . ) . ^ F. T. K n i c k e r b o c k e r , O l i g o p o l i s t i c R e a c t i o n and M u l t i n a t i o n a l E n t e r p r i s e ( B o s t o n : H a r v a r d U n i v e r s i t y P r e s s , 1973). C. P. K i n d l e b e r g e r , American B u s i n e s s Abroad: S i x L e c t u r e s on D i r e c t Investment (New Haven: Y a l e U n i v e r s i t y P r e s s , 1969), p. 11. S. H. Hymer, "The I n t e r n a t i o n a l O p e r a t i o n s o f N a t i o n a l F i r m s : A Study o f D i r e c t F o r e i g n Investment," c i t e d i n American B u s i n e s s Abroad, by C. P. K i n d l e b e r g e r . g S. H. Hymer and R. Rowthorn, I n t e r n a t i o n a l B i g B u s i n e s s 195767: A Study o f Comparative Growth (Cambridge: Cambridge U n i v e r s i t y P r e s s , 1971). 9 R. Z. A l i b e r , "A Theory o f D i r e c t F o r e i g n Investment, i n The I n t e r n a t i o n a l C o r p o r a t i o n , C. P. K i n d l e b e r g e r ( e d . ) . 7  R. Z. A l i b e r , The I n t e r n a t i o n a l Money Game (New York: B a s i c Books I n c . , 1973). 1 0  I I  A l i b e r , "A Theory," p. 28.  12 A l i b e r , Money Game, p. 187. Ragazzi. 1 4  I b i d . , p. 493. J . H. Dunning, The M u l t i n a t i o n a l E n t e r p r i s e , p. 57. Ibid.  1 7  A l i b e r , Money Game. Ragazzi.  100 19  R a g a z z i , p. 478. Ibid.  21 2  2  "The Bankers Take the Plunge," E x e c u t i v e  (June 1971), p. 33.  T>  Ragazzi. 23 2  4  Kindleberger,  American B u s i n e s s , p. 14.  n Dunning.  25 R. D. I r w i n 2  6  C. P. K i n d l e b e r g e r , I n t e r n a t i o n a l Economics I n c . , 1968), p. 393.  (Homewood, 111.:  TU-A  Ibid. 27  A l i b e r , M u l t i n a t i o n a l E n t e r p r i s e , p. 50.  28 S. H. Hymer, "The M u l t i n a t i o n a l C o r p o r a t i o n : An A n a l y s i s o f Some o f the M o t i v e s f o r I n t e r n a t i o n a l B u s i n e s s I n t e g r a t i o n , " c i t e d i n The M u l t i n a t i o n a l E n t e r p r i s e , J . H. Dunning ( e d . ) . 29 R a g a z z i , p. 485. 30  Kindleberger,  American B u s i n e s s .  31 R. Vernon, " I n t e r n a t i o n a l Investment and I n t e r n a t i o n a l Trade i n t h e Product C y c l e , " Q u a r t e r l y J o u r n a l o f Economics, 80 (1966), 190207. 32 Ibid. 33 Knickerbocker. Ibid. 3  5  TT, • A  Ibid. H. A. Simon, A d m i n i s t r a t i v e and Co., 1951), p. 108.  B e h a v i o r (New York: M a c M i l l a n  37 R. E. Caves, " I n t e r n a t i o n a l C o r p o r a t i o n s : The I n d u s t r i a l Economics o f F o r e i g n Investment," Economica, 38 (1971), p. 15. oo  J . K. G a l b r a i t h , The New I n d u s t r i a l S t a t e Books, 1967).  (New York:  Signet  101  B. Balassa, "American Direct Investments i n the Common Market," Banca Nazionale Del Lavora (June 1966). 3 9  ^  Caves.  Chapter Seven  TOWARD A THEORY OF INTERNATIONAL BANKING EXPANSION BANKING: AN OLIGOPOLISTIC INDUSTRY Throughout t h e above d i s c u s s i o n o f t h e v a r i o u s t h e o r i e s o f f o r e i g n d i r e c t i n v e s t m e n t , one common f e a t u r e emerged: a l l t h e o r i e s assume some d e v i a t i o n from p e r f e c t l y c o m p e t i t i v e market c o n d i t i o n s . Kindleberger  In fact  argues t h a t :  f o r d i r e c t i n v e s t m e n t t o t h r i v e t h e r e must be some i m p e r f e c t i o n s i n markets f o r goods, o r f a c t o r s , i n c l u d i n g among t h e l a t t e r t e c h n o l o g y ; or some i n t e r f e r e n c e i n c o m p e t i t i o n by government o r by f i r m s , w h i c h s e p a r a t e s markets.1 The  argument i s based on t h e presumption t h a t i f p e r f e c t markets d i d i n  f a c t e x i s t then t h e r e would be no d i r e c t i n v e s t m e n t s . c a p i t a l f l o w p o s s i b l e would be p o r t f o l i o i n v e s t m e n t . f i n d no f a u l t w i t h t h e above l i n e o f r e a s o n i n g  T h i s w r i t e r can  and i t f o l l o w s  t h a t t h e s t a r t i n g p o i n t i n development o f a t h e o r y b a n k i n g e x p a n s i o n s h o u l d be a s e a r c h  The o n l y t y p e o f  therefore  to explain foreign  f o r market i m p e r f e c t i o n s  i n the  banking i n d u s t r y . I t i s w e l l known t h a t t h e Canadian b a n k i n g i n d u s t r y f i t s t h e t e x t b o o k d e s c r i p t i o n o f an o l i g o p o l y — a h o r r i b l e sounding word d e r i v e d  2 from t h e Greek word " o l i g o s " meaning few.  An o l i g o p o l i s t i c i n d u s t r y i s  c h a r a c t e r i z e d by a few s e l l e r s who produce an almost i d e n t i c a l p r o d u c t . Economic t h e o r y s t a t e s t h a t f i r m s i n t h i s type o f i n d u s t r y  recognize  t h e i r mutual i n t e r d e p e n d e n c e and t h u s end up a d m i n i s t e r i n g p r i c e s . I t  102  103 i s argued t h a t t h e r e i s a c e r t a i n amount o f waste t o s o c i e t y  involved  i n t h i s type o f i n d u s t r y because p r i c e s a r e c e r t a i n t o exceed m a r g i n a l costs.  In a d d i t i o n  t o l o s s o f the f a m i l i a r consumer s u r p l u s  there i s  a l s o a "dead weight l o s s " t h a t r e s u l t s from t o o l i t t l e o f t h e product b e i n g produced. lows :  Samuelson g r a p h i c a l l y i l l u s t r a t e s t h e f o r e g o i n g  as f o l -  3  PRICE l o s s o f consumer  surplus  Actual Price \  dead weight  \  loss  V \  v  AC = MC \  >^Demand y  MR\ • v  • — QUANTITY  There i s an i m p l i c i t assumption throughout t h i s type o f a n a l y s i s t h a t a number o f s m a l l f i r m s a t a lower that  1  ideal price.'  i n an i n d u s t r y  could  s u p p l y t h e i r product  In t h e banking i n d u s t r y a case can be made  t h e r e a r e economies o f s c a l e which c o u l d w e l l mean t h a t  the m a r g i n a l  c o s t / m a r g i n a l revenue i n t e r s e c t i o n f o r s m a l l banks i s w e l l above t h e ideal price.  I t may even be v e r y c l o s e t o the a c t u a l p r i c e charged f o r  l o a n s and s e r v i c e s .  While t h i s b r i e f d i s c u s s i o n  s i o n from the i s s u e a t hand, the w r i t e r it  c l e a r that  considers  i s somewhat o f a d i v e r i t important t o make  there i s nothing n e c e s s a r i l y e v i l or s i n i s t e r  about  104  o l i g o p o l y and,  f u r t h e r , t h a t the case f o r h i g h a d m i n i s t e r e d p r i c e s i s  not proven. There a r e c u r r e n t l y t e n c h a r t e r e d banks i n Canada. October 3 1 s t , 1973,  the f i v e l a r g e s t c o n t r o l l e d 91.5  a s s e t s t o t a l l i n g $75,021 m i l l i o n . Canadian b a n k i n g . June 30th, 1974,  The  Concentration  s i t u a t i o n i n the U.S.  As  at  per cent of i n d u s t r y  i s definitely a fact i n  i s somewhat d i f f e r e n t .  t h e r e were 14,338 banks i n the U.S.  with total  At  assets  4 o f $853 b i l l i o n . i n no way  On the s u r f a c e i t would appear t h a t the i n d u s t r y i s  c h a r a c t e r i z e d by o l i g o p o l y .  However t h e r e i s i n f a c t a con-  s i d e r a b l e amount of c o n c e n t r a t i o n i n U.S. c e n t r a t i o n i s growing. t o t a l loans belong  One  q u a r t e r of a l l d e p o s i t s and 22 per cent  t o the f i v e l a r g e s t banks.  per cent of i n d u s t r y a s s e t s .  The  of  top t e n banks h o l d  Furthermore the n a t u r e o f U.S.  law s e r v e s t o promote c o n c e n t r a t i o n . ing  b a n k i n g and the degree of con-  35  banking  Laws p r e v e n t i n g banks from b r a n c h -  a c r o s s s t a t e l i n e s r e s u l t i n the d o m i n a t i o n of the many r e g i o n a l  markets by a few l a r g e banks.  For example the C a l i f o r n i a market i s  dominated by BankAmerica ($57,351 m i l l i o n ) , Western Bankcorp ($14,740 m i l l i o n ) , Security Pacific  ($12,571 m i l l i o n ) , W e l l s Fargo ($8,880  m i l l i o n ) , and C r o c k e r N a t i o n a l ($8,326 m i l l i o n ) . Perhaps more i m p o r t a n t banks c e n t e r e d i n New  f o r the purposes o f t h i s s t u d y the  Y o r k (and BankAmerica i n C a l i f o r n i a ) a r e the  mary p a r t i c i p a n t s i n f o r e i g n m a r k e t s . o f 36.3  top  The  pri-  top t e n banks h o l d an average  per cent of t h e i r d e p o s i t s w i t h f o r e i g n e r s w h i l e the v a s t major-  i t y of d e p o s i t s w i t h the f i f t i e t h t h r o u g h two h u n d r e d t h l a r g e s t banks a r e d o m e s t i c .  U.S.  I n f a c t 150 of the n a t i o n s 200 l a r g e s t banks have  105  n e g l i g i b l e holdings The  of f o r e i g n d e p o s i t s  ( l e s s than 10 per  cent).  f i r s t and most o b v i o u s d e v i a t i o n from p e r f e c t l y  markets then i s i n d u s t r y c o n c e n t r a t i o n — o r  oligopoly.  One  competitive  of the  impli-  c a t i o n s t h a t f a l l s out of an o l i g o p o l i s t i c i n d u s t r y s t r u c t u r e i s t h a t i t i s v e r y d i f f i c u l t t o s i g n i f i c a n t l y a l t e r one's share of the domestic market.  The b a n k i n g i n d u s t r y has  one  r a t h e r unique a d d i t i o n a l f e a t u r e  about i t t h a t i s not common t o o t h e r i n d u s t r i e s — t o t a l domestic market s i z e i s c o n t r o l l e d by c e n t r a l monetary a u t h o r i t i e s . trolling  That i s , by  con-  the s u p p l y of r e s e r v e s , the c e n t r a l bank set's an upper l i m i t  the amount by w h i c h banks can expand t h e i r domestic a s s e t s . t o t a l market i s growing by 10 per cent per y e a r , the o n l y way  on  I f the a particu-  l a r bank can grow more r a p i d l y i s a t the expense of some o t h e r bank. T h i s can be v e r y e x p e n s i v e and banks w i l l l i k e l y r e t a l i a t e .  i n f a c t may  not be p o s s i b l e s i n c e  other  A good example i s the i n t r o d u c t i o n of  the  'Western A c c o u n t ' by the Bank of B r i t i s h Columbia, a s m a l l r e g i o n a l bank w i t h about one per cent of t o t a l market s h a r e .  The  'Western Account' i s  a package of u s u a l r e t a i l b a n k i n g s e r v i c e s s o l d t o customers a t a monthly r a t e . perceived  The  i d e a caught on q u i c k l y and,  flat  as soon as the major banks  even a minute s h i f t i n market s h a r e , they a l l came out  with  e s s e n t i a l l y the same p l a n . NEED FOR  GROWTH  P r o t e c t i o n of market share i s a f a c t of l i f e i n b a n k i n g (as i t i s i n o t h e r o l i g o p o l i s t i c i n d u s t r i e s ) but t h i s does not i n i t s e l f vide a motivation  f o r f o r e i g n d i r e c t investment.  The m o t i v a t i o n  proi s more  106 l i k e l y to be an almost innate need for growth.  There are a variety of  good reasons for a bank to set growth as an objective. i s that there are economies of scale i n banking.  The most obvious  Three areas can be  singled out where a large bank can operate more e f f i c i e n t l y than a smaller bank:  a)  a c q u i s i t i o n of deposits;  b)  asset management; and  c)  clearing mechanism.  The use of computers can lower the costs of a l l three of the above functions.  The growth of branch banking i s also a good indication  that economies can be achieved i n the i n t e r n a l transfer of funds.  The  most obvious example i s f a c i l i t a t i n g the flow of funds from surplus units (households i n r u r a l areas) to d e f i c i t units (business firms i n indust r i a l i z e d areas). At least one author has questioned the assumption that larger banks are more e f f i c i e n t .  G. J . Benston has conducted a study of U.S.  banks which he claims casts some doubt on the accepted truism that economies of scale exist i n banking."'  His findings were that a doubling i n  size of a bank was associated with something i n the order of a 7 per cent decrease i n unit costs which the author claims i s r e l a t i v e l y i n s i g nificant.  Benston also argues that i f growth i s achieved by branching  then economies are not achieved.  There were some serious problems  associated with the study however—the most important being the extreme d i f f i c u l t y i n measuring the output of a bank.  Benston himself admits  107 that his methodology did not measure the a b i l i t y of a bank to make large loans to valuable deposit c l i e n t s nor the economies that might be expected from more e f f i c i e n t funds management.^ A more rigorous study of the economies of scale question g been carried out by L. K a l i s h and R. G i l b e r t . ting of 898 U.S.  has  Using a sample consis-  commercial banks the authors attempted to obtain a  measure of the relationship between size and average unit cost as follows: Average Unit Cost  Bank Output  The objective was was  to locate point A on the above average cost curve.  the case i n the Benston study, there was  As  d i f f i c u l t y i n measuring  bank output, however the authors did agree that the average cost curve took on a p o s i t i v e slope at a r e l a t i v e l y low l e v e l of output.  Specifi-  c a l l y , the Kalish and G i l b e r t study found a bank with assets i n the  $5  9 to $15 m i l l i o n range to have the lowest per unit average cost.  These  results were compared to two other studies (Alhadeff and Gramley) as follows:"^  108 Comparison o f Long Run Average Cost Curves Kalish/ Gilbert  Alhadeff Gramley (cost per u n i t of output)  Bank S i z e (thousands)  $.0438 .0289 .0256 .0282 .0255 .0199 N/A  under . . . . $2,000 2,000 5,000 5,000 15,000 15,000 50,000 50,000 150,000 150,000 - 1,000,000 1,000,000  $.0401 .0349 .0304 .0307 .0318 .0323 .0457  $.0278 .0239 .0200 .0196 N/A  There a r e a c o u p l e o f p o i n t s t o n o t e about t h e above d a t a . f i r s t i s t h a t t h e s t u d i e s a r e n o t i n agreement.  Both t h e A l h a d e f f and  Gramley s t u d i e s i n d i c a t e no p o s i t i v e s l o p e i n t h e average c o s t  curve.  The second p o i n t i s t h e absence o f d a t a on major b a n k s — s a y w i t h above $10 b i l l i o n .  The  assets  There were no major banks i n c l u d e d i n t h e A l h a d e f f  and Gramley s t u d i e s and t h e l a r g e s t bank i n t h e K a l i s h / G i l b e r t study had a s s e t s o f o n l y $1 b i l l i o n .  T h i s l e a v e s open t h e d i s t i n c t p o s s i b i l i t y  the a u t h o r s have c o n c e n t r a t e d samples.  that  on much t o o narrow an a s s e t range i n t h e i r  I t c o u l d w e l l be t h e case t h a t t h e average c o s t c u r v e o f major  banks i s indeed  lower than those o f t h e s m a l l e r banks.  W h i l e t h e case f o r economies o f s c a l e i n b a n k i n g remains unproven, predominant o p i n i o n seems t o be i n f a v o u r o f t h e h y p o t h e s i s .  The r e c e n t  t r e n d toward s t a t e - w i d e , m u l t i p l e - b r a n c h b a n k i n g i n t h e U n i t e d S t a t e s be e v i d e n c e t h a t bankers b e l i e v e t h a t t h i s form o f e x p a n s i o n s c a l e economies.  may  achieves  Roger E. Anderson, Chairman o f t h e Board o f C o n t i n e n t a l  I l l i n o i s N a t i o n a l Bank has r e c e n t l y s t a t e d : "An i n t e r n a l advantage f o r the b r a n c h bank i t s e l f i s f e l t t o be i n c r e a s e d o p e r a t i n g e f f i c i e n c y and lower c o s t s , s i n c e a bank c o u l d o f f e r t h e same s e r v i c e s a t many e s t a b lishments.  109  For our purposes i t i s not i m p o r t a n t t o prove the e x i s t e n c e o t h e r w i s e ) of economies of s c a l e .  (or  What might be i m p o r t a n t i s t h a t bank  management b e l i e v e t h a t t h e r e a r e s c a l e economies or t h a t they want " s c a l e " f o r some r e a s o n o t h e r than f o r economies.  Baumol s u g g e s t s t h a t :  Though businessmen a r e i n t e r e s t e d i n the s c a l e of t h e i r o p e r a t i o n s p a r t l y because they see some c o n n e c t i o n between s c a l e and p r o f i t s , I t h i n k management's c o n c e r n w i t h the l e v e l of s a l e s goes even further.12  The - c l e a r i m p l i c a t i o n h e r e i s t h a t growth would c o n t i n u e even though f u r t h e r s c a l e economies were not We  have uncovered some s k e t c h y  be c o r r e c t .  The  U.S.  t o be  important  achieved.  e v i d e n c e t h a t i n d i c a t e s Baumol  F e d e r a l Reserve Board a n n u a l l y p u b l i s h e s  income,  expense, and d i v i d e n d d a t a b r o k e n down by s i z e of member bank. i n t e r e s t i n g t o n o t e t h a t the major i n t e r n a t i o n a l banks do not p r o f i t r a t i o s t h a t compare f a v o u r a b l y  t o s m a l l e r r e g i o n a l U.S.  may  It is generate banks.  13 T a b l e s 7-1  and  7-2  summarize the  data.  Table  7-1  PROFIT RATIOS BY SIZE OF U.S. Net Incme as % of $1Gross 2000 Revenue  BANK  S i z e Group by D e p o s i t s 000's o m i t t e d 2000- 500010000- 25000- 500001000005000 10000 25000 50000 100000 500000  500000 & up  1973  13.9  15.1  15.1  15.4  14.3  13.3  12.0  11.3  1972  13.9  12.8  14.3  14.8  14.7  14.3  14.0  13.8  110 Table  7-2  PROFIT RATIOS OF SELECTED BANKS Net Incme as % o f Gross Revenue  BankAmerica  Chase  Man/Han  Chemical  Morgan  Bankers Trust  1973  10.0  6.9  8.0  5.8  11.4  5.2  1972  11.6  10.2  10.8  9.3  16.0  9.9  Another advantage t h a t i s o f f e r e d by growth i s t h a t b i g n e s s i s a s s o c i a t e d by the b a n k i n g p u b l i c w i t h s a f e t y , e f f i c i e n c y , and E v i d e n c e of t h i s i s p r o v i d e d by r e c e n t events i n t h e U.S. U.S.  banks a r e c u r r e n t l y undergoing a l i q u i d i t y c r i s i s .  problem i s t h e f a c t t h a t the l a r g e New  service.  banking  industry.  Compounding the  York banks c o n t i n u e t o e x p e r i e n c e  r a p i d growth w h i l e t h e s m a l l r e g i o n a l banks a r e i n t r o u b l e .  To  quote  Professor Paul Nadler:  When bad news about one bank g e t s o u t , p e o p l e p a n i c , f i g u r i n g t h a t i f i t can happen t o one bank i t can happen t o a n o t h e r . So they withdraw t h e i r money from r e g i o n a l banks and s h i p i t a l l o f f t o the ' b i g g i e s ' because p e o p l e equate b i g n e s s w i t h soundness.14  The banks a r e w e l l aware o f t h e importance o f s i z e so growth becomes a very r e a l objective. Growth i s a l s o i m p o r t a n t f o r another r e a s o n — g e n e r a t i o n o f employee enthusiasm.  Banking i s u n q u e s t i o n a b l y a 'people' b u s i n e s s and i t i s  v i t a l t o r e t a i n a g g r e s s i v e young employees. grow.  One way  t o do t h i s i s t o  Growth of any o r g a n i z a t i o n i n c r e a s e s o p p o r t u n i t i e s f o r t h e upward i  m o b i l i t y of i t s employees.  T h i s p r o c e s s appears q u i t e l o g i c a l t o t h i s  Ill writer and indeed seems essential to ensure the continued health of an organization. Galbraith however has a d i f f e r e n t interpretation of the process. While acknowledging that growth i s i n the s e l f - i n t e r e s t of the technostructure (defined as those who p a r t i c i p a t e i n corporate decision making), Galbraith views the growth process as being inherently i n c o n f l i c t with the preferred goal of p r o f i t  maximization:  The paradox of modern economic motivation i s that p r o f i t maximization as a goal requires that the i n d i v i d u a l member of the technostructure subordinate h i s personal pecuniary interest to that of the remote and unknown stockholder. By contrast, growth, as a goal i s wholly consistent with the personal and pecuniary interest of those who part i c i p a t e i n decisions and direct the enterprise.15 The case for growth i s widely accepted within the banking industry. The focus i s on expanding markets but the assumption p r o f i t s w i l l j u s t i f y the growth. swallow.  i s that, eventually,  Theorists find this a tough p i l l to  In fact, Kindleberger, i n response to this type of statement,  stated: But the explanations which businessmen give of their thought processes must not be taken with l i t e r a l seriousness. Like Monsieur Jourdain i n Moliere's Le Bourgeois Gentilhomme who spoke prose a l l h i s l i f e without having been aware of i t , they doubtless maximize p r o f i t s rather than merely follow markets.16  This i s a rather brave statement vided no supportive evidence.  to make e s p e c i a l l y since the author pro-  The comment indicates Kindleberger's  staunch resistance to relaxing one of the c r i t i c a l economic assumptions underlying the theory of the firm: p r o f i t maximization.  At least some  other economists seem more prepared to a l t e r their position.  After  112 observing the behavior of o l i g o p o l i s t i c firms for several years (always with the p r o f i t maximization assumption firmly entrenched i n h i s thought processes), W. J . Baumol f i n a l l y concluded that: This ( d i f f i c u l t y forming a theory of the firm) i s largely the r e s u l t of my stubborn reluctance to part company with the universal applicab i l i t y of the p r o f i t maximization hypothesis. Only after a number of unsuccessful attempts to force i t s implications down the throats of otherwise highly cooperative firms f o r which I was consulting did i t occur to me that something might be wrong with the central tenets of my position.17  Here i s a comment from a B r i t i s h observer of international banking that lends some support to Baumol's observation: Economists might wonder what has happened to the theory which explained everything a firm did i n terms of p r o f i t maximization. The order of the day on the international banking scene now seems to be business maximization i r r e s p e c t i v e of p r o f i t s , though i t i s hoped, of course that one w i l l follow from the other.18  PROFIT CONSTRAINT  Bigness and the need for growth i s not a l l that counts i n banking however.  There i s a p r o f i t constraint imposed by the shareholders and by  the need to finance further growth.  There are good reasons to believe  however that the constraint imposed by shareholders i s something than p r o f i t maximization.  less  P r o f i t norms for the banking industry have  evolved over time and as long as a bank generates s u f f i c i e n t revenue to make normal dividend payments, i t i s extremely unlikely that the position of management w i l l be threatened.  On the other hand i f growth i s not up  to the industry norm and the bank s t a r t s to s l i p i n r e l a t i v e s i z e i t i s l i k e l y that shareholders, through the board of directors, w i l l begin to  113 ask questions about the e f f i c i e n c y and competence of management. The above phenomena are not unique to Canadian and U.S.  banking.  A B r i t i s h magazine, "The Banker," publishes an annual survey of the top 300 commercial banks.  This publication recognizes and defends the need  for growth of banks. There are many reasons why bankers, e s p e c i a l l y chairmen and senior managers, are concerned about the s i z e of their bank, quite apart from any guide that l i s t i n g s give them. Now that t r a d i t i o n a l d i s t i n c tions of status based on class at b i r t h or inherited wealth have l a r g e l y disappeared i n advanced s o c i e t i e s and there i s a fast growing, multinational, m u l t i l i n g u a l f i n a n c i a l community comprising men of most diverse o r i g i n s , the r e l a t i v e r i s e of the i n s t i t u t i o n they work for goes some way to determine their status generally.-^  "The Banker" goes on to point out that the goal of s i z e i t s e l f can help management define at least one r e a d i l y understandable corporate goal for the organization.  In an industry that e s s e n t i a l l y deals with a homogen-  eous product a growth goal subject to a p r o f i t constraint has become accepted worldwide. MAINTENANCE OF MARKET SHARE A very important offshoot of the inherent need for growth i s the need within the banking industry to (as a minimum) maintain one's size r e l a t i v e to competitors. Queen's dictum: "Now, i n the same place.  Bankers may  well r e f l e c t adherence to the  Red  here, i t takes a l l the running you can do to keep I f you want to get somewhere else, you must run at 20  least twice as fast as that." From the point of view of the Chase Manhattan Bank i t was  a disas-  ter to s l i p from the world's second largest bank to t h i r d largest within  114  the p a s t few y e a r s .  F o r C i t i c o r p on t h e o t h e r hand i t was a major v i c -  t o r y t o move i n t o second p l a c e . I t i s i n t e r e s t i n g t o n o t e t h a t t h e r e i s no e v i d e n c e t h a t Chase was b e i n g c r i t i c i z e d by i t s s h a r e h o l d e r s f o r n o t m a i n t a i n i n g p r o f i t s a t the same l e v e l as i t ' s main c o m p e t i t o r s .  F o r t h e t e n y e a r p e r i o d ended  December 3 1 s t , 1973, t h e Chase had e x p e r i e n c e d an average growth i n e a r n i n g s p e r share o f 1\ p e r c e n t , w e l l under t h e growth r a t e s o f BankAmerica (8.9 p e r c e n t ) , C i t i c o r p (10.5 p e r c e n t ) , and J . P. Morgan (10.9 p e r 21 cent).  However i t was n o t u n t i l t h e Chase s l i p p e d i n t o t h i r d p l a c e  t h a t m a n a g e r i a l competence was q u e s t i o n e d .  I n response t o c r i t i c s ,  D a v i d R o c k e f e l l e r , Chairman, i s r e p o r t e d t o have embarked on a p e r s o n a l crusade t o r i d Chase Manhattan " o f i t s image as t h e s l u m b e r i n g g i a n t o f 22 i n t e r n a t i o n a l banking." T h i s i n v o l v e d s e v e r a l t o p management changes i n c l u d i n g t h e r e s i g n a t i o n o f t h e p r e s i d e n t i n 1972. I t i s apparent t h a t 23 R o c k e f e l l e r ' s crusade i s s t i l l g o i n g on. The same p r e s s u r e i s i n e v i d e n c e i n Canadian b a n k i n g .  W. E.  M c L a u g h l i n , Chairman and P r e s i d e n t o f t h e R o y a l Bank o f Canada has o b s e r ved t h a t h i s bank i s Canada's l a r g e s t and f u l l y i n t e n d s t o remain number one.  The comparison has been on t h e b a s i s o f a s s e t s n o t p r o f i t s . The need t o m a i n t a i n one's p o s i t i o n i n t h e i n d u s t r y m a n i f e s t s  i t s e l f by t h e p r a c t i c e o f t h e banks matching e i g n markets.  each o t h e r s moves i n t o  T h i s p r a c t i c e has been observed  for-  i n o t h e r i n d u s t r i e s and  i s more a f u n c t i o n o f i n d u s t r y s t r u c t u r e than t y p e .  Kindleberger says:  Indeed, i n c o n c e n t r a t e d i n d u s t r i e s t h e r e i s p r e s s u r e f o r each f i r m to develop a p o s i t i o n i n each i m p o r t a n t o r p o t e n t i a l l y i m p o r t a n t  115  m a r k e t — r e g a r d l e s s o f the r a t e o f p r o f i t o b t a i n a b l e i n a b s o l u t e t e r m s — t o p r e v e n t any of i t s few c o m p e t i t o r s from o b t a i n i n g a subs t a n t i a l advantage w h i c h i t c o u l d put to use over a w i d e r a r e a . 2 4  25 T h i s o b s e r v a t i o n has been s u p p o r t e d by Vernon 26 by K n i c k e r b o c k e r , who  and i n v e s t i g a t e d i n depth  p r o v i d e s e m p i r i c a l s u p p o r t f o r the argument. GOVERNMENT INTERFERENCE  The a c c e p t a n c e o f growth as a g o a l i n b a n k i n g does n o t i n i t s e l f e x p l a i n why  the banks would expand abroad.  o p p o r t u n i t i e s i n domestic f i n a n c i a l m a r k e t s .  There may w e l l be  attractive  We have a l r e a d y argued  t h a t e x p a n s i o n of a s h a r e o f t h e domestic b a n k i n g market i s v e r y c u l t f o r a s i n g l e bank.  However we a r e now  diffi-  t a l k i n g about e x p a n s i o n i n t o  near b a n k i n g o p e r a t i o n s . o r ' c o n g e n e r i c s e r v i c e s ' (meaning b a n k i n g r e l a t e d services).  There i s a l u c r a t i v e market t o be e x p l o i t e d i n Canada, how-  e v e r , the c h a r t e r e d banks have t a k e n o n l y v e r y t e n t a t i v e s t e p s i n t h i s area.  The r e a s o n i s another  o f government i n t e r f e r e n c e .  'market i m p e r f e c t i o n , ' t h i s time i n the form The Bank A c t of 1967 i s v e r y ' i f f y ' on t h e  s u b j e c t o f d i v e r s i f i c a t i o n by the banks i n t o o t h e r f i n a n c i a l areas.  P r i o r t o 1967  service  the c h a r t e r e d banks had been p r o h i b i t e d from owning  t h e shares of another c h a r t e r e d bank and i t has a l s o been r u l e d t h a t owning more than 50 per cent of the s h a r e s o f any o t h e r c o r p o r a t i o n , whether f i n a n c i a l o r n o t , would be beyond the powers o f a bank. The 1964 R o y a l Commission on Banking and F i n a n c e l o o k e d c l o s e l y a t t h i s i s s u e and recommended t h a t e x i s t i n g p r o v i s i o n s be t i g h t e n e d .  Most  of the r e s t r i c t i v e P o r t e r recommendations were not heeded b u t the f o l l o w 27 i n g ownership p r o v i s i o n s were i n c l u d e d i n the new Bank a c t :  116  a)  a l i m i t of 10 per cent was placed on the ownership of a trust or mortgage loan company or other deposit taking i n s t i t u t i o n ; and  b)  a l i m i t of 50 per cent applies to a l l other companies unless the cost of shares i s over $5 m i l l i o n i n which case the l i m i t i s 10 per cent.  The above regulations c e r t a i n l y i n h i b i t the a b i l i t y of the banks to expand i n Canada. An interesting side issue i s the fact that American banks are not barred from the Canadian congeneric market.  Several major U.S. banks  have entered Canadian f i n a n c i a l markets and Canadian bankers are p u b l i c l y expressing disapproval of the present permissible posture i n Ottawa. An example i s the Bank of America which i s closely related to Power Corporation i n Canadian f i n a n c i a l markets.  BankAmerica now  con-  t r o l s 20 per cent of Montreat Trust, 5 per cent of Investors Group, and about 49 per cent of North Continent C a p i t a l (a Vancouver based indust r i a l leasing firm). D i v e r s i f i c a t i o n into Canadian f i n a n c i a l markets i s going to be a hotly debated subject during the 1977 decennial r e v i s i o n of the Bank Act. The point of relevance to this study i s that chartered banks, given that they want to expand and grow, have chosen to seek growth abroad. U n t i l recently there has been similar interference i n U.S. banking.  Up u n t i l the passage of the new Bank Holding Company Act i n 1970,  expansion of U.S. banks into near banking areas was d i f f i c u l t .  Since  1970 however, acquisition of non-bank a f f i l i a t e s by bank holding companies has been on firmer l e g a l ground.  This has predictably led to a rapid  expansion by the U.S. banks into a wide range of f i n a n c i a l a c t i v i t i e s , from f i n a n c e  companies to general insurance underwriting.  The l i s t of  permissible non-bank a c t i v i t i e s for U.S. bank holding companies has grown rapidly i n the three years since the 1970 Amendments were passed. 28 The current l i s t of approved a c t i v i t i e s as at June, 1974, includes: a)  finance companies;  b)  mortgage companies;  c)  factoring companies;  d)  dealers i n banker's  e)  credit card companies;  f)  operating an i n d u s t r i a l bank;  g)  trust companies;  h)  servicing loans;  i)  providing p o r t f o l i o investment  j)  furnishing general economic information and advice;  k)  investment  acceptances;  advice;  adviser to Real Estate Investment Trusts and to i n -  vestment companies under the Investment Company Act of 1940; 1)  f u l l pay-out leasing of personal and r e a l property;  m)  investments  n)  providing bookkeeping or data processing services;  o)  acting as insurance agent or b r o k e r — p r i m a r i l y i n connection  i n community welfare projects;  with credit extensions; p)  underwriting credit l i f e , accident, and health insurance;  q)  dealing i n gold and s i l v e r b u l l i o n and coins; and  r)  courier services f o r investments acter.  of a banking or f i n a n c i a l char-  118 The McFadden Act passed i n the 1920's which prohibits branching across state l i n e s represents a major form of government interference. It i s this type of l e g i s l a t i o n , based upon populist fears of a conspiracy of giant banking groups against small business interests and the r u r a l community (especially the farmer), that l e d to the unit banking structure i n the U.S. The above l e g i s l a t i v e framework would suggest that U.S. banking growth would have to occur i n the foreign sector.  The following comment  by Kindleberger (surprisingly) provides support: Indeed so r e s t r i c t i v e of s p a t i a l expansion by American banks i s popu l i s t sentiment inside the United States that i t may force expansion abroad by blocking i t at home, just as a n t i t r u s t laws are believed to do i n industry.29  This comment contains an underlying assumption that banks need to grow which i s consistent with the views of this study. U.S. banking laws are slowly being l i b e r a l i z e d and i t w i l l be i n teresting to see whether a removal of the b a r r i e r to domestic expansion and d i v e r s i f i c a t i o n w i l l divert attention away from the international sector.  This p o s s i b i l i t y w i l l be explored i n Chapter Nine below. At the present time however there remains s i g n i f i c a n t b a r r i e r s  to the expansion of U.S. banking at home.  Under the Bank Holding Company  Act the Federal Reserve Bank has the power to turn down acquisitions. Business Week reports that the BankAmerica,  C i t i c o r p , Bankers Trust, and  F i r s t Chicago ( a l l among the top ten U.S. banks) have had planned acqui- , . 30 s i t i o n turned down i n recent months. The various attempts i n the mid-1960's by the U.S. government  119  t o d e a l w i t h a c o n t i n u i n g b a l a n c e of payments d e f i c i t r e p r e s e n t s a n o t h e r form o f ' i n t e r f e r e n c e ' t h a t i n f l u e n c e d the growth o f f o r e i g n b a n k i n g . I n 1963, the I n t e r e s t E q u i l i z a t i o n Tax was i n t r o d u c e d .  Designed t o r e -  duce p r i v a t e c a p i t a l o u t f l o w s , i t p l a c e d a p r o h i b i t i v e t a x on the p u r chase o f f o r e i g n s t o c k s and bonds by U.S.  citizens.  The e f f e c t o f the  t a x was t o s u b s t a n t i a l l y reduce the a b i l i t y o f f o r e i g n i n s t i t u t i o n s c o r p o r a t i o n s t o s e l l s e c u r i t i e s i n U.S.  f i n a n c i a l markets.  Faced w i t h  a c l o s u r e of t h i s market, the f o r e i g n b o r r o w e r s t u r n e d t o the banks.  and  U.S.  " I t has been e s t i m a t e d t h a t p o s s i b l y as much as t w o - t h i r d s o f  a l l new commercial and i n d u s t r i a l l o a n s i n New York d u r i n g t h e 1963-64 31 p e r i o d were made t o f o r e i g n e r s . "  Thus i n : c l o s i n g one s o u r c e o f c a p i t a l ,  government i n t e r f e r e n c e had s w i f t l y opened a n o t h e r .  I n 1965 the govern-  ment i n t r o d u c e d a new b a l a n c e of payments program d e s i g n e d t o curb the g r a n t i n g of bank l o a n s t o f o r e i g n b o r r o w e r s .  Banks i n e f f e c t v o l u n -  t a r i l y p l e d g e d t o l i m i t the volume o f c r e d i t t h a t t h e y extended abroad t o 109 per c e n t o f the 1964 t o t a l .  E f f e c t i v e l y c u t o f f from s e r v i n g a  w o r l d market from a domestic b a s e , the banks soon r e a l i z e d t h a t , i f they w i s h e d t o c o n t i n u e t h i s a c t i v i t y they would have t o tap the E u r o d o l l a r market.  " S i n c e , by d e f i n i t i o n , E u r o d o l l a r s a r e h e l d o u t s i d e the U n i t e d  S t a t e s , t h e r e was a major i n c e n t i v e t o open o f f i c e s o v e r s e a s i n o r d e r t o 32 p a r t i c i p a t e d i r e c t l y i n t h i s a c t i v e market." One American banker has e x p r e s s e d what c o u l d w e l l be t h e predominant b a n k i n g v i e w of government i n t e r f e r e n c e . I t i s not out of p l a c e h e r e t o r e c a l l t h a t one of the d e t e r m i n i n g f a c t o r s f o r the e x i s t e n c e o f the Euro d o l l a r market i s the r e g u l a t i o n  120  that prevents banks i n the United States from paying for money the price that market conditions warrant.33  This comment r e f l e c t s the view that yet another act of interference, Regulation Q, was partly responsible for the development of the Eurod o l l a r market.  Under Regulation Q the U.S. banks are subject to an i n -  terest c e i l i n g on time deposits and are prohibited from paying interest on chequeing accounts.  Evidence that U.S. Government interference i n f l u -  ences foreign operations i s often provided by senior bankers.  The f o l -  lowing comment, from the 1971 annual report of J . P. Morgan and Company is illustrative: As has been the case for several years, r e s t r i c t i o n s imposed by U.S. authorities for balance of payments reasons strongly influence the pattern of our a c t i v i t i e s i n t h i s (international) f i e l d . 3 4  Foreign expansion was also spurred on by the Federal Reserve imposed 'credit crunch' of 1969-70.  At a time when U.S. banks were  experiencing l i q u i d i t y problems i n their domestic operations i t was important  to be able to tap the Eurodollar market.  Thus foreign branches  of U.S. banks were able to borrow i n the Euro d o l l a r market and re-lend to the U.S. head o f f i c e to ease l i q u i d i t y pressure.  At least one author  has claimed that the Euro d o l l a r market provided, "the motivation behind the setting up of most branches opened by American banks i n London i n the l a s t 10-12 y e a r s . "  35  U.S. l e g i s l a t i o n has also interfered with the a b i l i t y of banks to select the geographical location of banking outlets.  Under the pro-  visions of the Federal Reserve Act (Sec. 25), permission from the Board  121 of Governors must be obtained before a bank branch may be established i n 36  a foreign country.  This authority also extends to the investment by  member banks i n the stock of corporations engaged p r i n c i p a l l y i n i n t e r national or foreign banking.  Through the use of this power the Federal  Reserve Board has been able to influence the d i r e c t i o n of banking expansion.  In 1968 the Board was c l e a r l y discouraging expansion i n developed  countries, preferring instead that the banks e s t a b l i s h i n developing economies. Equity investment i n developed countries of continental Western Europe w i l l not, while the new provisions remain i n e f f e c t , be approved by the Board, unless circumstances c l e a r l y demonstrate that the transaction w i l l not be detrimental to the U.S. balance of payments. But, applications to make equity investments elsewhere w i l l be considered on their merits.37 It i s an i n t e r e s t i n g fact that the various U.S. government r e s t r i c tions on c a p i t a l flows have had an i n d i r e c t influence on the foreign a c t i v i t i e s of the Canadian banks. In March 1968 the Canadian government was able to obtain almost complete exemption from the U.S. c a p i t a l r e s t r a i n t program.  However as  part of the p r i c e for obtaining exemption, the government agreed to impose r e s t r i c t i o n s designed to prevent the 'flow through' of U.S. funds to 38 t h i r d countries. 1.  The guidelines read as follows:  The t o t a l of a bank's foreign currency claims on residents of countries other than Canada and the United States should not r i s e above the l e v e l of the end of February 1968 unless the i n crease i s accompanied by an equal increase i n i t s t o t a l foreign  122 currency l i a b i l i t i e s to residents of countries other than Canada and the United States. 2.  If there should be a decline i n the t o t a l of a bank's foreign currency l i a b i l i t i e s to residents of countries other than Canada and the United States from the l e v e l at the end of February  1968  the bank should achieve an equal reduction i n i t s t o t a l foreign currency claims on residents of countries other than Canada and the United States as quickly as the l i q u i d i t y of such assets w i l l permit. 3.  Each bank should allow an increase i n i t s U.S.  dollar  liabilities  to residents of the United States from the l e v e l at the end of February 1968 only to the extent that the increase i s f u l l y matched by the sum of (1) the increase from that date i n the bank's U.S.  d o l l a r claims on residents of Canada, (2) the de-  crease from that date i n the bank's U.S.  dollar l i a b i l i t i e s to  residents of Canada, and (3) the decrease from that date i n the bank's own spot position i n U.S.  dollars.  Freedman has argued that the above guidelines strongly influenced 39 the conduct of the chartered banks.  The f i r s t two guidelines prevented  the chartered banks from s o l i c i t i n g deposits from U.S. vesting the funds outside North America.  residents and i n -  Thus the banks could no longer  expand their Euro dollar a c t i v i t i e s from a domestic base.  If continued  growth was to be achieved i t was necessary to establish foreign branches in order to s o l i c i t an adequate deposit base. that U.S.  Thus i t can be argued  government 'interference' had an i n d i r e c t effect on the a b i l i t y  123  of the c h a r t e r e d  banks t o c o n t i n u e t h e i r growth.  i n t e r f e r e n c e was t o encourage t h e c h a r t e r e d t i o n s i n Europe i n order  The e f f e c t o f t h i s  banks t o expand t h e i r  opera-  to tap the Euro d o l l a r market.  SUPERIOR KNOWLEDGE THEORY  We have thus f a r e s t a b l i s h e d t h a t t h e r e a r e grounds f o r b e l i e v i n g t h a t t h e r e a r e l i n k s between t h e expansion o f f o r e i g n banking and direct  investment t h e o r i e s t h a t focus  on o l i g o p o l i s t i c b e h a v i o r and the  m a x i m i z a t i o n o f growth. However, t h e main l i n e o f d i r e c t investment theory superior  focuses  on  'knowledge' and a c c o r d i n g l y , we w i l l now l o o k f o r some s i m i l a r i -  t i e s i n the 'knowledge' a r e a  t h a t apply  t o banking.  I t should  bered o f c o u r s e t h a t s u p e r i o r knowledge a l s o r e p r e s e n t s p e r f e c t l y competitive The  market  be remem-  a d e v i a t i o n from  conditions.  fundamental argument advanced by t h e 'knowledge' t h e o r i s t s  i s t h a t some form o f advantage must e x i s t t h a t a l l o w s operate more p r o f i t a b l y than a domestic c o m p e t i t o r . i n t h i s area i s mixed t o say t h e l e a s t .  a foreign f i r m to The banking e v i d e n c e  Canadian c h a r t e r e d  banks a r e  not r e q u i r e d , nor do they deem i t n e c e s s a r y , t o r e p o r t e a r n i n g s from foreign operations. generalities.  The r e f e r e n c e s  t o p r o f i t s a r e always v e i l e d i n  Witness the f o l l o w i n g quote from t h e Canadian Bankers  Association:  The banks' i n t e r n a t i o n a l o p e r a t i o n s have become i n c r e a s i n g l y import a n t t o t h e i r b a l a n c e o f revenue. I n 1955, o n l y about 11% o f t o t a l a s s e t s c o n s i s t e d o f f o r e i g n c u r r e n c y a s s e t s ; whereas by 1960 t h i s 40 had i n c r e a s e d t o 16%; and by 1970 t o 30%.  124 The  statement c e r t a i n l y l e a d s one  to b e l i e v e that f o r e i g n  a r e p r o f i t a b l e ; but the e v i d e n c e i s not As p a r t of our f i e l d s t u d y , we t i o n with senior executives major c h a r t e r e d banks.  conclusive. explored  the p r o f i t a b i l i t y ques-  i n the i n t e r n a t i o n a l d i v i s i o n s of the  No one was  In t h i s connection  i t was  were about as p r o f i t a b l e  mentioned t h a t t h e r e a r e major  d i f f i c u l t i e s i n a l l o c a t i n g c o s t s and measuring the a c t u a l p r o f i t between domestic and  foreign  five  w i l l i n g t o r e v e a l a c t u a l f i g u r e s but  t h e r e were i n d i c a t i o n s t h a t f o r e i g n o p e r a t i o n s as d o m e s t i c .  operations  split  operations.  There appears t o be good r e a s o n t o assume t h a t Canadian and banks do i n f a c t have some c o m p e t i t i v e f o r e i g n markets.  We  advantages i n o p e r a t i n g  asked i n t e r n a t i o n a l o p e r a t i o n s '  banks had  any  'advantage' t h a t a l l o w e d  The  answer was:  I n c e r t a i n f o r e i g n markets the s i z e and  t i v e management was  in  chartered  them t o o p e r a t e more p r o f i t a b l y  i n f o r e i g n markets t h a n i n d i g e n o u s banks. cases."  in certain  executives  Canada's f i v e l a r g e c h a r t e r e d banks i f t h e y thought t h a t the  U.S.  thought t o r e p r e s e n t  "yes, i n some  reputation f o r conserva-  an advantage.  However i t was  unanimously agreed t h a t t h i s advantage d i d not c a r r y over i n t o major w o r l d markets.  New  Y o r k and London were i d e n t i f i e d as two examples of markets  where the c h a r t e r e d banks had no  advantage.  Whether or not the s i z e advantage i s t r a n s l a t e d i n t o s u p e r i o r p r o f i t s remains open t o q u e s t i o n .  The  evidence i s again  conflicting.  Here i s a comment c o n c e r n i n g the p r o f i t s i s s u e by J . P. K o s z u l ,  Vice-  P r e s i d e n t , C i t i c o r p : "The  r e s u l t of a l l t h i s ( l a c k of a l o c a l  deposit  base) i s t h a t t h e i r (U.S.  bank's) p r o f i t margins tend t o be more l i m i t e d  125 than those of their indigenous competitors."  41  This comment appears to  be somewhat at variance with a recent report that Citibank earns a higher 42 than proportional share of i t s p r o f i t s from overseas operations. Much of the foreign business of the U.S.  and Canadian banks i s  centred i n the Euro-dollar market and there i s good evidence that spreads are very thin i n this highly competitive market. f i c u l t to see how  On the whole i t i s d i f -  the Kindleberger/Hymer thesis has much explanatory  power with respect to behavior i n the banking industry.  The crux of the  theory depends on a superior ' I ' i n the formulation:  There i s no convincing evidence available that i t applies to banking.  On  the other hand this writer concedes that, because of the absolute unavaila b i l i t y of data i t i s probably not possible to b u i l d a convincing empiric a l case against the theory. While i t i s not possible to obtain conclusive p r o f i t figures from the foreign operations of U.S. dence.  banks, there are scattered b i t s of e v i -  Walter Wriston, Chairman of C i t i c o r p reports that foreign earn-  ings as a percentage of t o t a l earnings i n 1972  and 1973  t o t a l l e d 50 per  43 cent and 60 per cent respectively.  Given that less than 50 per cent  of C i t i c o r p ' s assets are invested abroad i t appears that foreign operations were more p r o f i t a b l e than domestic operations, at least i n 1972 and  1973. Some of the major U.S.  banks now v o l u n t a r i l y offer more informa-  tion about their foreign operations.  The Chase Manhattan Bank, i n  126 p a r t i c u l a r , appears to have adopted a policy of more adequate disclosure.  In September, recognizing the desire by investors and others f o r more information about Chase, we gave a presentation to the investment community with unprecedented d e t a i l about our operations and p o l i c i e s . This year's annual report underscores our continued determination to provide broader information to shareholders and the p u b l i c — i n c l u d i n g many new facts i n the f i n a n c i a l review and e l s e where. 44  Based on information provided by Chase i t now appears that the rate of return on foreign assets approximates the rate of return on 4 5  domestic assets: 1973 %  1972  %  1971 %  1970 %  foreign p r o f i t s as a % of total profits  Al  34  21  17  foreign assets as a % of t o t a l assets  39  34  28.9  27.5  Furthermore, a geographical breakdown of assets and net income reveals the following:  U.S. 1972 1973  Europe/Africa 1972 1973  assets as a % of t o t a l  66  61  17  18  net income as a % of t o t a l  66  59  12  17  Asia/Middle East 1972 1973  11  Caribbean/Latn America/Canada 1972 1973 11  12  13  13  The following are the contributions of foreign operations to other major U.S. banks:  46  127  BankAmerica 1972 1973  Manufacturers Hanover 1972 1973  J.P. Morgan 1972 1973  Bankers Trust 1972 1973  % foreign p r o f i t s  28  32  33  33  35  46  35  45  % foreign assets  31  36  29  34  N/A  N/A  N/A  N/A  In summary, i t appears f a i r to say that foreign operations of the U.S.  banks have not generated 'excess' p r o f i t s nor have they harmed the  o v e r a l l p r o f i t performance of the U.S. U.S.  banks.  From the point of view of  bankers this i s the relevant v a r i a b l e . However, the t r u l y relevant figures i n this issue are d e f i n i t e l y  not available; that would be a comparison not of foreign/domestic ratios of the Canadian or U.S.  profit  banks but a comparison of the p r o f i t r a t i o  of an indigenous bank i n — s a y France—with the p r o f i t s generated by a Canadian or U.S.  bank operating i n France.  In order for the  Kindleberger/  Hymer analysis to hold, i t i s necessary to i l l u s t r a t e that a foreign bank can make s u f f i c i e n t p r o f i t s i n the host country to exceed the regular p r o f i t s of an indigenous bank after allowing for the cost of the  inherent  disadvantage of operating i n an unfamiliar market. Some authors (including Aliber) argue that the U.S.  banks have a  47 competitive  edge i n i n t e r n a t i o n a l markets.  The reasons given are s i z e ,  leaner cost structure and use of more advanced technology. the U.S.  banks are accustomed to a competitive  atmosphere at home unlike  the 'clubby' arrangements of some European bankers. tages also apply to the Canadian banks. t a i n l y met.  In addition  Some of these advan-  The size q u a l i f i c a t i o n i s cer-  There i s also not much difference between the interest  spread (markup) i n Canada and the U.S.  rate  A comparison between the prime  128  lending rate and interest rates paid on deposits has often been used by analysts i n determining the 'leanness' of a bank's cost structure Canadian and U.S. banks show up well i n these comparisons.  While admit-  tedly well behind the U.S. i n the use of computer technology, Canada probably has an advantage i n t h i s f i e l d over banks i n other countries. The requirement of the Kindleberger/Hymer theory that p r o f i t s from direct investment be higher than a l l alternative methods of penet r a t i n g the foreign market would not seem to apply i n general to the banking industry.  Vernon has pointed out that d i r e c t investment i s the  only route for service industries.  "When s k i l l i n purveying services  i s involved, i t i s especially d i f f i c u l t to use the export route i n order to test the marketability of what one has to o f f e r .  Here again one has  to test one's marketing advantage by setting up a subsidiary abroad. This i s what lay behind the bold expansion of . . . U.S. banking organ48 izations a f t e r W.W.I." This comment however does not deal with the more d i f f i c u l t question of why the banks do not s e l l their superior knowledge v i a a l i c e n s i n g arrangement.  Perhaps an example of the Canadian and U.S.  t r a t i o n of the medium term loan market w i l l shed some l i g h t ficulty  involved i n l i c e n s i n g .  pene-  on the d i f -  Walter Wriston (Chairman of C i t i c o r p ) ,  once observed that European bankers thought medium term loans were 49 'naughty.'  This observation led to an advantage by U.S. and Canadian  banks who were f a m i l i a r with medium term financing. P r i o r to the 1960's European industry seemed to have no need for medium term bank c r e d i t .  However for a variety of reasons i n the mid  129  1960's t r a d i t i o n a l s o u r c e s o f f i n a n c i n g were i n a d e q u a t e t o s u p p o r t expanding European b u s i n e s s .  European bankers were u n w i l l i n g t o f i l l  the gap so U.S. and Canadian bankers stepped i n . W i t h i n a v e r y s h o r t p e r i o d o f time t h e market was booming.  One q u e s t i o n t h a t f a l l s o u t o f  t h i s e x p e r i e n c e i s : Why d i d t h e U.S. and/or Canadian banks n o t approach European bankers w i t h a package d e s i g n e d t o a l l o w t h e l a t t e r t o e s t a b l i s h a market f o r medium term bank l o a n s ?  Could n o t a s a t i s f a c t o r y  l i c e n s i n g arrangement be e s t a b l i s h e d t h a t would g e n e r a t e p r o f i t s f o r both parties?  From t h e p o i n t o f v i e w o f t h e l i c e n s o r s t h e n e c e s s i t y  of making a d i r e c t investment i n an u n f a m i l i a r f o r e i g n market c o u l d be avoided.  On t h e o t h e r hand, t h e l i c e n s e e s had a w e l l e s t a b l i s h e d  b r a n c h network t h a t g e n e r a t e d a good s o u r c e o f f u n d s .  local  So why was  l i c e n s i n g not the solution?  PREFERENCE FOR DIRECT INVESTMENT T h i s w r i t e r would suggest t h a t t h e r e a r e a t l e a s t t h r e e important f a c t o r s that c o n t r i b u t e to the preference f o r d i r e c t investment: (a) The f i r s t i s t h e d i f f i c u l t y i n p l a c i n g a p r i c e on some i l l - d e f i n e d t e c h n o l o g y p o s s e s s e d by t h e l i c e n s o r .  The concept o f t e c h n o l o g y encom-  passes t e c h n i c a l and m a n a g e r i a l know-how w h i c h i s embodied i n p h y s i c a l and human c a p i t a l and i n p u b l i s h e d documents.  (b) I n b a n k i n g , t e c h -  n o l o g y i s r e l a t i v e l y l e s s i m p o r t a n t than i n — s a y t h e m a n u f a c t u r i n g i n d u s try.  I n t h e medium term l o a n f i e l d f o r example, t h e r e a r e no s p e c i a l  ' s e c r e t s ' t h a t c o u l d be s o l d t o European b a n k e r s . of  d i f f e r i n g management p h i l o s o p h i e s .  The problem was one  130 European bankers have usually been asset lenders; they would go around a company's plant, kick the walls, look at the deed and the mortgage, and, then, on the basis of physical assets, make their decision on how much to lend and on what conditions. American bankers look at cash flow and lend on prospects.51  The difference i n lending philosophies i s obvious.  Based on  this observation i t i s d i f f i c u l t to conceive of a s i t u a t i o n where U.S. or Canadian bankers could have sold European bankers on the idea of medium term c r e d i t . the  Furthermore, that European bankers should pay for  idea (which i s r e a l l y a l l i t i s : i t i s not technology) i s unthinkable.  The problem i s based on differences among management men i n Europe and the United States.  I t i s a management gap and this management i s not a  commodity that can be sold v i a a l i c e n s i n g arrangement.  Perhaps one of  Servan Schreiber's observations about the U.S. manager i s relevant to that country's bankers: Americans are not more i n t e l l i g e n t than other people. Yet human f a c t o r s — t h e a b i l i t y to adapt e a s i l y , f l e x i b i l i t y of organizations, the creative power of teamwork—are the key to their success.52  It i s the 'human factor' or managerial philosophy that allows U.S. and Canadian bankers to p r o f i t a b l y exploit the medium term loan market i n Europe.  Here i s one U.S. banker's perception of h i s advantage:  American them (to which i s achieved  banks are deeply convinced that they bring something with the foreign market): new methods and sometimes a new s p i r i t , an asset i n i t s e l f , and this b e l i e f i s supported by success i n a l l parts of the world.53  This 'new s p i r i t ' cannot be sold; i t must be transferred v i a d i r e c t i n vestment .  131  The bankers interviewed unanimously agreed that no consideration had been given to entering foreign markets by any route other than direct investment. ment.  A l l banks wanted some element of control over their invest-  In cases where the equity investment was less than 100 per cent,  the banks seemed to emphasize the importance of 'having a team of their own men on the scene.' (c) The other important reason for preferring direct investment over licensing i s that the primary objective of the banks i s not p r o f i t maximization; i t i s growth of assets.  I t i s the writers hypothesis that,  given the opportunity to penetrate a foreign market that would y i e l d i d e n t i c a l p r o f i t s through either d i r e c t investment or l i c e n s i n g , the bank would choose direct investment every time.  The reason of course i s that  gross revenues and assets would show more growth i f the d i r e c t investment were undertaken.  While the l i c e n s i n g arrangement would (under the assump-  tion) r e s u l t i n the same net p r o f i t figure, there would be no appreciable effect on the balance sheet.  Given what i s said about growth (above) i t  i s clear that d i r e c t investment i s preferable to l i c e n s i n g . i s not unique to the banking industry.  This finding  Other multinational firms pursue  multiple objectives which include growth of sales and assets subject to some 'acceptable' p r o f i t constraints. CROSS HAULING A major requirement of a theory of foreign banking i s that i t explain the preponderence  of 'cross hauling' i n the industry.  There i s  absolutely no doubt that foreign banks would establish i n Canada i f the  132 b a n k i n g l e g i s l a t i o n were l i b e r a l i z e d .  The same would be t r u e i n t h e U.S.  and i n f a c t i s b e i n g o b s e r v e d i n some s t a t e s t h a t have opened t h e doors to f o r e i g n banks.  Both C a l i f o r n i a  and New Y o r k have s e v e r a l f o r e i g n  banks competing a g a i n s t domestic banks i n t h e r e t a i l and w h o l e s a l e markets.  A c c o r d i n g t o t h e H y m e r / K i n d l e b e r g e r t h e o r y t h e s e f o r e i g n banks  must have some 'knowledge' advantage t h a t t h e y can e x p l o i t .  I t i s some-  what d i f f i c u l t t o b e l i e v e t h a t t h e s e f o r e i g n banks have some advantage t h a t would a l l o w them t o g e n e r a t e l a r g e r p r o f i t s domestic c o m p e t i t o r s , e s p e c i a l l y i n t h e U.S. the market might p r o v i d e a p a r t i a l answer.  than the w e l l e s t a b l i s h e d  However t h e wide range o f F o r example Japanese banks  c o u l d c o n c e n t r a t e on p r o v i d i n g s e r v i c e t o Japanese f i r m s o p e r a t i n g i n Canada w h i l e European banks might f o c u s on f u n n e l i n g European funds i n t o r e a l e s t a t e and e q u i t y i n v e s t m e n t s i n Canada.  The t y p e o f 'knowledge'  advantage i n t h i s case would be b e t t e r ' c o n n e c t i o n s , ' a v a r i a b l e t h a t has always been i m p o r t a n t i n b a n k i n g . I t appears t o t h i s w r i t e r however t h a t a more g e n e r a l e x p l a n a t i o n o f c r o s s h a u l i n g i s p r o v i d e d by i n d u s t r y s t r u c t u r e .  I f banks i n  most c o u n t r i e s a r e l o c a t e d i n o l i g o p o l i s t i c markets t h e tendency f o r them would be t o expand o u t s i d e n a t i o n a l b o r d e r s .  Thus we would e x p e c t  t h a t , g i v e n t h e need f o r growth, L l o y d s Bank may be a t t r a c t e d t o t h e U.S., w h i l e BankAmerica would be a t t r a c t e d t o B r i t a i n . E n t r y i n t o t h e f o r e i g n market f r e e s a bank somewhat from t h e n e c e s s i t y of ' j o i n i n g  the l o c a l c l u b . '  w i t h o u t as much f e a r o f r e t a l i a t i o n .  Market s h a r e can be f o u g h t f o r Support f o r t h i s l i n e o f r e a s o n i n g  i s p r o v i d e d by Stephen Hymer who argues t h a t a l l dominant  oligopolists  133 have a s i m i l a r w o r l d wide market. o f o l i g o p o l y and  54  Cross h a u l i n g i s a n a t u r a l  the need f o r growth.  A somewhat p a r a d o x i c a l i m p l i c a t i o n  of c r o s s h a u l i n g i s t h a t i t i n t r o d u c e s a c o m p e t i t i v e t h a t would not  extension  element to b a n k i n g  e x i s t i f domestic markets were served o n l y by  indigenous  banks.  ALIBER'S THEORY  A l i b e r ' s theory may  c o n t a i n some f e a t u r e s t h a t a p p l y to b a n k i n g .  As mentioned above, h i s theory exchange r i s k , and i n U.S.  dollars.  on c a p i t a l market r e l a t i o n s h i p s ,  the market's p r e f e r e n c e The  market t h a t enables not r e l e v a n t .  focuses  first  U.S.  The U.S.  f e a t u r e , i n v o l v i n g a b i a s i n the  and  Canadian banks o b t a i n t h e i r funds  In f a c t i n Europe, the Canadian and U.S.  banks pay  The  banks o f t e n must  for certain currencies.  the U.S.  dollar.  than  the  f o r deposits.  r e l e v a n t p a r t of A l i b e r ' s theory  rency brand name' and  essentially  thus o b t a i n no advantage i n  o b t a i n t h e i r funds i n the i n t e r b a n k market a t r a t e s h i g h e r indigenous  securities  f i r m s to o b t a i n cheaper f i n a n c i n g , i s d e f i n i t e l y  from d e p o s i t o r s a t going market r a t e s , and t h i s area.  f o r h o l d i n g a s s e t s dominated  The U.S.  d o l l a r has  i s the market l o n g been the  preference 'preferred cur-  i t appears l o g i c a l to a s s o c i a t e the U.S.  This could represent  a s i g n i f i c a n t advantage.  advantage i s a l s o thought to have 'rubbed o f f  banks w i t h This  on the c h a r t e r e d banks:  World t r a d e — f a c i l i t a t e d by payments i n overseas U.S. d o l l a r s even between c o u n t r i e s w i t h s t r o n g c u r r e n c i e s of t h e i r own—and the need of m u l t i n a t i o n a l companies to o b t a i n arm's l e n g t h f i n a n c i n g have g i v e n Canadian banks the o p p o r t u n i t y to p a r t i c i p a t e i n overseas  134 markets on a large scale. Moreover since these same banks have had long experience dealing with U.S. multinationals and overseas U.S. d o l l a r s , they have b u i l t up a series of contacts that rank high i n world banking circles.55 This advantage could well lead to the U.S. and Canadian banks capturing a large share of the world market for d o l l a r deposits.  Some  support f o r this l i n e of reasoning was obtained from the bankers i n t e r viewed.  This type of advantage i s to be distinguished from the Kindle-  berger/Hymer type which translates d i r e c t l y into an increased p r o f i t margin.  The advantage that A l i b e r has i n mind does not imply that the cap-  ture of a large market share of deposits leads to superior p r o f i t margins. It may however lead to an increase i n absolute p r o f i t l e v e l s and c e r t a i n l y leads to growth i n assets. SUMMARY We opened this chapter by pointing out that a common feature of a l l theories of direct investment i s that they incorporate some departure from p e r f e c t l y competitive market conditions. In this sense the various theories are not i n great c o n f l i c t with each other.  I t i s t h i s writer's opinion that a l l of the theories add  something to an understanding of foreign banking.  The predominant forces  however are oligopoly, need for growth, and government interference. Advantages reaped from superior knowledge apply i n c e r t a i n s p e c i f i c cases and association with the preferred currency brand i s a favourable factor for U.S. and Canadian banks. observations  The next chapter w i l l attempt to draw these  together into a theory of i n t e r n a t i o n a l banking expansion.  135 Notes f o r Chapter Seven C. P. K i n d l e b e r g e r , American B u s i n e s s Abroad: S i x L e c t u r e s on D i r e c t Investment (New Haven: Y a l e U n i v e r s i t y P r e s s , 1969), p. 13. 1  2 P. A. Samuelson, Economics  ( T o r o n t o : M c G r a w - H i l l , 1968).  3 I b i d . , p. 567. "Are The Banks Over Extended?" B u s i n e s s Week (September 2 1 ,  4  1974) G. J . B e n s t o n , "Are L a r g e r Banks More E f f i c i e n t ? " The Banker (June 1974). 5  6  Ibid.  7  Ibid.  Q  L. K a l i s h and R. G i l b e r t , "An A n a l y s i s o f E f f i c i e n c y o f S c a l e and O r g a n i z a t i o n a l Form i n Commercial B a n k i n g , " J o u r n a l o f I n d u s t r i a l Economics ( J u l y 1973). 9  Ibid. Ibid.  Speech p r e s e n t e d t o t h e 1974 Canadian C o n f e r e n c e on B a n k i n g , T o r o n t o , September 61, 1974. 1 1  12 W. J . Baumol, B u s i n e s s B e h a v i o r V a l u e and Growth M a c M i l l a n Company, 1959), p. 45.  (New Y o r k :  F e d e r a l Reserve B u l l e t i n (June 1973) and (June 1974), and A n n u a l R e p o r t s from s e l e c t e d banks. 1 3  1 4  Quoted i n B u s i n e s s Week (September 21, 1974), p. 55.  J . K. G a l b r a i t h , The New I n d u s t r i a l S t a t e (New Y o r k : S i g n e t Books, 1967), pp. 181-82. 1 5  16 K i n d l e b e r g e r , American B u s i n e s s , p. 8. ^  Baumol, p. v i i i .  18 Quoted i n The Banker, v o l . 121, p. 661. 19  I b i d . , v o l . 123, p. 611.  136 20  L e w i s C a r r o l l , A l i c e I n Wonderland.  21 B u s i n e s s Week (September 2 1 , 1974). 2 2  Ibid.  ( F e b r u a r y 17, 1975), p. 74.  23 Ibid. 24 K i n d l e b e r g e r , American B u s i n e s s , p. 15. 25 R. Vernon, " F u t u r e o f M u l t i n a t i o n a l E n t e r p r i s e , " i n The I n t e r n a t i o n a l C o r p o r a t i o n , C. P. K i n d l e b e r g e r ( e d . ) . 26 F. T. K n i c k e r b o c k e r , O l i g o p o l i s t i c R e a c t i o n and M u l t i n a t i o n a l E n t e r p r i s e ( B o s t o n : H a r v a r d U n i v e r s i t y P r e s s , 1973). 27  J . H. P e r r y , "1967 Bank A c t R e v i s i o n s , " Canadian Banker (Summer  1967). 28  P. S. Rose, "The New I n t e r n a t i o n a l T h r u s t o f U.S. B a n k i n g , " Canadian Banker and ICB Review ( J u l y - A u g u s t 1974). 29 K i n d l e b e r g e r , American B u s i n e s s , p. 123. 10  B u s i n e s s Week (September 21, 1974), p. 52. 31 F. H e l d i n g , " M u l t i n a t i o n a l B a n k i n g S t r i v e s f o r I d e n t i t y , " Columbia J o u r n a l o f W o r l d B u s i n e s s (Nov.-Dec. 1968), p. 50. 32 I b i d . , p. 51. 33 J . P. K o s z u l , "American Banks i n Europe," i n The I n t e r n a t i o n a l C o r p o r a t i o n , ' C . P. K i n d l e b e r g e r ( e d . ) , p. 280. J . P. Morgan and Co. I n c o r p o r a t e d , 1971 Annual R e p o r t , p. 9. 35 K o s z u l , p. 280. 36 Board o f Governors o f t h e F e d e r a l Reserve System, Annual Report 1973. 37" Burrough's C l e a r i n g House (March 1968), p. 42. 38 C. Freedman, "The F o r e i g n C u r r e n c y B u s i n e s s o f t h e Canadian Banks: An E c o n o m e t r i c Study," Bank o f Canada S t a f f R e s e a r c h S t u d i e s , p. 24. 39 Ibid. 40  C.B.A. B u l l e t i n (May 1971), p. 2.  137 4 1  K o s z u l , p. 286.  4 2  S. Rose, "Why  4 3  The Banker ( J u l y 1974).  They C a l l i t "FAT CITY," F o r t u n e (March 1975).  44 Chase Manhattan C o r p o r a t i o n , 1973 Annual R e p o r t , p. 3. 4  TV. •  5  J  Ibid. 46 S e l e c t e d Annual R e p o r t s of the banks. 47 R. Z. A l i b e r , The I n t e r n a t i o n a l Money Game (New Y o r k : B a s i c Books I n c . , 1973). Vernon, " F u t u r e , " p. 376.  4 8  49 "The F i r s t R e a l I n t e r n a t i o n a l B a n k e r s , " F o r t u n e (December 1967), p. 196. S. H. Robock and K. Simmonds, I n t e r n a t i o n a l B u s i n e s s and M u l t i n a t i o n a l E n t e r p r i s e (Georgetown, Ont.: R. D. I r w i n , I n c . , 1973), p. 188. F o r t u n e (December 1967), p. 146. 52 Quoted i n Columbia J o u r n a l o f World B u s i n e s s (Nov.-Dec.  1968),  52. 53 K o s z u l , p. 289. ~* S. Hymer and R. Rowthorn, " M u l t i n a t i o n a l C o r p o r a t i o n s and I n t e r n a t i o n a l O l i g o p o l y : The Non American C h a l l e n g e , " i n The I n t e r n a t i o n a l C o r p o r a t i o n , C. P. K i n d l e b e r g e r ( e d . ) . 4  J . D a v i d s o n , "Canadian Banks T h i n k G l o b a l l y , " Canadian Banker and ICB Review, 1-74, p. 9.  Chapter Eight  A THEORY OF INTERNATIONAL BANKING EXPANSION  It i s our hypothesis that the financing of foreign trade and c a p i t a l flows no longer represents the primary explanation for the growth of international banking.  These factors, to be sure, s t i l l have an i n f l u -  ence but expansion of foreign banking i s proceeding somewhat independently of foreign trade.  The banking industry i s no longer a 'camp follower' of  i t s domestic customers.  " I f you want to sum up international banking i n  one sentence," says Geoff Styles, Deputy General Manager, of The Royal Bank of Canada, "you could say that Canadian banks have changed from banks with international departments to international banks which happen to have their head o f f i c e s i n Canada.""'"  In other words the banks have be-  come multinational corporations. It appears that U.S. regulatory bodies have become aware of the changing trend i n the international operations of U.S. banks.  An o f f i c e r  of the Federal Reserve Bank has observed: "In more recent years, however, U.S. banking organizations have d i v e r s i f i e d the scope of services a v a i l able to their overseas customers and with these services have t r i e d to a t t r a c t new customers from the countries i n which they are doing business." It i s the purpose of this chapter to develop a theory that w i l l explain the above process. The primary determinants of the expansion of foreign banking for at least the past f i v e to ten years have been the market imperfections discussed i n the preceding chapter.  A model (Figure 8-1)  138  encompassing  139  OLIGOPOLISTIC BANKING INDUSTRY  NEED FOR GROWTH GOVERNMENT INTERFERENCE  ASSOCIATION WITH U.S. DOLLAR  SUPERIOR KNOWLEDGE  F i g u r e 8-1 MODEL OF FOREIGN EXPANSION  140 the v a r i a b l e s d i s c u s s e d i n Chapter Seven has been developed t o g r a p h i c a l l y i l l u s t r a t e t h e major f o r c e s l e a d i n g t o i n v e s t m e n t o v e r s e a s .  The diagram  i s meant t o i l l u s t r a t e t h a t t h e p r i m a r y f o r c e b e h i n d o v e r s e a s e x p a n s i o n i s t h e o l i g o p o l i s t i c i n d u s t r y s t r u c t u r e and a need f o r growth. I n c l u s i o n o f growth as a key v a r i a b l e i s t h e r e s u l t  of a wealth  of i m p r e s s i o n i s t i c e v i d e n c e a v a i l a b l e . f r o m v a r i o u s p u b l i s h e d s o u r c e s . Some o f t h i s e v i d e n c e was p r e s e n t e d i n t h e p r e v i o u s c h a p t e r .  Prominent  o b s e r v e r s o f t h e b a n k i n g scene have a l s o been impressed by t h e i m p o r t a n c e bankers p l a c e on growth.  P a u l N a d l e r , f o r example, has s t a t e d t h a t :  Bankers a r e always k i d d e d about t h e i r o b s e s s i o n w i t h growth r a t h e r than p r o f i t s . F o r i t appears t h a t many bankers would r a t h e r jump 20 or 30 p l a c e s on t h e American Banker's l i s t o f t h e top 10,000 banks i n o r d e r o f s i z e than i n c r e a s e e a r n i n g s p e r share by a s i z e a b l e amount. 3  I n c l u s i o n o f t h e o l i g o p o l i s t i c i n d u s t r y s t r u c t u r e as a major v a r i a b l e has been i n f l u e n c e d by Caves who: h y p o t h e s i z e d t h a t f i r m s i n o l i g o p o l i s t i c i n d u s t r i e s i n each c o u n t r y encounter l i m i t s t o i n c r e a s i n g t h e s a l e s o f t h e i r t r a d i t i o n a l p r o d u c t i n t h e domestic market; t o c o n t i n u e t h e i r growth r a t e , t h e y must choose between expanding a c r o s s a p r o d u c t boundary i n t h e domestic market o r expanding a c r o s s a n a t i o n a l b o r d e r w i t h t h e i r t r a d i t i o n a l product. 4  As w i l l be demonstrated below, t h e c h o i c e f o r t h e banks h a s . l a r g e l y been i n f l u e n c e d by a n o t h e r major v a r i a b l e : government i n t e r f e r e n c e . Two o t h e r v a r i a b l e s t h a t r e c e i v e l e s s w e i g h t than t h e 'need f o r growth' b u t n e v e r t h e l e s s a r e q u i t e i m p o r t a n t , a r e government i n t e r f e r e n c e and a p r o f i t c o n s t r a i n t .  Note t h a t t h e term ' i n t e r f e r e n c e ' i s used t o  i n d i c a t e an observed governmental tendency t o meddle i n t h e a f f a i r s o f  141 the banking industry.  In general, this 'interference,' or 'meddling' i f  you w i l l , represents a departure from p e r f e c t l y competitive market conditions i n the banking industry.  The reader should note that no judgment  i s being passed on the d e s i r a b i l i t y or otherwise of this government tendency.  Clearly, some forms of government interference may, on net be  desirable, while other forms may not. It i s important to note also that p r o f i t i s included i n the model as a constraint rather than as a goal.  This i s consistent with  theories that stress growth as the main objective of a firm.  From the  evidence we have been able to locate on the banking industry, i t appears reasonable to argue that the p r o f i t constraint on foreign operations i s that the r a t i o of foreign p r o f i t s to foreign assets employed be similar to the domestic r a t i o . . That i s , i f foreign assets represent  50 per cent  of t o t a l assets then foreign p r o f i t s should also represent roughly 50 per cent of t o t a l p r o f i t s . Before discussing the model further we should perhaps c l a r i f y some of the concepts underlying the adoption of the oligopoly-growth model.  The discussion that follows has been influenced i n no small way  by the writings of W. J . Baumol who hypothesized that o l i g o p o l i s t s t y p i c a l l y seek to maximize their sales subject to a minimum p r o f i t constraint.  5  By simply substituting asset growth rather than sales growth  as the objective i n the banking industry we should be able to adapt Baumol's work for our purposes. Figure 8-2 i s a s t a t i c model of the variables interacting i n the growth-profit  constraint part of our primary model (Figure 8-1).  142  ASSETS  DEBT ASSETS  E»5  D3  4-  D.2  Dl Po P i ? F i g u r e 8-2  2  P 3  PROFITS  MODEL OF PROFIT CONSTRAINT 1.  A^ P^ D^  100 p e r cent e q u i t y f i n a n c i n g .  2.  ^2 ^4 ^2  V °£i-t  3.  A^ P^ Dg  h i g h l y levered p o s i t i o n : regulatory bodies  T  maximization point. restrict  growth. 4.  A^ P 2 D^  5.  A,. PQ D,. beyond t h i s p o i n t t h e bank i s t e c h n i c a l l y i n s o l v e n t .  i n t e r n a l l y imposed p r o f i t c o n s t r a i n t s .  143 A c c o r d i n g t o the diagram, p r o f i t s a r e maximized a t a l e v e l o f P4 w i t h a s s e t s o f A2 and a d e b t / a s s e t r a t i o o f D2.  Asset maximization  i s unde-  f i n e d i n an a b s o l u t e sense but c l e a r l y cannot exceed A5 where the a s s e t r a t i o o f 1.00,  o t h e r w i s e the f i r m would be i n s o l v e n t .  t i o n a l purposes, asset maximization  o c c u r s a t e i t h e r A3 o r A4.  reason f o r i n d e c i s i o n on t h i s statement i s t h a t t h e r e a r e two c o n s t r a i n t s t h a t impinge on the d e t e r m i n a t i o n o f a s s e t  a)  operaThe  forms o f  maximization:  P2 w h i c h i s an i n t e r n a l l y imposed p r o f i t c o n s t r a i n t ( t o be cussed b e l o w ) ,  b)  For  debt/  dis-  and  D3 which i s a maximum d e b t / a s s e t c o n s t r a i n t imposed by r e g u l a t o r y b o d i e s and/or the investment  community.  There i s no c o m p e l l i n g reason t o b e l i e v e t h a t one o r the o t h e r c o n s t r a i n t s h o u l d always be dominant. nant i n F i g u r e 8-2  We  have shown the p r o f i t c o n s t r a i n t t o be domi-  because i t r e p r e s e n t s what i s g o i n g on today.  the g o v e r n m e n t s — p a r t i c u l a r l y the U n i t e d S t a t e s — a r e s t a r t i n g about h i g h d e b t / a s s e t r a t i o s and i t may  However  to w o r r y  w e l l be t h a t t h i s c o n s t r a i n t w i l l  soon dominate t h e d e t e r m i n a t i o n of maximum a s s e t s i z e .  This feature w i l l  be d i s c u s s e d more f u l l y i n Chapter N i n e . F i g u r e 8-3 t i o n of bank s i z e .  r e p r e s e n t s a n u m e r i c a l example o f the s t a t i c  determina-  I t i s our c o n t e n t i o n t h a t Bank D would be s e l e c t e d by  bank management as the o p t i m a l s i z e a l t h o u g h the r a t i o n a l economic would p i c k Bank C. F i g u r e 8-3  man  Perhaps some j u s t i f i c a t i o n o f the assumptions made i n  i s i n order.  We have assumed t h a t the banks i n our example a r e  p r i c e t a k e r s i n the debt market.  That i s , t h e r e i s no p r i c e c o m p e t i t i o n f o r  Bank A  B  C  D  E  F  Assets  000  2, 000  4, 000  5, 000  6, 000  8,000  Debt  970  1,940  3,880  4, 850  5,820  7,760  30  60  120  150  180  240  SE  .0975A  195 .00  .095A  380. 00  .0940A  470. 00  .0935A  561. 00  .0925A  740. 00  77. 60  .08D  155 .20  .08D  310. 40  .08D  388. 00  .08A  465. 60  .08D  620. 80  25. 00  .0175A  .015A  120. 00  Ir  .10A  100. 00  Ip  .08D  E  .025A  P Pmin  (.04SE)  P r o f i t maximization Asset maximization  35 .00  • 015A  60. 00  .015A  75. 00  .015A  90. 00  (2. 60)  4 .80  9. 60  7. 00  5. 40  (.so;  1. 20  2 .40  4. 80  6. 00  7. 20  9. 60  = 9.60  A s s e t s = 4,000  = 5,000  P r o f i t s = 7.00  Assumptions 6^ D e f i n i t i o n s E q u i t y = SE Debt = D Assets = A Interest received = I r Profits = P Other expenses = E I n t e r e s t p a i d = Ip Minimum l e v e l o f p r o f i t s ( p r o f i t c o n s t r a i n t ) = Pmin P = ( I r - Ip) - E Ip = constant 8% Ir = d e c l i n i n g f u n c t i o n of A E = d e c l i n i n g f u n c t i o n o f A to 5,000, then c o n s t a n t @ 1.5% A D/SE r a t i o .= 97/3 = 32.33 Pmin = .04SE  Figure  8-3  NUMERICAL EXAMPLE OF THE STATIC DETERMINATION OF BANK SIZE  4>  145 s a v i n g s and  the banks have a good supply a v a i l a b l e at 8 per c e n t .  Ex-  penses a r e s e t as a d e c l i n i n g f u n c t i o n of a s s e t s to a l l o w f o r s c a l e economies.  At some p o i n t these  penses become a c o n s t a n t  economies a r e assumed to cease and  p r o p o r t i o n of a s s e t s .  r a t i o i s a l s o assumed f o r t h i s simple model.  A constant The  debt/equity  consequences of  r e l a x i n g t h i s assumption w i l l be d i s c u s s e d below.  Up  w r i t e r would argue t h a t the assumptions a r e q u i t e  reasonable.  The  to t h i s p o i n t  assumption of a r e d u c i n g y i e l d on a s s e t s may  c r i t i c i s m but i s necessary  i t does appear r e a s o n a b l e to promote a s s e t growth.  prompt some  T h i s i s e s p e c i a l l y t r u e when we  out above t h a t even though the Canadian and  United  I t was  o f t e n does not c a r r y over i n t o the f o r e i g n market. observed t h a t e n t r y by a Canadian or U.S.  P a r t of the r i v a l r o u s b e h a v i o r p e t i t i o n f o r l o a n s and  and  manifests  pointed  S t a t e s banks a r e  (and behave as such) i n t h e i r domestic markets, t h i s  often introduces r i v a l r o u s behavior  the  to argue t h a t some p r i c e c u t t i n g  c o n s i d e r t h a t growth i s o c c u r r i n g i n a f o r e i g n market.  polists  ex-  oligo-  behavior  Indeed i t has  been  bank i n t o a f o r e i g n market  improved market itself  efficiency.  i n the form o f p r i c e com-  investments so i t seems a p p r o p r i a t e to i n c l u d e  the assumption t h a t as a s s e t s i n c r e a s e so do revenues, but at a d e c l i n ing r a t e . I n c l u s i o n of a p r o f i t c o n s t r a i n t i n F i g u r e 8-2 c a l f o r o b v i o u s l y the f i r m cannot c o n t i n u e  seems v e r y  logi-  to grow or even s u r v i v e i f  p r o f i t s d e c l i n e to z e r o .  P r o f i t s are a b s o l u t e l y e s s e n t i a l to a l l o w  f i r m to grow.  d e s c r i b e d the d e t e r m i n a t i o n  Baumol has  l e v e l as f o l l o w s :  the  of a minimum p r o f i t  146  r a t i o n a l b e h a v i o r would r e q u i r e t h a t the f i r m determine i t s m i n i mum p r o f i t l e v e l , i t s d i v i d e n d payments and the magnitude o f i t s r e t a i n e d e a r n i n g s i n a way which a c h i e v e s a b a l a n c e between i t s c u r r e n t f i n a n c i n g needs and the e f f e c t s of i t s d i v i d e n d h i s t o r y on the a v a i l a b i l i t y of cash i n the f u t u r e i n the form of demand f o r future issues of securities.6  The above d e s c r i p t i o n p r o v i d e s no o p e r a t i o n a l way i n g a minimum p r o f i t  level.  f o r determin-  However Baumol goes on to say t h a t :  In p r a c t i c e , the d e t e r m i n a t i o n of a minimum a c c e p t a b l e p r o f i t l e v e l p r o b a b l y comes down to no more than a rough attempt, a g a i n p a r t l y by r u l e o f thumb, to p r o v i d e c o m p e t i t i v e l y a c c e p t a b l e e a r n i n g s to s t o c k h o l d e r s w h i l e l e a v i n g enough over f o r investment i n f u t u r e o u t put expansion a t the maximum r a t e which management c o n s i d e r s to be r e a s o n a b l y safe.7  As w i l l be p o i n t e d out i n Chapter Nine, a t p r e s e n t , t h e r e appears some disagreement  to be  between bankers and t h e i r r e g u l a t o r y b o d i e s over  d e f i n i t i o n of a  ' s a f e ' r a t e of a s s e t growth.  t h a t has caused  us t o hedge i n our d e f i n i t i o n o f a s s e t m a x i m i z a t i o n  Figure  disagreement in  8-2. As mentioned, we  ratio.  It i s this  the  T h i s was  assumed i n F i g u r e 8-3  a constant debt/equity  p r i m a r i l y to a v o i d a c o n t r o v e r s y over whether o r not  t h e r e e x i s t s some o p t i m a l r a t i o t h a t w i l l minimize  the bank's c o s t of  c a p i t a l and thus maximize the v a l u e of the bank to i t s s h a r e h o l d e r s . I t i s g e n e r a l l y accepted w i t h i n the f i e l d of f i n a n c e t h a t i t i s not p o s s i b l e to p r o v i d e c o n c l u s i v e support f o r e i t h e r the  traditional  approach which assumes the f o l l o w i n g r e l a t i o n s h i p : k  D/E  147 and  t h e r e f o r e an o p t i m a l  debt/equity  r a t i o ; or the ' M o d i g l i a n i - M i l l e r '  approach which assumes the f o l l o w i n g r e l a t i o n s h i p :  k  D/E and  t h e r e f o r e independence of the c o s t of c a p i t a l and  a firm's  capital  structure. A f t e r some r e f l e c t i o n i t becomes c l e a r t h a t n e i t h e r p o s i t i o n does any  harm to our approach.  debt/equity new  ratio,  the MM  I f we  p o s i t i o n would say  equity financing increases  achieved  a f f e c t the c h o i c e The realistic model.  obtaining by  of lower c o s t  i s t h a t the minimum p r o f i t  over d i f f e r e n t d e b t / e q u i t y  ratios.  of a s s e t o p t i m i z a t i o n over p r o f i t  I t would  not  maximization.  t r a d i t i o n a l approach (which appears to t h i s w r i t e r to be  d e p i c t i o n of the a c t u a l s i t u a t i o n ) o f f e r s good support f o r  The  over a c e r t a i n range.  age weighted c o s t of c a p i t a l .  our  This r e s u l t s i n a d e c l i n i n g aver-  Beyond some p o i n t l e v e r a g e  debt c o s t s i n c r e a s e , d r i v i n g up The  a  t r a d i t i o n a l approach h y p o t h e s i z e s t h a t the c o s t of debt r e -  mains constant  h i g h and  constant  r a t i o increases  through the use  What t h i s means i n terms o f F i g u r e 8-3  c o n s t r a i n t would v a r y  t h a t the c o s t of  as the d e b t / e q u i t y  j u s t enough to o f f s e t the s a v i n g s debt.  r e l a x the assumption of a  becomes too  the o v e r a l l c o s t of  capital.  above phenomenon appears r e l e v a n t to the banking  industry  and  i n f a c t has  mon  with other  r e c e n t l y been e x p e r i e n c e d by  the Japanese banks.  Japanese b u s i n e s s e s t h a t c o u n t r y ' s banks are  In com-  notoriously  148  over l e v e r e d .  A f t e r the o i l c r i s i s and  r e s u l t a n t b a l a n c e of payments  problems changed the p o s i t i o n of the Japanese banks from b e i n g p l i e r s to net borrowers of E u r o - d o l l a r s , these banks found, because of t h e i r o v e r - l e v e r e d  p o s i t i o n , they had  to pay  net  sup-  that,  a full  2  per  g cent  above the London i n t e r bank r a t e .  charge each other  ( T h i s i s the base r a t e banks  f o r Euro c u r r e n c i e s . )  of p r i c e d i s c r i m i n a t i o n brought about by due  T h i s event was  r e c o g n i t i o n of i n c r e a s e d  i n l a r g e p a r t to the extremely h i g h d e b t / e q u i t y  Japanese banks.  a c l e a r cut  In t h i s w r i t e r ' s o p i n i o n  r a t i o s of  i t would be  case  risk  the  difficult  for  M o d i g l i a n i and M i l l e r to argue t h a t the average weighted c o s t of  capital  of the Japanese banks had  process.  I f we  remained constant  h o l d to the t r a d i t i o n a l approach t h a t the c o s t o f  i n c r e a s e s beyond some o p t i m a l t i g h t e n one if  throughout the above  of the p r o f i t  debt/equity  r a t i o then t h i s s e r v e s  c o n s t r a i n t s i n F i g u r e 8-2.  the c o s t of c a p i t a l b e g i n s to i n c r e a s e  capital.  appropriate  t h i s w i l l have the e f f e c t o f operations  g i v e n a c e r t a i n l e v e l of  equity  More about t h i s f e a t u r e w i l l be p r e s e n t e d i n Chapter N i n e . A s t a t i c model of the form set out  usefulness pointed  to  More s p e c i f i c a l l y ,  g i v i n g management a more c l e a r d e f i n i t i o n of the l e v e l o f t h a t the market c o n s i d e r s  capital  i n a constantly  i n F i g u r e 8-2  changing banking environment.  has As  only l i m i t e d Baumol  has  out:  A l t h o u g h the s t a t i c theory of the f i r m i s a h e l p f u l snapshot d e s c r i p t i o n o f a system i n motion, i t i s u s e f u l a l s o to have an a l t e r n a t i v e c o n s t r u c t i o n . . . another e q u i l i b r i u m a n a l y s i s i n which the r a t e of growth of output, r a t h e r than i t s l e v e l , i s the v a r i a b l e whose v a l u e i s determined by o p t i m a l i t y c o n s i d e r a t i o n s . 9  149 A g a i n , we c o n s i d e r  i t u s e f u l t o adopt Baumol's f o r m u l a t i o n t o  s e t out the v a r i a b l e s and c o n s t r a i n t s i n f l u e n c i n g the l e v e l o f growth o f the banks.  The f o r m u l a t i o n  maxxmxze  g=  f(i,  subject to  I =  f(n,  n=  D + E  i s as f o l l o w s :  n) D) + E  g = growth r a t e o f a s s e t s  where  I = growth r a t e o f e q u i t y  capital  II = p r o f i t r a t e as a % o f p r e s e n t D = dividend  equity  as a % o f p r o f i t s  E = r e t a i n e d e a r n i n g s as a % o f p r o f i t s .  Under t h i s f o r m u l a t i o n , ment and p r o f i t  the r a t e o f growth i s r e l a t e d t o i n v e s t -  r a t e s as f o l l o w s :  g profit constraint  That i s , growth v a r i e s d i r e c t l y w i t h investment but has f i r s t a p o s i t i v e , then a n e g a t i v e eventual  r e l a t i o n s h i p to p r o f i t s .  The b e h a v i o r a l  i n v e r s e r e l a t i o n s h i p w i t h p r o f i t s i s t h a t , behond some r a t e ,  growth s t r a i n s the f i r m ' s e n t r e p r e n e u r i a l r e s o u r c e s pany 's  reason f o r t h e  and adds to the com-  risks. The e q u a t i o n I = f(n,  D) + E i l l u s t r a t e s " t h a t t h e p r o f i t  rate  150 i n d i r e c t l y a s s i s t s growth by p r o v i d i n g c a p i t a l through r e t a i n e d and by a t t r a c t i n g funds from o u t s i d e depends b o t h on the d i v i d e n d  sources a t a r a t e , f ( n , D), which  r a t e and the company's p r o f i t rate.""'"'"'  Bank management would l i k e l y f i n d t h e above f o r m u l a t i o n relevant  than t h e p r e v i o u s  earnings,  s t a t i c model.  As w i l l be d i s c u s s e d  Nine, i t appears t h a t because o f g e n e r a l l y depressed market  more i n Chapter  conditions,  the banks now must r e l y on r e t a i n e d e a r n i n g s t o f i n a n c e f u r t h e r growth. I f we assume t h a t t h e banks a r e a t t h e i r maximum p e r m i s s a b l e  debt/equity  p o s i t i o n s and t h a t new share i s s u e s a r e n o t f e a s i b l e , then the p o t e n t i a l growth o f a s s e t s j u s t e q u a l s the r a t e o f growth o f r e t a i n e d  earnings.  Assume the f o l l o w i n g s i t u a t i o n f o r Bank X:  I  = 0 ; n = 10% ; D = .411 ; E = .611  Then t h e maximum r a t e o f growth o f a s s e t s o f Bank X i s simply as  6 per cent  follows:  Period  A  1,000  1,000  1  Period 2  D  970  E  30  A  1,060.00  Note t h a t t h e above example says n o t h i n g  cept o f the p r o f i t c o n s t r a i n t o p e r a t i n g  D 1,028.20 E  1,000  I t i s hoped t h a t the f o r e g o i n g  1,060.00  about p r o f i t  31.80 1,060.00  maximization.  d i s c u s s i o n has c l a r i f i e d i n our model  the con-  ( F i g u r e 8-1).  now t u r n t o a d i s c u s s i o n o f the other v a r i a b l e s i n c l u d e d  We  i n t h e model.  The other key v a r i a b l e i n t h e model, government i n t e r f e r e n c e i n  the banking i n d u s t r y , m a n i f e s t s to  itself  ' f l o a t i n g on a sea of c o n t r o l s . '  i n many ways.  Bankers a r e used  C i t i b a n k Chairman, Walter  Wriston  i s r e p o r t e d t o have shrugged o f f a q u e s t i o n about the e f f e c t o f c o n t r o l s w i t h t h e s h o r t remark: "Our n a t u r a l h a b i t a t i s the c o n t r o l l e d ment."  environ-  Government i n t e r f e r e n c e o f v a r i o u s types was d i s c u s s e d i n  11  Chapter Seven. The  dashed l i n e s i n F i g u r e 8-1 r e p r e s e n t s p e c i f i c  types o f i n f l u -  ence as f o l l o w s :  1.  L i n e one r e p r e s e n t s i n t e r f e r e n c e encountered when a f i r m i n an o l i g o p o l i s t i c i n d u s t r y attempts t o grow by expanding i t s share of  the domestic market.  I n c l u s i o n o f t h i s v a r i a b l e has been  i n f l u e n c e d by B a l a s s a who argued: "when a mature o l i g o p o l i s t i c s t r u c t u r e has been e s t a b l i s h e d i n the domestic market, the f i r m may be induced its  share  t o i n v e s t abroad because e f f o r t s a t i n c r e a s i n g  i n the domestic market would meet r e t a l i a t i o n  from  12 other 2.  oligopolists."  L i n e two r e p r e s e n t s government i n t e r f e r e n c e i n the domestic mark e t which i s m a n i f e s t e d  by c o n t r o l o f t h e money supply and thus  the u l t i m a t e c o n t r o l o f the s i z e o f the domestic market. the U n i t e d S t a t e s , t h i s l i n e c o u l d a l s o r e p r e s e n t  In  government  c o n t r o l o f the g e o g r a p h i c a l markets which p r o h i b i t s expansion across s t r e e t , 3.  county, o r s t a t e l i n e s .  L i n e t h r e e r e p r e s e n t s v a r i o u s government imposed b a r r i e r s t o d i v e r s i f i c a t i o n i n t o o t h e r domestic f i n a n c i a l markets.  152  The  primary message t h a t the model attempts to convey i s t h a t  the banks have a s t r o n g need f o r growth.  T h i s growth need c o u l d be  i n the domestic and/or f o r e i g n markets, but  government  which l i m i t s growth i n the domestic s e c t o r has a t t e n t i o n to the f o r e i g n market. i s only at t h i s point to p l a y .  Superior  t h a t the other  knowledge and  interference  d e f l e c t e d the focus  T h i s i s the h e a r t  of  of the t h e o r y .  It  t h e o r e t i c a l v a r i a b l e s have a r o l e  a s s o c i a t i o n w i t h the  'preferred  cur-  rency brand' o n l y have an i n f l u e n c e on bank b e h a v i o r i n s p e c i f i c Superior  met  knowledge enables the banks to e n t e r  areas.  c e r t a i n f o r e i g n market  s e g m e n t s — f o r example the medium term f i n a n c i n g f i e l d mentioned above. This i s represented sents  by  dotted  l i n e number f i v e .  s u p e r i o r knowledge i n r e t a i l b a n k i n g .  L i n e number f o u r  For example the  repre-  Canadian  banks were a b l e to e s t a b l i s h an e n t i r e r e t a i l banking i n d u s t r y i n the Caribbean.  Superior  e r a l l y however.  'knowledge' i n r e t a i l banking does not  For example, w h i l e a t l e a s t two  have e s t a b l i s h e d i n the U n i t e d storm the r e t a i l market.  The  Kingdom, none has  gen-  hundred f o r e i g n banks s e r i o u s l y attempted  same would p r o b a b l y be  banks were a l l o w e d to branch i n t o Canada.  apply  to  true i f f o r e i g n  Witness the f o l l o w i n g comments  by David R o c k e f e l l e r :  I see no t h r e a t to the v i a b i l i t y of any banking s y s t e m — a n d c e r t a i n l y not one as h e a l t h y as C a n a d a ' s — b e c a u s e of the presence of f o r e i g n banks. Canada's r e t a i l banking system i s e s t a b l i s h e d so f i r m l y a c r o s s the n a t i o n t h a t i t should not s u f f e r any a d v e r s i t y i n the form of f o r e i g n banking presences.13  L i n e s i x i n d i c a t e s t h a t the U.S.  and  Canadian banks may  s u p e r i o r knowledge i n c o n g e n e r i c s e r v i c e s — b u t  only i n s p e c i f i c  have areas.  153 For example, U.S. banks have developed e x p e r t i s e i n t h e l e a s i n g and  have been a b l e t o p r o f i t a b l y e x p l o i t t h i s i n f o r e i g n  field  markets—partic-  u l a r l y i n Canada. A s s o c i a t i o n w i t h the ' p r e f e r r e d c u r r e n c y  brand' may g i v e the  U.S. and Canadian banks an advantage i n t h e commercial and w h o l e s a l e markets ( l i n e s seven and e i g h t ) .  T h i s argument has been put forward by  A l i b e r as f o l l o w s :  The t h i r d advantage o f U.S. banks i n t h e new i n t e r n a t i o n a l market i s t h a t t h e i r domestic c u r r e n c y , the d o l l a r , i s l i k e l y to remain the p r e f e r r e d c u r r e n c y brand name. Indeed, the share o f banking b u s i ness denominated i n d o l l a r s r e l a t i v e t o o t h e r c u r r e n c i e s i s l i k e l y to i n c r e a s e . T h i s g i v e s a c l e a r advantage to U.S. banks, f o r i f dep o s i t o r s p r e f e r d o l l a r denominated d e p o s i t s , they w i l l a l s o p r e f e r t h a t these d e p o s i t s be i s s u e d by U.S. b a n k s . I 4  For  the reasons o u t l i n e d i n Chapter Seven, p a r t o f t h i s advantage i s  thought t o have 'rubbed o f f on the Canadian banks. the s u p e r i o r knowledge and p r e f e r r e d c u r r e n c y o n l y i n c e r t a i n s p e c i f i c market The  v a r i a b l e s have i n f l u e n c e  areas.  above comments r e p r e s e n t  the primary reason f o r the d i v e r -  s i o n away from the main l i n e o f the theory focus  I n summary, however,  on s u p e r i o r knowledge t h a t a l l o w s  r a t e s o f r e t u r n than l o c a l c o m p e t i t o r s .  of d i r e c t i n v e s t m e n t — t h e  a f o r e i g n f i r m to obtain  higher  Bankers l o o k a t overseas oppor-  t u n i t i e s somewhat d i f f e r e n t l y than do i n d u s t r i a l c o r p o r a t i o n s .  The  Canadian and U.S. banks do not g e n e r a l l y attempt t o compete head on w i t h i n d i g e n o u s banks.  This i s i n d i r e c t contrast  to i n d u s t r i a l  corporations.  Fortune magazine has put the p r o c e s s o f f o r e i g n expansion by the banks i n perspective  as f o l l o w s :  154  They (banks) cannot hope to storm the entrenched markets of n a t i v e banks. Nor do they expect a. p a r t i c u l a r l y h i g h r a t e of p r o f i t . Banki n g i n Europe i s not i n h e r e n t l y more p r o f i t a b l e than i n the U.S.; the spread between what a bank pays and what i t can charge a b o r rower i s about the same. The banks going abroad do not even i n s i s t on s u b s t a n t i a l e a r n i n g s from every b r a n c h . The aim r a t h e r i s to b u i l d up a system whose i n t e r t w i n e d o p e r a t i o n s w i l l improve the bank's o v e r a l l earnings.15  RESULTS OF  In g e n e r a l to our model was  i t is fair  mixed.  ment i n t e r f e r e n c e and  INTERVIEWS  to say  t h a t the r e a c t i o n of s e n i o r bankers  Some bankers supported our h y p o t h e s i s t h a t  l i m i t e d domestic growth o p p o r t u n i t i e s had  the d e c i s i o n to l o o k outward to f o r e i g n markets. t h a t the model made no our  interviews.  cluded  allow  T h i s was  influenced  pointed  out  t r u e a t the time of have i n -  p r o f i t s as a c o n s t r a i n i n g v a r i a b l e .  and  general  agreement on the i n c l u s i o n of  ' a s s o c i a t i o n w i t h the U.S.  entry  thought we trade  to p r o f i t s .  or two  In the f i n a l v e r s i o n of the model however we  There was ledge'  reference  One  govern-  i n t o f o r e i g n markets. should  flows.  We  ' s u p e r i o r know-  d o l l a r ' as important v a r i a b l e s  that  In t h i s area however some bankers  include a v a r i a b l e that recognizes r e s i s t e d t h i s suggestion  the importance of  f o r the reasons o u t l i n e d i n  Chapter F i v e . The  area of our model t h a t ran i n t o h e a v i e s t  'need f o r growth' v a r i a b l e . v a r i a b l e played  anything  i n t e r n a t i o n a l banking.  No banker was  o p p o s i t i o n was  w i l l i n g to admit t h a t  the  this  more than a minor r o l e i n the development of Some bankers i n s i s t e d t h a t the p u r s u i t of  was  the more important v a r i a b l e .  our  d i s c u s s i o n we  And  yet at various  profit  times throughout  uncovered cases where d i r e c t investments were made  155 without g i v i n g p r o f i t p r o j e c t i o n s anymore than a c u r s o r y fact  glance.  one banker s t a t e d t h a t h i s bank d i d n o t p r e p a r e p r o f i t  when c o n s i d e r i n g  a f o r e i g n d i r e c t investment.  ment o f a top e x e c u t i v e  was i d e n t i f i e d  In  projections  I n some cases ego i n v o l v e -  as the key t o a d e c i s i o n t o e n t e r  a f o r e i g n market. Based on the w e a l t h o f i m p r e s s i o n i s t i c evidence a v a i l a b l e i n t h e literature, willing  some o f which was p r e s e n t e d i n Chapter Seven, we a r e n o t  t o concede t h a t  'need f o r growth' i s a n y t h i n g  l e s s than the KEY  v a r i a b l e t h a t has i n f l u e n c e d f o r e i g n growth over the past f i n a l a n a l y s i s however, we r e c o g n i z e  decade.  In the  t h a t the reader must weigh t h e  a v a i l a b l e evidence and then d e c i d e f o r h i m s e l f .  SUMMARY A l o g i c a l extension to e m p i r i c a l t e s t i n g .  o f t h i s c h a p t e r would be t o s u b j e c t  However the absence o f s u f f i c i e n t l y d e t a i l e d  'hard' data r u l e s out t h i s p o s s i b i l i t y . o f f e r e d i s i n the form o f a n e c d o t a l i n Chapter Seven. tive  The main support t h a t can be  e v i d e n c e , much o f which was p r e s e n t e d  T h i s evidence must be weighed a g a i n s t  r e a c t i o n obtained  i n our f i e l d  t h e r a t h e r nega-  study.  We a l s o have a v a i l a b l e some s k e t c h y i n f o r m a t i o n  on t h e d e c i s i o n  making p r o c e s s f o l l o w e d when a bank i n v e s t s i n a f o r e i g n market. process i s discussed  our model  This  i n Appendix I I i n t h e hope t h a t i t w i l l l e n d some  support f o r our model.  156 Notes f o r Chapter E i g h t  ^ Quoted i n The Canadian Banker and ICB Review,  1-74,  p. 9.  2 F e d e r a l Reserve Bank o f C h i c a g o : Economic Review 1974), p. 3. P a u l N a d l e r , "Why (June 1974), p. 615. 3  A Bank Has to Grow—A U.S.  (October  View," The  Banker  Quoted by R. Z. A l i b e r , "The M u l t i n a t i o n a l E n t e r p r i s e i n a M u l t i p l e Currency World," i n The M u l t i n a t i o n a l E n t e r p r i s e , J . H. Dunning ( e d . ) , p. 50. 4  W. J . Baumol, B u s i n e s s B e h a v i o r V a l u e and Growth (New M a c M i l l a n Company, 1959). 5  York:  ^ I b i d . , p. 52. I b i d . , p. 53.  7  Q  F i n a n c i a l P o s t (September  21, 1974), p. J12.  9  •• W. J . Baumol, "On the Theory o f Expansion o f the F i r m , " i n The Theory of the F i r m , G. C. A r c h i b a l d ( e d . ) , p. 319. I b i d . , p. 1  1  326.  Quoted i n The Banker, v o l . 123  (1973), p.  613.  12 Quoted i n G. R a g a z z i , " T h e o r i e s of the Determinants of D i r e c t Investment," IMF S t a f f Papers ( J u l y 1973), p. 489. 13 E x c e r p t from a speech to the Canadian Conference on Banking, Toronto, September 16, 1974. Foreign  R. Z. A l i b e r , The I n t e r n a t i o n a l Money Game (New York: Books I n c . , 1973), p. 161. Fortune (December 1967), p.  143.  Basic  Chapter Nine  CURRENT EVENTS AND  There are two the c u r r e n t  THE  THEORETICAL MODEL  elements of our model t h a t are b e i n g  i n t e r n a t i o n a l banking environment.  i s c u r r e n t l y being  r e t a r d e d by v a r i o u s  i s t h a t government  ' i n t e r f e r e n c e ' i s being  tightened and  i n others.  first  i s that  environmental f a c t o r s . relaxed  the above events i n o r d e r  by  growth  The  i n some a r e a s  In view of the f a c t t h a t government  a need f o r growth form the f o u n d a t i o n  r i a t e to d i s c u s s  The  influenced  second and  interference  of our approach, i t i s appropto t e s t the  ' d u r a b i l i t y ' of  the model developed i n Chapter E i g h t . The left  recent  r a p i d growth r a t e s of U.S.  them somewhat over l e v e r e d .  should  have i n order  t i o n but  The  banks, i n p a r t i c u l a r , has  amount of c a p i t a l t h a t a bank  to ensure the s a f e t y of d e p o s i t o r s  some r u l e s of thumb have evolved.  The  i s open to ques-  capital/asset ratio  been suggested as a measure of the amount by which a bank's a s s e t s shrink before  the d e p o s i t o r s w i l l  face a l o s s .  Binhammer has  out however t h a t a b e t t e r measure of shock a b s o r b i n g the r a t i o , c a p i t a l to r i s k a s s e t s resides.  1  considered  The  can  pointed  c a p a c i t y may  be  s i n c e i t emphasizes where exposure  p r i n c i p l e t h a t the q u a l i t y of bank a s s e t s  i n judging  has  c a p i t a l adequacy has  should  be  r e c e i v e d growing acceptance 2  among American bank s u p e r v i s o r y t r u e t h a t other  and  regulatory bodies.  f a c t o r s such as age,  While i t i s  s i z e , managerial experience,  and  a s s e t d i v e r s i f i c a t i o n , a r e a l s o important, the c a p i t a l / a s s e t r a t i o i s a convenient  ' e a r l y warning' index.  Once the r a t i o b e g i n s to f a l l  157  the  158  s i g n a l i s g i v e n to commence a more d e t a i l e d e v a l u a t i o n encompassing other  f a c t o r s named  the  above.  The c a p i t a l / a s s e t r a t i o f o r the BankAmerica  f o r example i s as  3 follows f o r selected years: 1950  1955  1960  1965  1970  1971  1972  1973  1974  5.8%  5%  5.5%  5.2%  4.1%  3.9%  3.5%  3.1%  2.8% (projected)  I t appears t h a t the s t e a d i l y d e c l i n i n g r a t i o i s p l a c i n g a c o n s t r a i n t on BankAmerica.  The bank was  r e c e n t l y turned  growth  down by the  F e d e r a l Reserve Board i n i t s b i d to a c q u i r e a f o r e i g n i n s u r a n c e  company.  The f o l l o w i n g i s an e x p l a n a t i o n o f the Board's d e c i s i o n o f f e r e d by Messrs. W a l l i c h and Sheehan, members o f the Board o f Governors of the F e d e r a l Reserve:  We agree t h a t the a p p l i c a n t ' s (BankAmerica's) c a p i t a l p o s i t i o n i s somewhat lower than what the Board would c o n s i d e r a p p r o p r i a t e . We a l s o agree w i t h out c o l l e a g u e ' s concern over the tendency of many U.S. banking o r g a n i z a t i o n s to pursue a p o l i c y of r a p i d expansion and agree t h a t funds earmarked f o r expansion by U.S. banking o r g a n i z a t i o n s w i t h c a p i t a l p o s i t i o n s not c o n s i d e r e d a p p r o p r i a t e should be used i n s t e a d to s t r e n g t h e n the c a p i t a l p o s i t i o n s of such o r g a n i z a tions. 4  While the ' a p p r o p r i a t e ' c a p i t a l p o s i t i o n i s not d e f i n e d , presumably something g r e a t e r than 2 per cent ( F i g u r e 9-1)  to 3 per c e n t .  The f o l l o w i n g graph  i l l u s t r a t e s t h a t a d e c l i n i n g c a p i t a l / a s s e t r a t i o has  g e n e r a l l y i n the U.S.  banking i n d u s t r y .  While the adequacy  i t is  occurred  5  of the c a p i t a l of Canadian banks has not r e -  c e i v e d widespread p u b l i c a t t e n t i o n , some s e c u r i t i e s a n a l y s t s have  F i g u r e 9-1 CAPITAL/ASSET RATIOS OF U.S. BANKING INDUSTRY*  160  criticized  the banks f o r o p e r a t i n g  on r a t i o s t h a t are too t h i n .  A comparison of c a p i t a l / a s s e t r a t i o of the R o y a l Bank and Commerce r e v e a l s than the  t h a t they are indeed i n a r e l a t i v e l y weaker p o s i t i o n  BankAmerica:  1965  1970  1971  1972  1973  1974  Royal  4.9%  3.4%  3.1%  2.9%  2.6%  2.3%  Commerce  4.9%  3.6%  3.7%  3.4%  3.0%  2.7%  The  obvious s o l u t i o n to the above c o n s t r a i n t on the a b i l i t y  the banks to grow i s to i s s u e more share c a p i t a l . sed  the  s t o c k market c o n d i t i o n s r e p r e s e n t  alternative.  No  major U.S.  attempt to f l o a t an e q u i t y  depres-  an environmental c o n s t r a i n t on  banks have y e t shown a w i l l i n g n e s s  this  to  i s s u e a l t h o u g h t h r e e Canadian banks have come  out w i t h r i g h t s i s s u e s i n the past y e a r . depressed p r i c e s .  However c u r r e n t  of  A l l i s s u e s were at  I t c e r t a i n l y appears u n l i k e l y t h a t any  relatively  l a r g e bank w i l l  attempt to f l o a t a major share i s s u e u n t i l the s t o c k market turns  around.  There i s r e a s o n a b l e e v i d e n c e t h a t the banks themselves were not w i l l i n g to f o r s a k e BankAmerica was  t h e i r g o a l of more g r o w t h — a t l e a s t i n i t i a l l y .  vexed a t the thought of the Fed  l a r g e s t bank a p u b l i c spanking.  g i v i n g the world's  In response to c r i t i c i s m t h a t i t  u n d e r c a p i t a l i z i n g i t argued t h a t i t s " c a p i t a l p o s i t i o n i s s t r o n g f u l l y c a p a b l e of b u i l d i n g d i v i d e n d The against  expansionary moves by  dence t h a t the banks were not  was and  growth."  f a c t t h a t the F e d e r a l Reserve has  s e v e r a l other  The  g i v i n g up  had  to step i n and  rule  the banks i s a l s o good  growth without a  fight:  evi-  161 Not o n l y BankAmerica, but C i t i c o r p , second b i g g e s t i n the w o r l d , and Bankers T r u s t and F i r s t Chicago, each among the n a t i o n s t e n b i g g e s t banking o p e r a t i o n s , have a l l had planned a c q u i s i t i o n s turned down by the Fed i n r e c e n t months. Two weeks ago the Fed announced t h a t i t would not a l l o w bank h o l d i n g companies to underwrite mortgage guarant e e i n s u r a n c e because i t f e a r e d the h o l d i n g companies were growing too f a s t . 7  It ledged by  appears t h a t the the banks.  slow' message has  r e c e n t l y been acknow-  r e c e n t l y r e c e i v e d much pubg l i c i t y over i t s d e c i s i o n to slow down the growth of i t s a s s e t s . For our purposes i t i s v i t a l  The  'go  Bank of America has  t h a t the reader  understand t h a t t h i s d e c i s i o n  was  9  o n l y taken a f t e r  'prodding  by  the F e d e r a l Reserve Board.'  backed i n t o a corner by the Fed attempting assured  tive.  t h a t i f i t s major c o m p e t i t o r s  do not  'acceptable.' fall  l e a s t not without  i n t o l i n e and  a strong  adopt a  I t i s probably  First  the growth o b j e c t i v e f o r v e r y  necessary  i n t h e i r best  inter-  to t e m p o r a r i l y abandon what  'performance c u l t ' o f the 1960's and  Francisco,  e a r l y 70's;  but  only  c e r t a i n weaknesses t h a t c r e p t i n t o the r a p i d l y growing system can Of course  objec-  fight.  John B a l l e s , P r e s i d e n t of the F e d e r a l Reserve Bank of San  shaken out.  rest  York to r e p l a c e i t as the world's l a r g e s t bank  l o n g because, as p o i n t e d out by G a l b r a i t h , i t i s not  c a l l s the  may  t h a t BankAmerica w i l l a g a i n adopt a growth  Bank management w i l l not g i v e up  e s t s to do so.  merely  One  I t i s u n l i k e l y t h a t the Bank of America w i l l a l l o w the  N a t i o n a l C i t y Bank of New —at  i t appears t h a t the Bank i s now  to make t h e i r d e c i s i o n p u b l i c a l l y  c o n s o l i d a t i o n philosophy,  A f t e r being  be  the inadequate c a p i t a l base w i l l a l s o have to  rectified. While t h e r e has been no p u b l i c i t y over the s t a t e of  the  until  be  162 c a p i t a l i z a t i o n r a t i o s of the c h a r t e r e d banks, t h i s w r i t e r submits t h a t i t i s e x t r e m e l y l i k e l y t h a t the Bank o f Canada has used 'moral s u a s i o n ' to slow down the banks.  The r e a s o n i s t h a t some of the banks, i n t h e i r  1974 a n n u a l r e p o r t s , defended the adequacy o f t h e i r c a p i t a l  levels.  They a r e b e i n g prodded by s o m e o n e — l i k e l y the Bank of Canada. I n d e f e n d i n g t h e adequacy of t h e i r c a p i t a l , t h e c h a r t e r e d banks put f o r t h the argument t h a t t h e f o l l o w i n g i t e m s c o n s t i t u t e  their  capital: shareholder's equity; a p p r o p r i a t i o n s f o r l o s s e s ; and debentures. The argument might have some v a l i d i t y — i f the f o c u s of a t t e n t i o n i s on t h e s a f e t y of d e p o s i t o r s .  T h i s w r i t e r submits however t h a t the  f o c u s o f c o n c e r n s h o u l d a l s o be on the s h a r e h o l d e r s .  I n t h i s case i t i s  o n l y r a t i o n a l to argue t h a t a bank's c a p i t a l c o n s i s t s o n l y of t o t a l shareholder's equity. W h i l e t h e i n n a t e need f o r growth r e m a i n s , t h e major banks do seem to be c u r r e n t l y f o c u s i n g t h e i r a t t e n t i o n on l i q u i d i t y brought about by t h e move o f OPEC funds t h r o u g h the system.  problems We have r e -  c e n t l y w i t n e s s e d the u n u s u a l s i t u a t i o n o f major banks d e c l i n i n g t o t a k e up a l l d e p o s i t funds o f f e r e d .  The r e a s o n s a r e t w o f o l d : (a) the funds  are v e r y v o l a t i l e , and (b) t h e funds a r e p r o v i d e d by a l i m i t e d number of sources.  The l a t t e r p o i n t i n v o l v e s t h e concept o f banker's r i s k ( i t i s  l e s s r i s k y t o have 100  customers w i t h d e p o s i t s of $10  each than t e n  163  customers w i t h d e p o s i t s o f $100 each). bank's l i q u i d i t y p r o b l e m s — e s p e c i a l l y  The former p o i n t r e l a t e s to the i n the Euro d o l l a r market.  S i n c e t h e e a r l y 1960's t h e Euro d o l l a r market has c o n s i s t e d m a i n l y of banks c o l l e c t i n g s h o r t term d e p o s i t s and u t i l i z i n g  these  to extend medium and l o n g term l o a n s t o i n d u s t r i a l c l i e n t s .  The market  functioned reasonably  smoothly—until  the o i l c r i s i s .  The o i l p r o d u c i n g  n a t i o n s have t y p i c a l l y p l a c e d t h e i r funds on d e p o s i t f o r a v e r y term and o f t e n p u l l l a r g e sums out of t h e market f o r l i t t l e reason.  T h i s a c t i o n o f course  to r e - c y c l e those stances  short  apparent  s e v e r e l y l i m i t s t h e a b i l i t y o f the banks  ' p e t r o d o l l a r s ' toward p r o d u c t i v e use.  some prudence has been s e l f - i m p o s e d  In the c i r c u m -  by the banks which i n d i c a t e s  some awareness t h a t growth cannot proceed without variables.  funds  regard  to other  I n these u n c e r t a i n times growth must take a back s e a t t o the  more important  o v e r r i d i n g g o a l o f any o r g a n i z a t i o n : i t s own s u r v i v a l .  Governmental i n t e r f e r e n c e o f b o t h t h e p o s i t i v e and n e g a t i v e i s a l s o c u r r e n t l y having  an i n f l u e n c e on i n t e r n a t i o n a l b a n k i n g .  type  On  January 29, 1974, t h e F e d e r a l Reserve Board announced t e r m i n a t i o n o f the Voluntary  F o r e i g n C r e d i t R e s t r a i n t (VFCR) p r o g r a m . ^ 1  o r d i n a t e d w i t h t h e simultaneous l i f t i n g program a d m i n i s t e r e d  by t h e T r e a s u r y  T h i s a c t i o n was c o -  o f the c a p i t a l o u t f l o w  and Commerce Departments o f the U.S.  T h i s i n c l u d e d t e r m i n a t i o n o f the I n t e r e s t E q u a l i z a t i o n Tax. 30,  1974, the M i n i s t e r s o f Finance  restraint  and o f I n d u s t r y ,  On January  Trade and Commerce  announced the w i t h d r a w a l o f Canadian g u i d e l i n e s t h a t had o r i g i n a l l y been erected i n order The  t o o b t a i n exemption from t h e U.S. p r o g r a m .  11  r e s u l t o f the above a c t i o n i s t h a t b o t h Canadian and U.S.  164  banks have been g r a n t e d an i n c r e a s e d amount o f freedom t o o p e r a t e i n i n t e r n a t i o n a l markets.  F o r t h e Canadian banks i t means t h a t they may be a b l e  to renew t h e i r r o l e as a c o n d u i t Europe.  o f U.S. funds between N o r t h America and  That i s , a Canadian bank may b i d f o r U.S. d o l l a r d e p o s i t s i n  Canada o r the U.S. and, i f i n t e r e s t r a t e d i f f e r e n t i a l s e x i s t , t h e funds may be i n v e s t e d  i n a f o r e i g n market.  The e f f e c t o f t h e removal o f t h e v a r i o u s  g u i d e l i n e s on t h e  Canadian and U.S. banking systems i s u n c e r t a i n a t t h i s time. simply would  too many e n v i r o n m e n t a l v a r i a b l e s .  There a r e  C l e a r l y , the U.S. government  l i k e the U.S. banks t o p a r t i c i p a t e i n t h e Euro d o l l a r market  domestic base.  I n f a c t , former P r e s i d e n t  Nixon's i n t e r n a t i o n a l economic  r e p o r t o f February 1974 s p e c i f i c a l l y urged t h a t Euro d o l l a r market t i o n s of U.S. banks be brought home.  from a  opera-  12  However, t h e r e a r e s i g n i f i c a n t b a r r i e r s t o t h i s  occurring.  Reserve requirements and c e i l i n g s on d e p o s i t y i e l d s would l i k e l y make i t impossible  f o r t h e domestic U.S. banks t o compete f o r Euro d o l l a r s .  (Note t h a t a Euro d o l l a r p l a c e d bank becomes s u b j e c t  on d e p o s i t  a t a domestic branch o f a U.S.  to a l l the U.S. banking r e g u l a t i o n s . )  appear f e a s i b l e f o r the F e d e r a l Reserve t o grant Euro d o l l a r s s i n c e  exemptions  I t does n o t f o rrepatriated  'a d o l l a r i s a d o l l a r ' w i t h i n the b o r d e r o f the n a t i o n .  Some bankers have p r e d i c t e d however t h a t t h e removal o f c o n t r o l s w i l l have an impact: With t h e d i s a p p e a r a n c e o f c o n t r o l s , d i r e c t l e n d i n g from t h e U.S. i s bound t o surge, thus l e s s e n i n g the need to use f o r e i g n branches t o fund loans t o m u l t i n a t i o n a l c u s t o m e r s . ^ 3  165  Other bankers simply see the l i f t i n g  o f r e s t r i c t i o n s as g i v i n g  them (and t h e i r c l i e n t ) the f l e x i b i l i t y t o choose the l o c a t i o n o f f i n a n 14 cing.  Presumably the p r i c e mechanism, o p e r a t i n g through i n t e r e s t  rates  w i l l a t l a s t have a r o l e to p l a y i n the a l l o c a t i o n o f funds on a w o r l d wide b a s i s from s u r p l u s to d e f i c i t While t h e above government  spending u n i t s . a c t i o n might be termed  t h e r e i s a h i g h p r o b a b i l i t y t h a t some a d d i t i o n a l n e g a t i v e will  'positive,' interference  soon impinge upon the f o r e i g n o p e r a t i o n s o f U.S. banks.  The Board  of Governors o f t h e F e d e r a l Reserve System has c r e a t e d a s t e e r i n g committee: charged w i t h the r e s p o n s i b i l i t y o f r e a s s e s s i n g t h e s t r u c t u r a l a s p e c t s of U.S. i n t e r n a t i o n a l banking r e g u l a t i o n s t h a t i n v o l v e home c o u n t r y r e s p o n s i b i l i t i e s f o r U.S. banks o v e r s e a s . ^  The Board o f Governors o f t h e F e d e r a l Reserve System has f o r some time been charged w i t h the r e s p o n s i b i l i t y o f r e g u l a t i n g t h e i n t e r n a t i o n a l o p e r a t i o n s o f U.S. banking o r g a n i z a t i o n s . i t y stems from the f o l l o w i n g :  The s t a t u t o r y a u t h o r -  16  a)  S e c t i o n 25 o f the F e d e r a l Reserve A c t (amended 1966);  b)  S e c t i o n 25(a) of the F e d e r a l Reserve A c t (known as the Edge A c t ) ; and  c)  The Bank H o l d i n g Company A c t 1956 (amended 1970).  C r i t i c s however have c l a i m e d t h a t the p o l i c y o f the Fed toward banking has been much too l a x .  foreign  1 7  A d i f f e r e n t p h i l o s o p h y now seems t o be emerging however and i t  166  appears l i k e l y t h a t a new  ' i n t e r f e r e n c e ' l i n e w i l l soon have to be  added  to our model (from government to the f o r e i g n m a r k e t ) .  These same r e g u l a t o r s (the Fed) t h a t p e r m i t t e d banks to grow and d i v e r s i f y a t breakneck speed a r e now t r y i n g to b r i n g t h i n g s back der c o n t r o l .  un-  x 8  C l e a r l y , the F e d e r a l Reserve Board has growth of f o r e i g n banking a c t i v i t i e s of U.S.  the power to r e t a r d the  banks.  However, i f r a t i o n -  a l i t y p r e v a i l s , one might hope t h a t the Fed w i l l concern i t s e l f o n l y minimizing by  the r i s k i n t r o d u c e d  to the domestic a c t i v i t i e s of U.S.  with  banks  their foreign operations. I t was  p o i n t e d out above t h a t Canadian l e g i s l a t i o n has  an i n d i r e c t i n f l u e n c e on the f o r e i g n o p e r a t i o n s  only  had  of the c h a r t e r e d banks.  V a r i o u s Bank A c t r e s t r i c t i o n s a g a i n s t d i v e r s i f y i n g i n t o domestic  financial  markets a r e thought to have d i v e r t e d a t t e n t i o n to f o r e i g n o p e r a t i o n s . The  Bank A c t  i s scheduled  f o r r e v i s i o n i n 1977  however and  some  f e e l t h a t the doors to some o t h e r Canadian f i n a n c i a l markets may  observers be  opened to the c h a r t e r e d banks. I t was  p o i n t e d out  i n Chapter Four t h a t U.S.  Canadian f i n a n c i a l markets by  banks have  c r e a t i n g s u b s i d i a r i e s t h a t p r o v i d e many  f i n a n c i a l s e r v i c e s t h a t the c h a r t e r e d banks a r e b a r r e d i s C i t i c o r p F i n a n c i a l S e r v i c e s Canada L t d . , a w h o l l y F i r s t N a t i o n a l C i t y Bank.  The  entered  company p r o v i d e s  from.  An  example  owned s u b s i d i a r y of  a wide range of  financial  s e r v i c e s i n c l u d i n g l e a s i n g , commercial c r e d i t s , mortgage f i n a n c i n g , consumer l e n d i n g , and  investment management.  In a r e c r u i t m e n t  poster for  MBA's the company a d v i s e s p r o s p e c t i v e employees t h a t : "In the past  year  167  we have doubled i n s i z e and p l a n s c a l l f o r expansion a t a s i m i l a r  rate  19 d u r i n g the next y e a r . " to  T h i s r a p i d growth has caused Canadian  lobby f o r e n t r y i n t o a wider range o f domestic f i n a n c i a l  Here i s an e x c e r p t from the t e x t o f the 1974 of the  markets.  Annual Report to S h a r e h o l d e r s  the Bank o f Nova S c o t i a p r e s e n t e d by C. E. R i t c h i e , Chairman: utmost  bankers  "It i s  of a b s u r d i t y to permit u n r e g u l a t e d f o r e i g n i n s t i t u t i o n s t o do  20 b u s i n e s s such as l e a s i n g which domestic banks are f o r b i d d e n to do." I t i s not p o s s i b l e a t t h i s time t o p r e d i c t whether the government w i l l a l l o w the banks to expand i n t o o t h e r domestic markets. p e r m i s s i o n to e n t e r o t h e r markets removal o f l i n e  However, i f  i s granted, t h i s would q u a l i f y as the  '3' i n terms o f our model.  The p r e d i c t i o n t h a t  follows  i s t h a t the p r e s s u r e f o r growth t h a t has i n the p a s t been d i v e r t e d to f o r e i g n markets may  be r e - d i r e c t e d toward  growth i n the domestic a r e a .  Some s l a c k e n i n g i n the pace o f f o r e i g n growth s h o u l d then be In  expected.  summary, e n v i r o n m e n t a l f a c t o r s can be expected to c o n t i n u a l l y  p l a y a r o l e i n the development  of i n t e r n a t i o n a l banking.  I t i s submitted  t h a t the model developed can a d e q u a t e l y d e a l w i t h v a r i o u s events as they occur a l t h o u g h i t may  be t h a t some a d d i t i o n a l v a r i a b l e s  ment i n t e r f e r e n c e l i n e r u n n i n g  to  (e.g., a govern-  f o r e i g n market) w i l l have to be added.  As l o n g as the banks c o n t i n u e t o embrace growth as a g o a l however, our model s h o u l d remain  valid.  The f i n a l c h a p t e r w i l l be devoted to a ' c r y s t a l b a l l ' future.  One  growth w i l l  l o o k a t the  f e a t u r e t h a t w i l l be d e a l t w i t h i s the p r o b a b i l i t y c o n t i n u e as the o v e r r i d i n g g o a l of the banking  that  industry.  I  168 Notes f o r Chapter Nine  H. H. Binhammer, Money, Banking and t h e Canadian System (Toronto: Methuen, 1968), p. 13.  Financial  Ibid..  2  3 BankAmerica,  1973 Annual R e p o r t .  B u s i n e s s Week (Sept. 21, 1974), p. 52.  4  Ibid.  5  6  Ibid.  (Feb. 24, 1975), p. 55.  7  Ibid.  (Sept. 21, 1974), p. 52.  8  Ibid.  (Feb. 24, 1975).  Ibid. Board o f Governors o f t h e F e d e r a l Reserve System, 1973 Annual  9  Report. ^  Bank o f Canada, 1973 Annual Report.  12 E. P. Imhof, "Rapid Expansion o f Overseas Banking," I n t e r economics , No. 8, 1974. 13 S. C. E y r e , " E x p l o r i n g Some Trends i n I n t e r n a t i o n a l Banking," Burrough's C l e a r i n g House (February 1974), p. 54. 14 J . P. Morgan and Co. I n c . , 1973 Annual Report. ^ " B u s i n e s s C o n d i t i o n s , " F e d e r a l Reserve Bank o f Chicago (Oct. 1974), p. 3. 1  6  1  7  Ibid. B u s i n e s s Week (Sept. 21, 1974).  18 I b i d . , p. 52. 19 Canada L t d .  E x c e r p t from r e c r u i t m e n t p o s t e r , C i t i c o r p F i n a n c i a l  Services  20 " I n t e r n a t i o n a l C h a l l e n g e s and Canadian Responses," Bank o f Nova S c o t i a Monthly Review (Dec. 1974), p. 5.  Chapter  Ten  THE FUTURE The r e a d e r s h o u l d keep i n mind throughout t h i s c h a p t e r t h a t p r e d i c t i o n s o f the f u t u r e a r e n o t o r i o u s l y u n r e l i a b l e . t r u e than i n t h e b a n k i n g i n d u s t r y .  Nowhere i s t h i s more  Banking i s an a r e a c o n s t a n t l y b e i n g  i n t e r f e r e d w i t h by v a r i o u s governmental b o d i e s ; p r o g r e s s i o n through time i s c h a r a c t e r i z e d by b a n k i n g a c t i o n — g o v e r n m e n t  reaction—banking reaction.  I n t h e s e c i r c u m s t a n c e s , i t i s easy t o see t h e problems i n v o l v e d i n ' s t a r gazing.'  N e v e r t h e l e s s , t h e r e a r e some events u n f o l d i n g t h a t seem t o  p o i n t the banks i n c e r t a i n d i r e c t i o n s . There i s no doubt t h a t the v a r i o u s s t r a i n s i n the i n t e r n a t i o n a l environment  ( o i l c r i s i s , b a l a n c e o f payment problems, i n f l a t i o n ,  and  c r e e p i n g s o c i a l i s m ) have had and w i l l c o n t i n u e t o have more than a nomin a l impact on i n t e r n a t i o n a l b a n k i n g .  The l i q u i d i t y c r i s i s ( d i s c u s s e d  e a r l i e r ) , f o r e i g n exchange l o s s e s and s e v e r a l bank f a i l u r e s a r e p a r t l y the r e s u l t of t h e s e e n v i r o n m e n t a l e v e n t s .  Incompetent  management has  a l s o c o n t r i b u t e d ; e s p e c i a l l y i n the f a i l u r e of some s m a l l e r banks. major Canadian and U.S.  The  banks appear c a p a b l e of w e a t h e r i n g the storm,  however p u b l i c a t t e n t i o n has now been f o c u s e d on t h e b a n k i n g i n d u s t r y . From the p o i n t of v i e w of b a n k e r s , t h i s i s u n f o r t u n a t e .  Bankers  gener-  a l l y p r e f e r to m a i n t a i n a low p u b l i c p r o f i l e , w h i c h p e r m i t s them more freedom t o pursue t h e i r growth g o a l s . The f o c u s of p u b l i c a t t e n t i o n on b a n k i n g has r e s u l t e d i n a s w e l l of p r o t e c t i o n i s m i n s e v e r a l i n t e r n a t i o n a l b a n k i n g markets.  169  groundAs a t  170  June 1973, one o f the world's top t e n banks r a t e d the degree o f d i f f i c u l t y w i t h which a f o r e i g n bank can o p e r a t e i n a p a r t i c u l a r c o u n t r y .  In  o r d e r t o r a t e t h e degree o f d i f f i c u l t y o r ease o f o p e r a t i o n the c o u n t r i e s have been ranked on a one to f i v e s c a l e .  The c r i t e r i o n by which the  c o u n t r i e s a r e ranked i s as f o l l o w s :  1)  Complete freedom on the same terms as i n d i g e n o u s banks, i . e . , no discrimination at a l l .  2)  Areas where some d i s c r i m i n a t i o n , e.g., t h e r e must be some l e g a l p a r t i c i p a t i o n or f o r m a l r u l e s a p p l i e d t o f o r e i g n banks;  informal  constraints are ignored. 3)  Areas o f heavy d i s c r i m i n a t i o n , e.g., no branches a l l o w e d or d i r e c t subsidiaries.  4)  Areas where o n l y a v e r y f a i n t  f o r e i g n b a n k i n g presence i s a l l o w e d ,  e.g., o n l y through r e p r e s e n t a t i v e 5)  Areas where a l l  offices.  f o r e i g n banks o f whatever d e s c r i p t i o n a r e banned.  Grouped by r e g i o n s , the c o u n t r i e s have been r a t e d a c c o r d i n g t o (a) b e f o r e opening o f f i c e s , and (b) a f t e r o f f i c e s have been e s t a b l i s h e d .  Where o n l y  one r a t i n g i s g i v e n , the r a t i n g i s the same f o r b o t h (a) and ( b ) . t h e r e a r e two numbers, the f i r s t  i s (a) and the second ( b ) .  Taken from The Banker, v o l . 123, 1973.  Where  EUROPE U.K. Germany Greece Netherlands Italy France Belgium Luxembourg Switzerland Republic of Ireland Austria Denmark Portugal Spain Sweden Norway Finland U.S.S.R. Hungary Poland Yugoslavia Rumania Bulgaria Albania Germany Democratic Republic  1 1 1 1 1 1 1 1 2 2 2 2 3 3 3 3 3 4 4 4 4 4 5 5 5  CANADA-CARIBBEAN 1 Nicaragua E l Salvador 1 1 Barbados Netherlands A n t i l l e s 1 1 Puerto R i c o 1 V i r g i n Islands  Nassau Jamaica Haiti Cayman I s l a n d s Costa Rica Honduras Venezuela Trinidad Dominican R e p u b l i c Canada Mexico Bermuda Guatemala Cuba United States* SOUTH AMERICA Ecuador Paraguay Bolivia Colombia Brazil Argentina Uruguay Peru Chile AFRICA MIDDLE EAST SOUTH ASIA Nigeria Egypt Ethiopia South A f r i c a Zaire Sudan Morocco  1 1 1 1 2 2 2 2 2-1 3 3 3-2 4 4 3 2-3 2 2 3 3 3 3 4 5  2 5 2 1 1 3 2  Algeria Tanzania Kenya Ghana Uganda Angola Mozambique Cameroon Upper V o l t a Mali Rhodesia' Tunisia Malawi I v o r y Coast Zambia Guinea Senegal Niger Chad Somalia Dahomey S i e r r a Leone Libya Togo Central A f r i c a n Republic Liberia Mauritania . Lesotho Congo ( B r a z z a v i l l e ) Mauritius Botswana Gabon Swaziland Gambia Saudi A r a b i a  5 5 1 3 2 2 2 1 1 5 1 1 1 1 2 3 1 1 1 5 1 1 5 1 1 1 1 1 3 1 1 1 1 1 1  Muscat U n i t e d Arab E m i r a t e s Lebanon Jordan Syria Turkey Iran Kuwait Iraq India Pakistan Afghanistan Nepal Bangla Desh S r i Lanka Cyprus ASIA-PACIFIC Hong Kong Brunei Fiji Malaysia Singapore Philippines Vietnam Guam Japan Taiwan Australia Indonesia Thailand Korea People's Rep/China Burma Mongolia  1 1 1 1 5 3 3 4 5 1 1 3 1 1 1 1  1 2-1 2 2-3 2-3 2 2 2 2-4 2-4 3-4 3-4 3-4 3-4 4 5 5 £ h-  1  w r i t e r ' s estimate  172  There i s no doubt t h a t the i n t e n s i t y o f d i s c r i m i n a t i o n f o r e i g n bankers w i l l grow.  The European Commission  against  (the i n i t i a t o r of  p o l i c y f o r the European Economic Community) has c u r r e n t l y under study a proposal  t h a t would s e v e r e l y r e s t r i c t  w i t h i n t h e Community. United  The p r o p o s a l  the operations  i s being  o f f o r e i g n banks  s t r o n g l y r e s i s t e d by the  Kingdom (a c o u n t r y t h a t welcomes f o r e i g n banks) b u t o t h e r  member  c o u n t r i e s may be i n f a v o r . S u r p r i s i n g l y enough, p r o t e c t i o n i s m United  States.  i s very prevalent  American p o l i t i c i a n s l o n g ago adopted t h e Marxian view  t h a t banking i s one o f t h e commanding h e i g h t s i s a height  t h a t should  be b a r r e d  o f the economy.  t o the f o r e i g n e r .  t i o n s who a r e thought t o move s a v i n g s i n t e r n a t i o n a l ) money c e n t r e s .  l i s t ) , formerly U.S.  atti-  organiza-  from r u r a l a r e a s t o the n a t i o n a l  Representative  Wright Patman (a popu-  Chairman o f the Banking and Currency Committee i n t h e  House o f R e p r e s e n t a t i v e s  f o r e i g n banks i n t o the U.S. Act  As such i t  The American  tude a l s o has i t s r o o t s i n the p o p u l i s t f e a r o f l a r g e banking  (or  i n the  has l o n g been an opponent o f the e n t r y o f H i s h i g h l y r e s t r i c t i v e F o r e i g n Bank C o n t r o l  submitted i n 1973, w h i l e n o t passed i n t o law, served  t o focus  atten-  2 t i o n on the problem.  There a r e now s e v e r a l s t u d i e s underway t h a t might  lead to discrimination against It  seems t o t h i s w r i t e r t h a t the most r e a s o n a b l e and l o g i c a l ap-  proach t o take i n t h i s a r e a and  f o r e i g n banking i n the U.S.  equality.  i s t o adopt the p h i l o s o p h y  of r e c i p r o c i t y  That i s , f o r e i g n banks be a l l o w e d i n t o the c o u n t r y  t h a t domestic banks a r e a l l o w e d t o enter  provided  the r e l e v a n t f o r e i g n market.  T h i s i s b a s i c a l l y the approach adopted by t h e American Banker's  173  Association.  3  Support f o r t h i s p h i l o s o p h y a l s o comes from t h e B i b l e :  "One law s h a l l be t o him t h a t i s homeborne, and unto t h e s t r a n g e r t h a t  -.4 s o j o u r n e t h among you. The w r i t e r i s n o t o p t i m i s t i c however t h a t t h e above p h i l o s o p h y w i l l prevail.  S u r p r i s i n g l y enough t h e Canadian Banker's A s s o c i a t i o n has  not come o u t w i t h a p o l i c y statement on t h e r e c i p r o c i t y and e q u a l i t y issue.  D u r i n g t h e c o u r s e o f our i n t e r v i e w s we found o u t why: t h e Can-  a d i a n banks cannot agree on t h e i s s u e .  Three o f t h e major banks a r e  s o l i d l y i n f a v o r o f r e c i p r o c i t y and e q u a l i t y and t h e o t h e r two a r e e i t h e r opposed o r v e r y n o n - c o m m i t t a l about t h e s u b j e c t . I n an apparent attempt t o e l i m i n a t e t h e s t u l t i f y i n g  seniority  system t h a t r e s u l t e d i n b a r r i e r s t o t h e e f f e c t i v e f l o w o f l e g i s l a t i o n , the U.S. House o f R e p r e s e n t a t i v e s r e c e n t l y removed s e v e r a l key committee chairman, i n c l u d i n g W r i g h t Patman, Chairman o f t h e Banking and C u r r e n c y Committee.  5  Patman's replacement i s a younger man who has t h e power t o  s t r o n g l y i n f l u e n c e t h e American p o l i c y toward i n t e r n a t i o n a l b a n k i n g . From t h e p o i n t o f v i e w o f t h e b a n k i n g community, t h e new chairman, Henry Reuss i s a d i s a p p o i n t m e n t .  The f o l l o w i n g q u o t a t i o n p r o v i d e s e v i -  dence t h a t Reuss i s l i k e l y t o c o n t i n u e where Patman l e f t o f f : The Government s h o u l d do f o r p e o p l e t h a t , and o n l y t h a t , w h i c h t h e y cannot do f o r t h e m s e l v e s , l i k e s t a n d i n g up t o conglomerates and m u l t i n a t i o n a l s , and o t h e r examples o f g i a n t i s m . . . I f t h a t be P o p u l i s m , I'm a Populist.^> As K i n d l e b e r g e r has p o i n t e d o u t , p o p u l i s m and n a t i o n a l i s m a r e c l o s e l y r e l a t e d and a r e a t t i t u d e s o f t h e 'True B e l i e v e r . '  174  Those who h o l d extreme o p i n i o n s are t h o r o u g h l y persuaded t h a t the o t h e r extreme a c t u a l l y shapes the course of events. N a t i o n a l i s m can e a s i l y be c a r r i e d to the p o i n t of b e l i e v i n g t h a t f o r e i g n e r s p l o t a g a i n s t the n a t i o n . J o i n e d w i t h populism, i t f e a r s f o r e i g n banking as the C h r i s t i a n S c i e n t i s t f e a r s f l u o r i d e . ^  Canada, o f c o u r s e , has  her  share of n a t i o n a l i s t s , the most famous  of whom i s p r o b a b l y W a l t e r Gordon.  He has  recently received  renewed g  a t t e n t i o n i n the media w i t h h i s " 3 0 - f i r m Gordon c l a i m s 52 per  cent  that a Gallup P o l l published  of Canadians favour  r e s t r i c t and  p l a n f o r b u y i n g back Canada." i n March 1974  l e g i s l a t i o n t h a t would  c o n t r o l f u r t h e r f o r e i g n investment; and  i n d i c a t e d that significantly  a f u r t h e r 17  per  9 cent p a r t l y f a v o u r e d such a move. banking.  T h i s i s bad  I f Canadian p o l i t i c i a n s r e f l e c t  news f o r i n t e r n a t i o n a l  the above sentiments, then i t  appears u n l i k e l y t h a t the doors w i l l be opened to f o r e i g n b a n k i n g . Other n a t i o n s who  permit f o r e i g n banks to e n t e r  p r o c i t y so the expansion by  the c h a r t e r e d banks i n t o these markets  be p r e v e n t e d .  Japan i s a good example.  only permitted  to open r e p r e s e n t a t i v e  banks are o n l y p e r m i t t e d  often s t i p u l a t e for  to e n t e r  Since  the Japanese banks  o f f i c e s i n Canada, the  recicould  are  chartered  the Japanese market on the same b a s i s  — a l t h o u g h i t i s known t h a t both p a r t i e s would p r e f e r to e s t a b l i s h f u l l s e r v i c e branches. In summary, the f i r s t  p r e d i c t i o n that evolves  from the above com-  ments i s t h a t i n t e r n a t i o n a l banking i s heading i n t o a p e r i o d of governmental i n t e r f e r e n c e ; spawned i n p a r t by w o r l d economic and  i n p a r t by  ing  as a  economic n a t i o n a l i s m  'commanding h e i g h t ' Of  of the  t h a t focuses  increased  troubles  q u i t e n a t u r a l l y on bank-  economy.  course the banks have become used to o p e r a t i n g  in controlled  175  environments and growth. recent  One  can be  possibility  expected to r e a c t i n ways t h a t a l l o w t h a t has  received  continued  a good d e a l of a t t e n t i o n i n  y e a r s i s the development of c o n s o r t i a .  I t i s thought t h a t  banding t o g e t h e r of f o u r or f i v e banks from d i f f e r e n t c o u n t r i e s reduce n a t i o n a l i s t i c sentiment somewhat.  J . H.  tends to  Coleman, f o r m e r l y  the Royal Bank once s t a t e d t h a t economic n a t i o n a l i s m  was  one  the  of  with the  reasons b e h i n d the R o y a l ' s d e c i s i o n to take an e q u i t y p o s i t i o n i n  the  O r i o n banking group ( d i s c u s s e d  Can-  above).  a d i a n c o n f e r e n c e on Banking, A. Limited,  stated  t h a t : "The  y e a r s i s the q u e s t i o n I t s h o u l d be  In an address to the 1974  F. Tuke, Chairman of B a r c l a y ' s  most important a s p e c t of the next f i v e to  remembered t h a t c o n s o r t i a banking b r i n g s  to be happy w i t h the arrangement.  ment i n t e r e s t s w i l l  i t w i l l be  i n t e r e s t i n g to see  potential  are  However, i f problems occur  likely  (large  i f c o n f l i c t i n g manage-  arise.  Another p o s s i b l e r e a c t i o n to growth c o n s t r a i n t s ous  ten  of c o n s o r t i a banking.""'"^  problems w i t h i t . When economies are booming, a l l p a r t n e r s  loan d e f a u l t s , etc.)  Bank  imposed by  vari-  governments i s the development of improved banking t e c h n o l o g y .  A l i b e r has mercial  predicted  t h a t a t e c h n o l o g i c a l r e v o l u t i o n i s about to h i t com-  banking.  The technology of money payments i s about to change, the geographic scope of the market w i l l i n c r e a s e , and the e f f e c t i v e n e s s of n a t i o n a l c o n t r o l s i n l i m i t i n g c o m p e t i t i o n among banks i s b e i n g e r o d e d . H  What A l i b e r has  i n mind of c o u r s e i s more s o p h i s t i c a t e d u t i l i z a t i o n  computer technology i n b a n k i n g .  of  176  E l e c t r o n i c banking w i l l f u r t h e r e n l a r g e the market a r e a f o r d e p o s i t s beyond n a t i o n a l b o u n d a r i e s . Chicago banks w i l l a d v e r t i s e i n Frankf u r t f o r mark d e p o s i t s and l o a n s w h i l e F r a n k f u r t banks w i l l compete f o r Chicago d e p o s i t s and l o a n s . Banks w i l l be a b l e to a t t r a c t f o r e i g n customers w i t h o u t the c o s t s of e s t a b l i s h i n g o f f i c e s a b r o a d . ± 2  With a l l due point.  r e s p e c t to P r o f e s s o r A l i b e r , he does miss a v e r y  important  As John Coleman, former Deputy Chairman of the R o y a l Bank once  s a i d : "The  product  o f banking i s the same, so i t s the p e r s o n a l  contact  13 t h a t counts."  Every banker has been aware of t h i s f o r y e a r s .  s t o r y i s o f t e n t o l d of the man  who  banker, d u r i n g the p a n i c of 1907 Morgan's r e p l y was  for  came to J . P. Morgan, the famous  to borrow a m i l l i o n d o l l a r s .  r e p o r t e d to be:  The  "No,  I won't l e n d you  a s l i g h t f e e , I ' l l walk down W a l l S t r e e t w i t h my  arm  Mr.  the money, but 14 around  you."  While computers w i l l undoubtedly p l a y an i n c r e a s i n g r o l e i n banking, i t i s i n c o n c e i v a b l e to t h i s w r i t e r t h a t the importance o f p e r s o n a l w i l l d e c l i n e — t h a t i s u n l e s s mechanized r o b o t s who  contact  speak computereze  assume e x e c u t i v e management of our major c o r p o r a t i o n s .  I t follows  there-  f o r e t h a t the need to have p h y s i c a l r e p r e s e n t a t i o n i n f o r e i g n markets w i l l not be e l i m i n a t e d by an improved payments mechanism. r e c e i v e d unanimous support  from the bankers i n t e r v i e w e d .  T h i s argument In f a c t  banker s t r o n g l y suggested t h a t computers had been ' o v e r s o l d to  one  the  banking community.' Up nature.  to t h i s p o i n t , the study has been p r i m a r i l y d e s c r i p t i v e i n  T h i s i s p a r t i c u l a r l y t r u e about the t h e o r e t i c a l model s t r e s s i n g  need f o r growth as the major m o t i v a t o r d e s i r a b i l i t y o f growth as a g o a l has Perhaps i t i s now  behind  f o r e i g n banking.  The  not been c a l l e d i n t o q u e s t i o n .  time to step back somewhat and  l o o k at banking as  just  177  one  p a r t of s p a c e s h i p e a r t h .  Growth as a g o a l has been c a l l e d  q u e s t i o n by the famous c l u b o f Rome study e n t i t l e d  "The  into  L i m i t s to  Growth. While some o f the assumptions and methodology used by the r e s e a r c h e r s has been q u e s t i o n e d ,  t h e r e appears to be r e a s o n a b l e  t h a t i f the growth t r e n d s o f i n d u s t r i a l i z a t i o n ,  p o p u l a t i o n , and  t i o n of non-renewable r e s o u r c e s i s not brought i n t o heading  for serious trouble.  The  author's  evidence deple-  check, the w o r l d i s  s p e c i f i c conclusion i s :  I f the p r e s e n t growth t r e n d s i n w o r l d p o p u l a t i o n , i n d u s t r i a l i z a t i o n , p o l l u t i o n , food p r o d u c t i o n , and r e s o u r c e d e p l e t i o n c o n t i n u e unchanged, the l i m i t s to growth on t h i s p l a n e t w i l l be reached sometime w i t h i n the next one hundred y e a r s . The most p r o b a b l e r e s u l t w i l l be a r a t h e r sudden and u n c o n t r o l l a b l e d e c l i n e i n both p o p u l a t i o n and i n d u s t r i a l capacity.1^  One  might ask what a l l t h i s has  q u i t e simply i s t h a t banking fuels  may  The  answer  w e l l be viewed as the g a s o l i n e t h a t  the engine of i n d u s t r i a l i z a t i o n .  view themselves i n t h i s r o l e  to do w i t h banking.  Evidence  t h a t the banking  industry  i s p r o v i d e d by the f o l l o w i n g statement  by  e x e c u t i v e s of the Chase Manhattan Bank:  Our major c h a l l e n g e l i e s a t the h e a r t of our s e r v i c e to c o r p o r a t e c u s t o m e r s — f i n a n c i n g t h e i r c o n t i n u i n g need to expand and modernize p r o d u c t i v e a s s e t s . In s h o r t f u e l i n g c o r p o r a t e growth.-*7  That  t h i s o b j e c t i v e might be somewhat out o f s t e p w i t h s o c i e t y ' s  wishes i s evidenced by the p r e s s u r e from many i n t e r e s t more s o c i a l g o a l s i n the d e t e r m i n a t i o n o f l o a n and  groups to i n c l u d e  investment  Bankers a r e r e l u c t a n t to g i v e i n to t h i s p r e s s u r e f o r two  policy.  reasons:  178 a)  i t i s the government's n o t the banker's duty to d e c i d e what should and should n o t be done t o improve the q u a l i t y o f l i f e ; and  b)  funds p l a c e d a t the bank's d i s p o s a l a r e t o be i n v e s t e d i n f i n a n c i a l l y s a f e a s s e t s t h a t p r o v i d e some p o s i t i v e y i e l d .  Rare i s  the s o c i a l p r o j e c t t h a t promises s a f e t y and a p o s i t i v e r e t u r n .  Nevertheless, upon the banks. of  t h e r e i s no denying  t h e p r e s s u r e brought to bear  S i n c e t h e banks h o l d an i n o r d i n a t e l y l a r g e p r o p o r t i o n  s o c i e t y ' s f i n a n c i a l r e s o u r c e s , they may be expected  i n the f u t u r e t o  p l a y an i n c r e a s i n g r o l e i n the a l l o c a t i o n o f r e s o u r c e s f o r s o c i a l poses.  There a r e some bankers who w i l l f i g h t t h i s .  Walter  pur-  Wriston,  Chairman o f C i t i c o r p responded t o a q u e s t i o n about the s o c i a l r e s p o n s i bility  o f banks as f o l l o w s :  Oh, the s o c i a l a u d i t was the g i r l a t l a s t y e a r ' s dance. Nobody knew what i t was, b u t i t sounded as i f i t was something w o n d e r f u l , and good. Then you a n a l y z e what t h e y ' r e t a l k i n g about and I've never yet found anybody who knew.-*8  It  i s the p r e d i c t i o n o f t h i s w r i t e r however t h a t i f banks a r e  going t o expect to  t o c o n t i n u e o p e r a t i n g i n f o r e i g n markets, they a r e going  have t o adopt the view t h a t s o c i a l r e s p o n s i b i l i t y i s a normal c o s t o f  doing b u s i n e s s . The problem f a c i n g the c h i e f e x e c u t i v e s o f banks i s t h e same as for  l e a d e r s o f o t h e r major c o r p o r a t i o n s : they a r e judged by t h e i r  b u t i o n t o the c o r p o r a t i o n over a v e r y s h o r t time span.  contri-  Most c o r p o r a t e  e x e c u t i v e s a r e i n power f o r o n l y f i v e to t e n y e a r s and t h e r e i s p r e s s u r e  179  on them t o produce w i t h i n t h a t p e r i o d .  The Club o f Rome study h i g h l i g h t s  t h i s as an important v a r i a b l e i n mankind's p u r s u i t o f s h o r t run g o a l s .  The two m i s s i n g i n g r e d i e n t s a r e a r e a l i s t i c , l o n g - t e r m g o a l t h a t can guide mankind t o the e q u i l i b r i u m s o c i e t y and the human w i l l t o a c h i e v e t h a t g o a l . Without such a g o a l and a commitment t o i t , s h o r t term concerns w i l l generate the e x p o n e n t i a l growth t h a t d r i v e s t h e world system toward the l i m i t s o f the e a r t h and u l t i m a t e c o l l a p s e . With t h a t g o a l and t h a t commitment, mankind would be ready now to beg i n a c o n t r o l l e d , o r d e r l y t r a n s i t i o n from growth t o g l o b a l e q u i l i b rium. 19  Senior leaders  executives  i n the banking i n d u s t r y w i l l  i n the r e j e c t i o n o f growth  f o r growth's  seen whether s o c i e t y i s a b l e to develop t h e w i l l from growth  to e q u i l i b r i u m .  I t remains t o be  to force the t r a n s i t i o n  I b e l i e v e i t i s f a i r t o say t h a t the banks  w i l l adapt t o s o c i e t y ' s w i s h e s . w i l l p l a y the game.  sake.  c e r t a i n l y n o t be  Once t h e r u l e s a r e l a i d down the banks  180  Notes f o r Chapter Ten  Reproduced  I  i n The Banker, v o l . 123 (1973).  2 C. S. Ganoe, "Banking A c r o s s B o r d e r s : R e c i p r o c i t y and E q u a l i t y , " Burrough's C l e a r i n g House (February 1974). Ibid.  3  Quoted i n " F u t u r e of M u l t i n a t i o n a l E n t e r p r i s e , " i n The I n t e r n a t i o n a l C o r p o r a t i o n , C. P. K i n d l e b e r g e r ( e d . ) . 4  Time (February 3, 1975).  5  ^ I b i d . , p. 11A. C. P. K i n d l e b e r g e r , American B u s i n e s s Abroad: S i x L e c t u r e s on D i r e c t Investment (New Haven: Y a l e U n i v e r s i t y P r e s s , 1969), p. 124. 7  Q  F i n a n c i a l P o s t (Oct. 5, 1974). Ibid.  9  A. F. Tuke, "Recent Developments and F u t u r e Trends i n M u l t i n a t i o n a l Banking," speech p r e s e n t e d t o the Canadian Conference on Banki n g , T o r o n t o , September 16, 1974. R. Z. A l i b e r , The I n t e r n a t i o n a l Money Game (New York: B a s i c Books I n c . , 1973), p. 149. I  I  12 13  Books,  Quoted i n Macleans  (March 1972), p. 77.  H. V. Prochnow and H. V. Prochnow, J r . The Changing World o f (New York: Harper and Row, 1974), p. 383.  1  Banking  I b i d . , p. 156.  4  D. H. Meadows e t a l . , The L i m i t s t o Growth (New York: S i g n e t 1972). 1  5  1  6  I b i d . , p. 29.  1  7  The Chase Manhattan C o r p o r a t i o n , 1973 Annual Report, p. 8.  18 I n t e r v i e w i n The Banker 19  Meadows, p. 188.  ( J u l y 1974), p. 744.  B I B L I O G R A P H Y  181  182  BOOKS  Aharoni, Y a i r . The F o r e i g n Investment D e c i s i o n P r o c e s s . U n i v e r s i t y P r e s s , 1966. A l i b e r , Robert Z. I n c . , 1973.  The I n t e r n a t i o n a l Money Game.  A r c h i b a l d , G. C. The Theory o f t h e F i r m . Penguin Books, 1971.  Boston: H a r v a r d  New York: B a s i c Books  Harmondsworth, England:  Baumol, W. J . B u s i n e s s B e h a v i o r , V a l u e and Growth. Company, 1959.  New York: M a c M i l l a n  Binhammer, H. H. Money, Banking and t h e Canadian F i n a n c i a l T o r o n t o : Methuen P u b l i c a t i o n s , 1968.  System.  Bond, D. E. and R. A. Shearer. The Economics o f t h e Canadian System. T o r o n t o : P r e n t i c e H a l l o f Canada L t d . , 1972. C a r r o l l , Lewis. 1946.  A l i c e i n Wonderland.  New York: G r o s s e t and Dunlap,  Dunning, J . H. The M u l t i n a t i o n a 1 E n t e r p r i s e . Unwin L t d . , 1971. G a l b r a i t h , J . A.  Canadian Banking.  G a l b r a i t h , J . K.  The New I n d u s t r i a l S t a t e .  London: George A l l e n and  T o r o n t o : Ryerson P r e s s , 1970. New York: S i g n e t Books, 1967.  G o l d s m i t h , R. W. F i n a n c i a l S t r u c t u r e and Development. Y a l e U n i v e r s i t y P r e s s , 1969. Hymer, S. and R. Rowthorn. of Comparative Growth.  Financial  New Haven, Conn.:  I n t e r n a t i o n a l B i g B u s i n e s s 1957-67: A Study Cambridge: Cambridge U n i v e r s i t y P r e s s , 1971.  K i n d l e b e r g e r , C. P. I n t e r n a t i o n a l Economics. I r w i n I n c . , 1968.  4 t h ed. Homewood, 111.:  . American B u s i n e s s Abroad: S i x L e c t u r e s on D i r e c t New Haven, Conn.: Y a l e U n i v e r s i t y P r e s s , 1969. . The I n t e r n a t i o n a l C o r p o r a t i o n : A Symposium. M.I.T. P r e s s , 1970.  Investment.  Cambridge,  Mass.:  K n i c k e r b o c k e r , F. T. O l i g o p o l i s t i c R e a c t i o n and M u l t i n a t i o n a l E n t e r prise. Boston: H a r v a r d U n i v e r s i t y P r e s s , 1973.  183  Markowitz, H. M. Investments.  P o r t f o l i o S e l e c t i o n : E f f i c i e n t D i v e r s i f i c a t i o n of New York: John W i l e y and Sons I n c . , 1959.  Meadows, D. H., D. L. Meadows, J . Randers, and W. Behrens. To Growth. New York: Signet Books, 1972.  The L i m i t s  Nehrt, L. C. I n t e r n a t i o n a l F i n a n c e f o r M u l t i n a t i o n a l B u s i n e s s . ton, Penn.: I n t e r n a t i o n a l Textbook Company, 1967. Orsinger,  Roger.  Banks o f the World.  Scran-  New York: Walker, 1967.  Prochnow, H. V. and H. V. Prochnow, J r . The Changing World o f Banking. New York: Harper and Row, 1974. Robock, S. H. and K. Simmonds. I n t e r n a t i o n a l B u s i n e s s and M u l t i n a t i o n a l Enterprises. Georgetown, O n t a r i o : Irwin-Dorsey L t d . , 1973. Samuelson, P. A. and A. S c o t t . Economics: An I n t r o d u c t o r y T o r o n t o : McGraw-Hill, 1968. Servan-Schreiber, J . J . 1968. Simon, H. A. 1951.  The American C h a l l e n g e .  Administrative  Behavior.  Analysis.  New York: Atheneum,  New York: M a c M i l l a n and Co.,  Vernon, Raymond. The Economic Environment o f I n t e r n a t i o n a l B u s i n e s s . Englewood C l i f f s , New J e r s e y : P r e n t i c e - H a l l I n c . , 1972. Z e n o f f , D. B. and J . Zwick. wood C l i f f s , New J e r s e y :  I n t e r n a t i o n a l F i n a n c i a l Management. P r e n t i c e - H a l l I n c . , 1969.  PERIODICALS, NEWSPAPERS, AND  MAGAZINES  B a l a s s a , B. "American D i r e c t Investments i n the Common Market." N a z i o n a l e D e l L a v o r a (June 1966). Bank o f England, Q u a r t e r l y The Banker  Bulletin  Engle-  Banca  (June 1974).  (London), 1970, 1971, 1972, 1973, 1974.  "The Bankers Take the Plunge." "Banking A c r o s s F r o n t i e r s . "  The E x e c u t i v e  (June 1971).  The Economist (Nov. 21, 1964).  Burrough's C l e a r i n g House, March 1968, January 1974, F e b r u a r y 1974, September 1974.  B u s i n e s s Week, J u l y 6, 1974; September 21, 1974; February 17, 1975; F e b r u a r y 24, 1975. Canadian Banker and I.C.B. Review, Summer 1967, Jan.-Feb. 1974, J u l y Aug. 1974. CBA B u l l e t i n , May 1971, June 1974. Caves, R. E. " I n t e r n a t i o n a l C o r p o r a t i o n s : The I n d u s t r i a l Economics o f F o r e i g n Investment." Economica, v o l . 38 (1971). F e d e r a l Reserve Bank o f Chicago.  "Business C o n d i t i o n s . "  October 1974.  F e d e r a l Res erve B u l l e t i n , June 1973, June 1974. F i n a n c i a l Post (Toronto).  O c t . 13, 1973; Sept. 21, 1974; Dec. 28, 1974,  Fortune, June 1967, December 1967, March 1975. "From Ottawa."  Canadian B u s i n e s s (Jan. 1974).  H e l d i n g , F. " M u l t i n a t i o n a l Banking S t r i v e s f o r I d e n t i t y . " J o u r n a l o f World B u s i n e s s (Nov.-Dec. 1968). Imhof, E. P. "Rapid Expansion o f Overseas Banking." No. 8, 1974. " I n t e r n a t i o n a l C h a l l e n g e s and Canadian Responses." Monthly Review (Dec. 1974).  Columbia  Intereconomics.  Bank o f Nova S c o t i a  K a l i s h , L. and R. G i l b e r t . "An A n a l y s i s o f E f f i c i e n c y o f S c a l e and O r g a n i z a t i o n a l Form i n Commercial Banking." J o u r n a l o f I n d u s t r i a l Economics ( J u l y 1973). Macleans  ( T o r o n t o ) , March 1972.  Mandich, D. R. " I n t e r n a t i o n a l Loans: P r o f i t C e n t r e o r Loss L e a d e r ? " J o u r n a l o f Commercial Bank L e n d i n g (Sept. 1972). R a g a z z i , G. " T h e o r i e s o f t h e Determinants o f D i r e c t F o r e i g n I.M.F. S t a f f Papers ( J u l y 1973).  Investment  Time (New Y o r k ) , Feb. 3, 1975. Vernon, R. " I n t e r n a t i o n a l Investment and I n t e r n a t i o n a l Trade i n t h e Product C y c l e . " Q u a r t e r l y J o u r n a l o f Economics, 80 (1966), 190-207  185  OTHER SOURCES  Bank America C o r p o r a t i o n , Annual R e p o r t s , 1971, 1972, 1973. Bankers T r u s t New York C o r p o r a t i o n , Annual R e p o r t s , 1971, 1972, 1973. Bank o f Canada, 1973 Annual Report. Bank o f Canada Review, Aug. 1974, October 1974. Bank o f M o n t r e a l , Annual R e p o r t s , 1972, 1973, 1974. The Bank o f Nova S c o t i a , Annual R e p o r t s , 1972, 1973, 1974. Board o f Governors o f the F e d e r a l Reserve System,  1973 Annual Report.  Bruce, B. D. " I n t e r n a t i o n a l Banking A c t i v i t i e s o f Canadian and American Banks." M.B.A. t h e s i s , U n i v e r s i t y o f B r i t i s h Columbia, 1969. Canada, R e v i s e d S t a t u t e s .  An A c t R e s p e c t i n g Banks and Banking, 1967.  Canadian I m p e r i a l Bank o f Commerce, Annual R e p o r t s , 1970, 1971, 1972, 1973, 1974. The Chase Manhattan  C o r p o r a t i o n , Annual R e p o r t s , 1971, 1972, 1973.  Chemical New York C o r p o r a t i o n , Annual R e p o r t s , 1971, 1972, 1973. C i t i c o r p , Annual R e p o r t s , 1971, 1972, 1973. Freedman, C h a r l e s . "The F o r e i g n C u r r e n c y B u s i n e s s o f the Canadian Bank o f Canada S t a f f Research S t u d i e s , 1974.  Banks."  J . P. Morgan and Co. I n c . , Annual R e p o r t s , 1971, 1972, 1973. M a n u f a c t u r e r s Hanover  C o r p o r a t i o n , Annual R e p o r t s , 1971, 1972, 1973.  Report o f the R o y a l Commission  on Banking and F i n a n c e .  Ottawa: Queen's  P r i n t e r , 1964. The R o y a l Bank o f Canada, Annual R e p o r t s , 1972, 1973, 1974. The Toronto-Dominion Bank, Annual R e p o r t s , 1972, 1973, 1974. U.S.  C o m p t r o l l e r o f the Currency, 1964 Annual Report.  A P P E N D I X E S  186  APPENDIX I INTERVIEW GUIDE FOR FIELD STUDY  188.  DISCUSSION QUESTIONS  A.  Scope of I n t e r n a t i o n a l  1.  P r e l i m i n a r y to our d i s c u s s i o n we would l i k e to o b t a i n an o v e r a l l view of your Bank's commitments to i n t e r n a t i o n a l b u s i n e s s . Would you k i n d l y i n d i c a t e the approximate percentage d i s t r i b u t i o n of r e sources employed i n the f o l l o w i n g a r e a s : Foreign Domestic a) employees - number - compensation  B.  Operations  b)  loans  c)  deposits  d)  total  assets  e)  gross  revenue  f)  net  The  D e c i s i o n to I n v e s t Abroad  profits  In t h i s s e c t i o n the o b j e c t i v e i s to determine those v a r i a b l e s which p l a y an important r o l e i n the d e c i s i o n to commit management time and o t h e r r e s o u r c e s to the conduct of i n t e r n a t i o n a l o p e r a t i o n s . 2.  3.  We would l i k e to d i s c u s s an expansion p r o j e c t which i s p r e s e n t l y under c o n s i d e r a t i o n : a)  what r e s o u r c e s would be  b)  what c r i t e r i a w i l l you use operation?  c)  a r e these c r i t e r i a d i f f e r e n t from those u s e d — s a y , f i v e ago?  to determine the v a l u e of the f o r e i g n  years  What o b j e c t i v e s do you have f o r i n t e r n a t i o n a l o p e r a t i o n s over next f i v e years? a)  4.  required?  are these o b j e c t i v e s d i f f e r e n t  from those  set f i v e years  the  ago?  Have growth o p p o r t u n i t i e s i n the domestic s e c t o r been l i m i t e d i n r e cent years? I f so, what i s the n a t u r e of the domestic l i m i t a t i o n ? For example:  189  a)  few p r o f i t o p p o r t u n i t i e s ?  b)  low p r o f i t  c)  r e s t r i c t i o n s a g a i n s t domestic  margins? diversification?  5.  Have l i m i t e d growth o p p o r t u n i t i e s a t home i n f l u e n c e d your to expand abroad?  6.  Some a n a l y s t s m a i n t a i n t h a t overseas investment o c c u r s because the i n v e s t i n g f i r m possesses some advantage (computer t e c h n o l o g y , manag e r i a l e x p e r t i s e , economies o f s c a l e ) t h a t a l l o w s them to o p e r a t e i n the f o r e i g n markets more p r o f i t a b l y than i n d i g e n o u s f i r m s .  7.  a)  does t h i s e x p l a n a t i o n a p p l y g e n e r a l l y to the banking i n d u s t r y ?  b)  to your bank?  c)  what i s the n a t u r e o f the  d)  do you compete i n any f o r e i g n market where you do not have an advantage over i n d i g e n o u s banks?  advantage?  Have you e n t e r e d , or would you c o n s i d e r e n t e r i n g a f o r e i g n market by any form o t h e r than d i r e c t * investments ( f o r example by: l i c e n s i n g or management s e r v i c e s c o n t r a c t ) ? a)  C.  decision,  what f a c t o r s would you c o n s i d e r i n c h o o s i n g the form o f e n t r y ?  The Role of Government  In t h i s s e c t i o n the o b j e c t i v e i s to determine whether governments have p l a y e d a r o l e ( p o s i t i v e or n e g a t i v e ) i n the growth o f i n t e r n a t i o n a l banking. 8. I s the Canadian money supply growing or a b l e to grow f a s t enough to enable your bank to meet i t s growth o b j e c t i v e s ? 9. Have Canadian government b a r r i e r s t o domestic d i v e r s i f i c a t i o n had i n f l u e n c e on overseas expansion? 10.  In g e n e r a l , s h o u l d governments adopt a ' r e c i p r o c i t y and a t t i t u d e toward f o r e i g n banks? Why?  branches,  equality'  ( i n c l u d i n g investments i n r e p r e s e n t a t i v e o f f i c e s , a g e n c i e s , s u b s i d i a r i e s and c o n s o r t i a )  any  190  D.  R e f l e c t i o n s and E x p e c t a t i o n s o f t h e F u t u r e  14.  I n r e t r o s p e c t , what would you say have been t h e major ( i f any) i n going i n t e r n a t i o n a l ? a)  l o s t o f p r o f i t o p p o r t u n i t i e s i n home market?  b)  political  c)  stiff  d)  economic n a t i o n a l i s m ?  disadvantages  complications?  competition—low  p r o f i t s margins?  15. What, do you see, i s t h e f u t u r e f o r p r i v a t e i n t e r n a t i o n a l banking?  16.  a)  do you f o r e s e e a c o n t i n u a t i o n o f growth?  b)  do you a n t i c i p a t e t h e e n t r y o f more banks i n t o t h e i n t e r n a t i o n a l arena?  c)  what changes i n o p e r a t i n g forms would you p r e d i c t ?  d)  what changes i n o p e r a t i n g methods, o r g a n i z a t i o n and management t e c h n i q u e s do you foresee?  Some o b s e r v e r s o f t h e banking scene say t h a t as t h e technology o f the payments system develops ( i n c r e a s i n g use o f computers), t h e major banks w i l l be a b l e t o s e r v i c e f o r e i g n customers without i n c u r r i n g the c o s t s and r i s k s o f e s t a b l i s h i n g overseas o f f i c e s . Do you agree? a)  will  t h e importance o f p e r s o n a l c o n t a c t w i t h c l i e n t s  diminish?  191  APPENDIX I I THE FOREIGN INVESTMENT DECISION  194  I t i s hoped t h a t the t h e o r e t i c a l framework developed i n Chapter E i g h t meets t h e t e s t o f l o g i c a l c o n s i s t e n c y . the t h e o r y i s c o n s i s t e n t w i t h observed  The w r i t e r b e l i e v e s  that  facts.  Perhaps an e x p l o r a t i o n o f t h e d e c i s i o n - m a k i n g p r o c e s s f o l l o w e d when a bank makes a d i r e c t f o r e i g n investment w i l l u n e a r t h some a d d i t i o n a l support f o r the t h e o r y . a d v i s a b l e to remind  I n l a u n c h i n g t h i s d i s c u s s i o n i t may be  the reader t h a t today's banker i s n o t an i n d i v i d u a l  e n t r e p r e n e u r , m o t i v a t e d s o l e l y by t h e p r o s p e c t s o f p r o f i t .  Rather he i s  an employee o f a huge c o r p o r a t i o n composed o f hundreds o f o t h e r d e c i s i o n makers, each w i t h h i s own s e t o f v a l u e s and g o a l s .  Furthermore,  today's  banker o p e r a t e s i n a w o r l d o f u n c e r t a i n t y where d e c i s i o n s a r e o f t e n , i n the end, r e a l l y based on i n t u i t i o n r a t h e r than hard d a t a .  This i s f a r  removed from the e c o n o m i c a l l y p e r f e c t w o r l d o f t e n assumed i n textbooks where investment d e c i s i o n s — f o r e i g n o r d o m e s t i c — a r e  simply made on t h e  b a s i s o f s e l e c t i n g those investments which maximize the n e t p r e s e n t v a l u e o f the e a r n i n g stream.  The problems o f d e c i s i o n - m a k i n g i n the  r e a l w o r l d have been e x p l o r e d by Y. A h a r o n i i n h i s book, The F o r e i g n Investment  Decision Process.  1  A h a r o n i ' s framework w i l l be kept i n mind  throughout our d i s c u s s i o n o f the d e c i s i o n - m a k i n g p r o c e s s f o l l o w e d by the  banks  when making a f o r e i g n d i r e c t  investment.  One c e n t r a l A h a r o n i h y p o t h e s i s has r e l e v a n c e from t h e o u t s e t :  In f a c t , one important t h e s i s o f t h i s book i s t h a t i n o r g a n i z a t i o n s composed o f i n d i v i d u a l s and groups w i t h i n a c e r t a i n c u l t u r e , f a c e d w i t h u n c e r t a i n t y , o p e r a t i n g on a b a s i s o f incomplete i n f o r m a t i o n , and c o n s t a n t l y p r e s s e d by ongoing a c t i v i t i e s , one simply cannot behave i n a r a t i o n a l way as t h i s term i s d e f i n e d i n economic t h e o r y . 2  195 There i s v e r y l i t t l e  evidence  t h a t the banks g e n e r a l l y have a  master p l a n to use when c o n s i d e r i n g a f o r e i g n investment. i s C i t i c o r p , one  of the more a g g r e s s i v e i n t e r n a t i o n a l banks.  i n t e r e s t i n g to note t h a t Walter W r i s t o n ,  exception It is  Chairman of C i t i c o r p was  merly i n charge of i n t e r n a t i o n a l o p e r a t i o n s . internationalist  One  The  fact that a strong  i s i n charge of o v e r a l l o p e r a t i o n s may  ence on t h a t bank's focus on o f f s h o r e b a n k i n g .  for-  have an  A h a r o n i has  dence t h a t the d r i v e of a h i g h r a n k i n g e x e c u t i v e can be a  influ-  found  evi-  powerful  3 m o t i v a t i n g f o r c e f o r i n t e r n a t i o n a l growth.  4  C i t i c o r p ' s p l a n i s based on a p a t t e r n of d e c e n t r a l i z a t i o n .  Long  term g o a l s i n c l u d e the s e t t i n g of t a r g e t r a t e s of r e t u r n , however the focus i n the s h o r t run seems to be more upon growth than on p r o f i t s . p l a n n i n g f o l l o w e d by C i t i c o r p seems to pay ever.  The  o f f e v e n t u a l l y i n p r o f i t s how-  For the twelve months ended June 30th, 1974,  Citicorp  reported  net o p e r a t i n g income of $268.2 m i l l i o n compared to $235 m i l l i o n f o r the l a r g e r BankAmerica.  5  i n g s per share o f 10.5 tors.  C i t i c o r p has had  a t e n year growth r a t e i n e a r n -  per cent, w e l l i n excess  T h i s might be evidence  of i t s two major competi-  t h a t a more s o p h i s t i c a t e d p l a n n i n g  process  s h o u l d be adopted by the o t h e r banks. During  i n t e r v i e w s w i t h s e n i o r e x e c u t i v e s of the f i v e major  t e r e d banks i t became c l e a r t h a t p l a n n i n g has not reached l e v e l of s o p h i s t i c a t i o n .  The  q u e s t i o n was  you have f o r i n t e r n a t i o n a l o p e r a t i o n s over  a very  char-  high  asked: "What o b j e c t i v e s do the next  f i v e years?"  In  some cases a g e n e r a l answer such as " t o become a major i n t e r n a t i o n a l f i n a n c i a l i n s t i t u t i o n " was  given.  T h i s i s f i n e as a statement of  an  196 o v e r a l l o b j e c t i v e , but to a c h i e v e t h i s end.  some o p e r a t i o n a l s t r a t e g i e s must be In a l l cases except one  d i d not have an o p e r a t i o n a l p l a n . point  The  one  i t was  implemented  c l e a r t h a t the bank  bank t h a t d i d , s t r e s s e d  t h a t once o b j e c t i v e s were e s t a b l i s h e d , p r o g r e s s toward  them i s c l o s e l y monitored. d e s c r i b e d by  the  achieving  I t i s i n t e r e s t i n g to note t h a t t h i s bank  other bankers as b e i n g  was  the i n d u s t r y l e a d e r i n i n t e r n a t i o n a l  operations. In two  cases we  were t o l d t h a t the bank e i t h e r d i d not  t i v e s or i f o b j e c t i v e s were s e t by revealed  the top e x e c u t i v e ,  to i n t e r n a t i o n a l d i v i s i o n .  f o r improvement i n the p l a n n i n g  set  objec-  they were not  I t appears t h a t t h e r e  i s much room  area.  Research c a r r i e d out by B. Bruce g e n e r a l l y s u p p o r t s the above, and  f u r t h e r m o r e , Bruce d i s c o v e r e d  " r e a c t i o n a r y planning."*'  a tendency f o r the banks to engage i n  Reactionary  planning  bocker's o l i g o p o l i s t i c r e a c t i o n discussed consider  i s the same as  below.  That i s , the banks  i t e s s e n t i a l to be where t h e i r c o m p e t i t o r s a r e .  would be p r e d i c t e d from our profit.  Knicker-  T h i s phenomenon  t h e o r e t i c a l model which s t r e s s e s growth over  Some American bankers deny t h a t they e n t e r markets because  t h e i r c o m p e t i t o r s are  there;  making p r o c e s s i s f o l l o w e d .  implying  t h a t a t o t a l l y independent d e c i s i o n -  This contention  i s not  consistent with  the  evidence. There i s c o n s i d e r a b l e —rather  than p r o f i t s .  evidence t h a t growth i s the r e a l  objective  When asked about the o b j e c t i v e s of i n t e r n a t i o n a l  investment most bankers i n c l u d e p r o f i t s as a g o a l .  However, when  w i t h evidence t h a t a s i g n i f i c a n t amount of f o r e i g n banking may  be  pressed  197  u n p r o f i t a b l e , bankers respond w i t h the p o i n t , a p p a r e n t l y t h a t m a x i m i z a t i o n of a system may one  or more sub-systems.  w e l l known,  r e q u i r e s u b - o p t i m a l performance' from  Banks appear to draw on t h i s i d e a i n e x p l a i n -  i n g t h e i r a c t i v i t i e s i n the i n t e r n a t i o n a l a r e n a — a n d i t may  be  The  produce  t h i n k i n g i s t h a t an u n p r o f i t a b l e f o r e i g n s u b s i d i a r y may  v a l u a b l e but  i n t a n g i b l e b e n e f i t s to head o f f i c e .  type of a n a l y s i s however i s t h a t i t i s v i r t u a l l y banks to o b t a i n good evidence of the d o l l a r v a l u e c o l l a t e r a l b e n e f i t s to head o f f i c e . l o s i n g f o r e i g n o p e r a t i o n may  engages i n o l i g o p o l i s t i c r e a c t i o n  problem w i t h  impossible  the  system.  i s e v i d e n c e t h a t the banking (an i n t e r a c t i v e k i n d of  Vice-President,  or  real  industry  corporate large  firms  another's moves by making s i m i l a r moves t h e m s e l v e s ) .  J u l i e n - P i e r r e Koszul,  this  o f the i n v i s i b l e  b e h a v i o r by which r i v a l s i n i n d u s t r i e s composed of a few counter one  for  There i s a danger t h a t a  be h i d d e n i n the  As mentioned above, t h e r e  The  valid.  7  C i t i c o r p , says:  C o m p e t i t i o n i s v e r y i n t e n s e among American banks. I t i s c l e a r that i f one American bank opens a branch i n a p a r t o f the w o r l d where American f i r m s a r e l o c a t e d i t w i l l stand a good chance o f g e t t i n g the l o c a l companies' banking b u s i n e s s . T h i s would be too much f o r the o t h e r American banking c o m p e t i t o r s to s i t back and w a t c h . 8  Koszul  goes on to p o i n t out  that there  i s more a t stake than j u s t l o s s  o f the f o r e i g n banking b u s i n e s s o f a major domestic c l i e n t : " I t i s a l s o to p r e v e n t the head o f f i c e s of these f o r e i g n s u b s i d i a r i e s from g l o b a l l y s h i f t i n g t h e i r huge b u s i n e s s to another more i n t e r n a t i o n a l American 9  bank."  An  example o f t h i s i s the a c q u i s i t i o n by C i t i c o r p of  accounts of Samsonite, a Denver based manufacturer of  the  luggage."^  198  Commencing i n 1964, countries.  Samsonite  established s u b s i d i a r i e s i n four  European  As i t t u r n e d out C i t i b a n k had a branch i n each o f the r e l e -  vant a r e a s .  As a r e s u l t Samsonite  banking needs and i t was  turned to C i t i c o r p f o r i t s f o r e i g n  not l o n g b e f o r e the bank o b t a i n e d a  p o r t i o n o f the domestic b u s i n e s s as w e l l .  W a l t e r Page, V i c e - P r e s i d e n t ,  Morgan Guaranty b e l i e v e s t h a t h i s company was two bank f o r a major U.S. s e r v i c e s performed  significant  a b l e to move from number  c h e m i c a l company to number one because  of  f o r the c h e m i c a l company i n v a r i o u s f o r e i g n a r e a s  where Morgan had branches."'""'' E v i d e n c e t h a t the f o l l o w - t h e - l e a d e r syndrome i s s t i l l i s p r o v i d e d by the r e c e n t change o f events i n the M i d d l e E a s t .  going on A  r e c e n t Banker a r t i c l e e n t i t l e d "Bankers Troop to the M i d d l e E a s t " d e s c r i b e s the r u s h by v a r i o u s banks to o b t a i n a f o o t h o l d i n a p r e v i o u s l y 12 ignored area.  The Canadian I m p e r i a l Bank o f Commerce and  BankAmerica  f o r example, have taken e q u i t y p o s i t i o n s i n Compagnie Arabe et I n t e r n a t i o n a l e d'Investissement i n an apparent attempt  to tap some o f the  new  The company was  ' p e t r o d o l l a r s ' f l o w i n g i n t o the Arab s t a t e s .  i n A p r i l 1973  formed  and i s engaged i n c h a n n e l i n g funds to the E u r o d o l l a r  market and i n t o d i r e c t and p o r t f o l i o investments around the w o r l d .  It  i s i n t e r e s t i n g to n o t e t h a t s e v e r a l o t h e r c h a r t e r e d banks had  something  to say about  1973  the M i d d l e E a s t market by the time t h e i r October  annual r e p o r t s were made a v a i l a b l e . South E a s t A s i a i s another case i n p o i n t .  The b i g f i v e c h a r t e r e d  banks have a l l r e c e n t l y e s t a b l i s h e d banking c o n n e c t i o n s i n the a r e a . The Toronto-Dominion  Bank and The R o y a l Bank were f i r s t  to make a  199 c o n c e n t r a t e d d r i v e i n t o the market. made d i r e c t investments In  13  The o t h e r major banks now  i n t h i s a r e a as w e l l .  summary, i t i s hoped t h a t t h i s b r i e f l o o k a t the  making p r o c e s s has added some support f o r our model. appears  t h a t the focus of d e c i s i o n - m a k i n g  the model.  decision-  Specifically i t  on growth i s c o n s i s t e n t w i t h  The p r o c e s s of o l i g o p o l i s t i c r e a c t i o n i s a l s o c o n s i s t e n t  w i t h the model. may  have  From an economic p o i n t o f view o f c o u r s e these  appear i r r a t i o n a l .  processes  However, as A h a r o n i has p o i n t e d out, once p r e -  c o n c e i v e d economic n o t i o n s are s e t a s i d e , an o r d e r l y system of b e h a v i o r  14 emerges.  I t has not been the purpose of t h i s study to develop norma-  t i v e theory based been to develop  on r e s t r i c t i v e assumptions.  t h e o r y t h a t can be used  b e h a v i o r of banks.  to d e s c r i b e and p r e d i c t  the  While o l i g o p o l i s t i c r e a c t i o n , f o r example, might  appear to p u r i s t s t o be i l l o g i c a l , ment the p r o c e s s may  Rather, our purpose has  from the p o i n t o f view o f bank manage-  be e s s e n t i a l to the a b i l i t y of the bank to s u r v i v e  i n i t s c o m p e t i t i v e environment.  The  f a c t t h a t some p r o f i t s may  be  f i c e d i n favour of growth becomes somewhat i r r e l e v a n t g i v e n a l l the cumstances .  sacricir-  200  Notes f o r Appendix I I  ^ Y a i r A h a r o n i , The F o r e i g n Investment D e c i s i o n P r o c e s s (Boston: Harvard U n i v e r s i t y P r e s s , 1966). I b i d . , p. 9.  2  Ibid.  3  4 Banker  G. A. Constanzo, " P l a n n i n g F o r I n t e r n a t i o n a l Growth," (June 1974). B u s i n e s s Week, "Annual Survey of Bank Performance,"  5  21,  The September  1974.  ^ B a r r y Bruce, " I n t e r n a t i o n a l Banking A c t i v i t i e s of Canadian and American Banks," M.B.A. T h e s i s , U n i v e r s i t y o f B r i t i s h Columbia, 1969. F. T. K n i c k e r b o c k e r , O l i g o p o l i s t i c R e a c t i o n and M u l t i n a t i o n a l E n t e r p r i s e (Boston: Harvard U n i v e r s i t y P r e s s , 1973). 7  ^ J . P. K o s z u l , "American Banks i n Europe," i n The C o r p o r a t i o n , C. P. K i n d l e b e r g e r ( e d . ) . I b i d . , p.  9  ^ 1  International  279.  Fortune (December 1967). 1  Ibid.  12 The Banker, "Bankers Troop to the M i d d l e E a s t , " March  1974.  13 October 13, ^  F i n a n c i a l P o s t , "Canadian Banks Push the A s i a n C o n n e c t i o n , " 1973. Aharoni.  

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